Question 1

Financial risk refers to the:

Accepted Answer

A)  risk of owning equity securities. 
B)  risk faced by equityholders when debt is used. 
C)  general business risk of the firm. 
D)  possibility that interest rates will increase. 
A)  risk of owning equity securities. 
B)  risk faced by equityholders when debt is used. 
C)  general business risk of the firm. 
D)  possibility that interest rates will increase. B

Question 2

The optimal capital structure is met when:

Accepted Answer

A)  additional borrowing results in lower financial distress costs. 
B)  additional borrowing is offset by the interest tax shield. 
C)  the tax savings from additional leverage are offset by the costs of distress. 
D)  the present value of the tax shield is greater than the value of an all-equity-financed firm. 
A)  additional borrowing results in lower financial distress costs. 
B)  additional borrowing is offset by the interest tax shield. 
C)  the tax savings from additional leverage are offset by the costs of distress. 
D)  the present value of the tax shield is greater than the value of an all-equity-financed firm. C

Question 3

Show how leverage increases financial risk by calculating the EPS and return on shares for a firm with $1 million in 10% debt.The firm also has 50,000 shares outstanding that sell for $40 each.Three states of the economy are possible: a slump under which the firm would have operating income of $150,000,a normal state under which the firm will earn $420,000,and a boom under which the firm will earn $600,000.The firm pays no taxes.

Accepted Answer

The answer of Show how leverage increases financial risk by...

Question 4

With a tax rate of 35%,calculate the WACC for a firm that pays 10% on its debt,requires an 18% rate of return on its equity,and finances 45% of assets with debt.

Accepted Answer

A)  12.83% 
B)  14.00% 
C)  14.40% 
D)  18.20% 
A)  12.83% 
B)  14.00% 
C)  14.40% 
D)  18.20%

Question 5

MM's proposition II states that the:

Accepted Answer

A)  expected return on equity increases as financial leverage increases. 
B)  expected return on assets decreases as expected return on debt decreases. 
C)  firm's capital structure is irrelevant to value determination. 
D)  greater the proportion of equity, the higher the expected return on debt. 
A)  expected return on equity increases as financial leverage increases. 
B)  expected return on assets decreases as expected return on debt decreases. 
C)  firm's capital structure is irrelevant to value determination. 
D)  greater the proportion of equity, the higher the expected return on debt.

Question 6

Debt financing affects neither the business risk nor the financial risk of the firm.

Accepted Answer

A) True 
 B)False

Question 7

MM's proposition I states that the required rate of return on equity increases as the firm's debt-equity ratio increases.

Accepted Answer

A) True 
 B)False

Question 8

What is the proportion of debt financing for a firm that expects a 24% return on equity,a 16% return on assets,and a 12% return on debt? Ignore taxes.

Accepted Answer

A)  54.0% 
B)  60.0% 
C)  66.7% 
D)  75.0% 
A)  54.0% 
B)  60.0% 
C)  66.7% 
D)  75.0%

Question 9

Debt usage will have an effect on:

Accepted Answer

A)  business risk. 
B)  financial risk. 
C)  operating risk. 
D)  asset risk. 
A)  business risk. 
B)  financial risk. 
C)  operating risk. 
D)  asset risk.

Question 10

When a corporation issues permanent debt,the value of all its securities:

Accepted Answer

A)  increases by the present value of the tax shield. 
B)  decreases by the present value of the tax shield. 
C)  increases by the annual interest tax shield. 
D)  decreases by the annual interest tax shield. 
A)  increases by the present value of the tax shield. 
B)  decreases by the present value of the tax shield. 
C)  increases by the annual interest tax shield. 
D)  decreases by the annual interest tax shield.

Question 11

According to MM,an increase in expected earnings per share can leave the share price unchanged if the:

Accepted Answer

A)  firm's operating risk decreases. 
B)  number of shares is decreased. 
C)  required return on equity increases. 
D)  firm has no financial leverage. 
A)  firm's operating risk decreases. 
B)  number of shares is decreased. 
C)  required return on equity increases. 
D)  firm has no financial leverage.

Question 12

Which of the following lists presents the order of financing from most preferred to least preferred according to the pecking order theory?

Accepted Answer

A)  Debt issue, stock issue, internally generated funds 
B)  Internally generated funds, debt issue, stock issue 
C)  Stock issue, internally generated funds, debt issue 
D)  Internally generated funds, stock issue, debt issue 
A)  Debt issue, stock issue, internally generated funds 
B)  Internally generated funds, debt issue, stock issue 
C)  Stock issue, internally generated funds, debt issue 
D)  Internally generated funds, stock issue, debt issue

Question 13

According to pecking order theory,managers will often choose to finance with:

Accepted Answer

A)  new equity rather than debt, due to bankruptcy costs. 
B)  debt rather than new equity, to avoid reduced share price. 
C)  debt rather than retained earnings, to lower the WACC. 
D)  new equity rather than debt, to strengthen EPS. 
A)  new equity rather than debt, due to bankruptcy costs. 
B)  debt rather than new equity, to avoid reduced share price. 
C)  debt rather than retained earnings, to lower the WACC. 
D)  new equity rather than debt, to strengthen EPS.

Question 14

A firm with a debt-equity ratio of 1/2,return on assets of 15%,and return on debt of 10% will have return on equity of:

Accepted Answer

A)  15.00%. 
B)  16.67%. 
C)  20.00%. 
D)  21.17%. 
A)  15.00%. 
B)  16.67%. 
C)  20.00%. 
D)  21.17%.

Question 15

Which of the following would not be expected to change with changes in the firm's capital structure?

Accepted Answer

A)  Weighted-average cost of capital 
B)  Expected return on equity 
C)  Expected return on assets 
D)  Expected earnings per share 
A)  Weighted-average cost of capital 
B)  Expected return on equity 
C)  Expected return on assets 
D)  Expected earnings per share

Question 16

According to MM II,as a firm's debt-equity ratio decreases:

Accepted Answer

A)  its financial risk increases. 
B)  its operating risk increases. 
C)  the required rate of return on equity increases. 
D)  the required rate of return on equity decreases. 
A)  its financial risk increases. 
B)  its operating risk increases. 
C)  the required rate of return on equity increases. 
D)  the required rate of return on equity decreases.

Question 17

How do corporate income taxes modify MM's leverage irrelevance proposition?
D. Future interest tax shields are usually valued by discounting at the borrowing rate rdebt. In the special case of permanent debt,
PV tax shield = Tc (rdebt * D)/rdebt = TcD
Of course interest tax shields are valuable only for companies that are making profits and paying taxes.

Accepted Answer

Debt interest is a tax-deductible expens

Question 18

What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.

Accepted Answer

A)  6.50% 
B)  9.90% 
C)  10.67% 
D)  11.14% 
A)  6.50% 
B)  9.90% 
C)  10.67% 
D)  11.14%

Question 19

When taxes are considered,the value of a levered firm equals the value of the:

Accepted Answer

A)  unlevered firm. 
B)  unlevered firm plus the value of the debt. 
C)  unlevered firm plus the present value of the tax shield. 
D)  unlevered firm plus the value of the debt plus the value of the tax shield. 
A)  unlevered firm. 
B)  unlevered firm plus the value of the debt. 
C)  unlevered firm plus the present value of the tax shield. 
D)  unlevered firm plus the value of the debt plus the value of the tax shield.

Question 20

Management's perceived signals to investors form an important component of pecking order theory.

Accepted Answer

A) True 
 B)False

Exam 16: Debt Policy

Financial risk refers to the:

The optimal capital structure is met when:

With a tax rate of 35%,calculate the WACC for a firm that pays 10% on its debt,requires an 18% rate of return on its equity,and finances 45% of assets with debt.

MM's proposition II states that the:

Debt financing affects neither the business risk nor the financial risk of the firm.

MM's proposition I states that the required rate of return on equity increases as the firm's debt-equity ratio increases.

What is the proportion of debt financing for a firm that expects a 24% return on equity,a 16% return on assets,and a 12% return on debt? Ignore taxes.

Debt usage will have an effect on:

When a corporation issues permanent debt,the value of all its securities:

According to MM,an increase in expected earnings per share can leave the share price unchanged if the:

Which of the following lists presents the order of financing from most preferred to least preferred according to the pecking order theory?

According to pecking order theory,managers will often choose to finance with:

A firm with a debt-equity ratio of 1/2,return on assets of 15%,and return on debt of 10% will have return on equity of:

Which of the following would not be expected to change with changes in the firm's capital structure?

According to MM II,as a firm's debt-equity ratio decreases:

What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.

When taxes are considered,the value of a levered firm equals the value of the:

Management's perceived signals to investors form an important component of pecking order theory.

Goals and Governance of the Corporation

Financial Markets and Institutions

Accounting and Finance

Measuring Corporate Performance

The Time Value of Money

Valuing Bonds

Valuing Stocks

Net Present Value and Other Investment Criteria

Using Discounted Cash-Flow Analysis to Make Investment Decisions

Project Analysis

Introduction to Risk,Return,and the Opportunity Cost of Capital

Risk,Return,and Capital Budgeting

The Weighted-Average Cost of Capital and Company Valuation

Introduction to Corporate Financing

How Corporations Raise Venture Capital and Issue Securities

Payout Policy

Long-Term Financial Planning

Short-Term Financial Planning

Risk, Return, and Capital Budgeting

Mergers, Acquisitions, and Corporate Control

International Financial Management

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