Question 1

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

Accepted Answer

A) True 
 B)False

Question 2

Which of the following statements is true regarding the trade-off theory?

Accepted Answer

A)  Target debt ratios are similar among firms in the same industry. 
B)  Riskier firms tend to rely mostly on debt financing. 
C)  Riskier firms should have high target debt ratios. 
D)  Less risky firms ought to have a greater amount of debt financing. 
A)  Target debt ratios are similar among firms in the same industry. 
B)  Riskier firms tend to rely mostly on debt financing. 
C)  Riskier firms should have high target debt ratios. 
D)  Less risky firms ought to have a greater amount of debt financing.

Question 3

Although the value of an additional interest tax shield may be positive,firms may restrict borrowing if:

Accepted Answer

A)  the returns on the project are too high. 
B)  their asset base is largely intangible. 
C)  their asset beta is zero. 
D)  the borrowing increases their WACC. 
A)  the returns on the project are too high. 
B)  their asset base is largely intangible. 
C)  their asset beta is zero. 
D)  the borrowing increases their WACC.

Question 4

The possibility of bankruptcy will do all of the following except:

Accepted Answer

A)  increase financial distress costs. 
B)  reduce the current market value of the firm. 
C)  reduce the interest rate on debt. 
D)  reduce the possible payoff to stockholders. 
A)  increase financial distress costs. 
B)  reduce the current market value of the firm. 
C)  reduce the interest rate on debt. 
D)  reduce the possible payoff to stockholders.

Question 5

The "trade-off theory" of capital structure suggests that:

Accepted Answer

A)  firms add leverage whenever interest rates are low. 
B)  firms with higher risk should use less debt. 
C)  firms should use 50% debt and 50% equity. 
D)  firms should use debt to overcome high par values of stock. 
A)  firms add leverage whenever interest rates are low. 
B)  firms with higher risk should use less debt. 
C)  firms should use 50% debt and 50% equity. 
D)  firms should use debt to overcome high par values of stock.

Question 6

With risky debt and MM II,the expected return on assets _____ as the debt-equity ratio ____.

Accepted Answer

A)  increases; increases 
B)  decreases; increases 
C)  increases; decreases 
D)  is constant; increases 
A)  increases; increases 
B)  decreases; increases 
C)  increases; decreases 
D)  is constant; increases

Question 7

Once you recognize the fact that debt also increases financial risk and causes shareholders to demand a higher return on their investment,debt is no cheaper than equity.

Accepted Answer

A) True 
 B)False

Question 8

What is the change in value for a firm with $1 million in equity,$1 million in permanent debt at a 10% interest rate,and a 35% tax rate if MM I is modified to recognize corporate taxes?

Accepted Answer

A)  Value increases by $35,000. 
B)  Value increases by $100,000. 
C)  Value increases by $350,000. 
D)  Value increases by $700,000. 
A)  Value increases by $35,000. 
B)  Value increases by $100,000. 
C)  Value increases by $350,000. 
D)  Value increases by $700,000.

Question 9

In a world with corporate taxes but no possibility of financial distress,the value of the firm is maximized when the:

Accepted Answer

A)  firm uses no debt in its capital structure. 
B)  firm uses no equity in its capital structure. 
C)  firm uses a debt-equity ratio of 1.0. 
D)  corporate tax rate approaches 100%. 
A)  firm uses no debt in its capital structure. 
B)  firm uses no equity in its capital structure. 
C)  firm uses a debt-equity ratio of 1.0. 
D)  corporate tax rate approaches 100%.

Question 10

Calculate the WACC for a firm with a debt-equity ratio of 1.5.The debt pays 10% interest and the equity is expected to return 16%.Assume a 35% tax rate and risk-free debt.

Accepted Answer

The answer of Calculate the WACC for a firm with...

Question 11

When large firms file for bankruptcy:

Accepted Answer

A)  the proceedings involve costly delays and legal tangles, and the business continues to deteriorate. 
B)  their purpose is usually to nurse the firm back to health and enable it to face the world again. 
C)  their benefit is that their creditors will be forced by law to give up their claims on the firm. 
D)  their creditors often try to seize the assets as soon as possible. 
A)  the proceedings involve costly delays and legal tangles, and the business continues to deteriorate. 
B)  their purpose is usually to nurse the firm back to health and enable it to face the world again. 
C)  their benefit is that their creditors will be forced by law to give up their claims on the firm. 
D)  their creditors often try to seize the assets as soon as possible.

Question 12

When taxes are ignored,which of the following can be used to calculate the weighted-average cost of capital?

Accepted Answer

A)  Ratio of expected operating income to book value of all securities 
B)  The expected return on equity times the debt-equity ratio 
C)  Ratio of expected operating income to market value of all securities 
D)  The required return on equity plus the required return on debt 
A)  Ratio of expected operating income to book value of all securities 
B)  The expected return on equity times the debt-equity ratio 
C)  Ratio of expected operating income to market value of all securities 
D)  The required return on equity plus the required return on debt

Question 13

Explain the pecking order theory of capital structure.How will this affect the "optimal" capital structure for a firm?

Accepted Answer

The pecking order theory says that firms

Question 14

What was the unsuccessful attempt at resuscitation at Eastern Airlines in 1989? What was the cost to Eastern's creditors of that attempt?

Accepted Answer

Thus far we have discussed only the dire

Question 15

The pecking order theory of capital structure depicts the fact that firms prefer internal financing to avoid sending out adverse signals that may lower the stock price.

Accepted Answer

A) True 
 B)False

Question 16

A decrease of debt in the capital structure tends to reduce a firm's EPS when the firm:

Accepted Answer

A)  faces high interest rates. 
B)  faces strong growth in business conditions. 
C)  pays taxes. 
D)  does not reinvest its earnings. 
A)  faces high interest rates. 
B)  faces strong growth in business conditions. 
C)  pays taxes. 
D)  does not reinvest its earnings.

Question 17

Restructuring a firm involves changing the:

Accepted Answer

A)  mix of liabilities and equity. 
B)  dividend payout ratio. 
C)  managerial personnel. 
D)  interest rate on debt. 
A)  mix of liabilities and equity. 
B)  dividend payout ratio. 
C)  managerial personnel. 
D)  interest rate on debt.

Question 18

A firm issues 100,000 equity shares with a total market value of $5,000,000.The firm's market value of debt is also of equal amount .The firm is expected to generate $1.5 million in operating income and pay $250,000 in interest.Ignoring taxes,this will generate $12.50 earnings per share.What will happen to EPS if the firm's borrowing and interest expense increases by 75% and the number of shares in circulation is cut by 75% (assuming that the share price remains unchanged with this change in capital structure)?

Accepted Answer

A)  EPS decrease to $10.00. 
B)  EPS stay at $12.50. 
C)  EPS increase to $30.00. 
D)  EPS increase to $42.50. 
A)  EPS decrease to $10.00. 
B)  EPS stay at $12.50. 
C)  EPS increase to $30.00. 
D)  EPS increase to $42.50.

Question 19

Those who benefit from the interest tax shield are:

Accepted Answer

A)  debtholders. 
B)  equity holders. 
C)  both debtholders and equity holders. 
D)  only the firm's customers. 
A)  debtholders. 
B)  equity holders. 
C)  both debtholders and equity holders. 
D)  only the firm's customers.

Question 20

When asked about key factors of debt policy,financial managers commonly mention:

Accepted Answer

A)  the tax advantage of debt. 
B)  the importance of maintaining their credit rating. 
C)  financial slack. 
D)  all of these. 
A)  the tax advantage of debt. 
B)  the importance of maintaining their credit rating. 
C)  financial slack. 
D)  all of these.

Exam 16: Debt Policy

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

Which of the following statements is true regarding the trade-off theory?

Although the value of an additional interest tax shield may be positive,firms may restrict borrowing if:

The possibility of bankruptcy will do all of the following except:

The "trade-off theory" of capital structure suggests that:

With risky debt and MM II,the expected return on assets _____ as the debt-equity ratio ____.

Once you recognize the fact that debt also increases financial risk and causes shareholders to demand a higher return on their investment,debt is no cheaper than equity.

What is the change in value for a firm with $1 million in equity,$1 million in permanent debt at a 10% interest rate,and a 35% tax rate if MM I is modified to recognize corporate taxes?

In a world with corporate taxes but no possibility of financial distress,the value of the firm is maximized when the:

Calculate the WACC for a firm with a debt-equity ratio of 1.5.The debt pays 10% interest and the equity is expected to return 16%.Assume a 35% tax rate and risk-free debt.

When large firms file for bankruptcy:

When taxes are ignored,which of the following can be used to calculate the weighted-average cost of capital?

Explain the pecking order theory of capital structure.How will this affect the "optimal" capital structure for a firm?

What was the unsuccessful attempt at resuscitation at Eastern Airlines in 1989? What was the cost to Eastern's creditors of that attempt?

The pecking order theory of capital structure depicts the fact that firms prefer internal financing to avoid sending out adverse signals that may lower the stock price.

A decrease of debt in the capital structure tends to reduce a firm's EPS when the firm:

Restructuring a firm involves changing the:

Those who benefit from the interest tax shield are:

When asked about key factors of debt policy,financial managers commonly mention:

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

Options

Risk Management

Filters

With risky debt and MM II,the expected return on assets _ as the debt-equity ratio .