Question 1

The reason that financial leverage increases shareholder risk is that there is:

Accepted Answer

A)  more debt which increases the operating risk. 
B)  less equity to absorb the operating risk. 
C)  less business risk to be spread around. 
D)  more financial risk due to reduced business risk. 
A)  more debt which increases the operating risk. 
B)  less equity to absorb the operating risk. 
C)  less business risk to be spread around. 
D)  more financial risk due to reduced business risk.

Question 2

An increase in a firm's financial leverage will:

Accepted Answer

A)  increase the variability in earnings per share. 
B)  always reduce the operating risk of the firm. 
C)  increase the value of the firm in a non-MM world. 
D)  increase the WACC. 
A)  increase the variability in earnings per share. 
B)  always reduce the operating risk of the firm. 
C)  increase the value of the firm in a non-MM world. 
D)  increase the WACC.

Question 3

An implicit cost of adding debt to the capital structure is that it:

Accepted Answer

A)  adds interest expense to the operating statement. 
B)  increases the required return on equity. 
C)  reduces the expected return on assets. 
D)  decreases the firm's beta. 
A)  adds interest expense to the operating statement. 
B)  increases the required return on equity. 
C)  reduces the expected return on assets. 
D)  decreases the firm's beta.

Question 4

What happens to an all-equity firm's EPS when $1 million of 20% debt is issued and proceeds used to repurchase two-thirds of the stock if operating income equals $1.5 million and EPS were $2 when the firm was all-equity-financed? Ignore taxes.

Accepted Answer

A)  EPS increase to $2.60. 
B)  EPS increase to $3.00. 
C)  EPS increase to $4.80. 
D)  EPS increase to $5.20. 
A)  EPS increase to $2.60. 
B)  EPS increase to $3.00. 
C)  EPS increase to $4.80. 
D)  EPS increase to $5.20.

Question 5

The pecking order theory suggests that less profitable firms borrow more because:

Accepted Answer

A)  equity issues are more expensive. 
B)  leverage is preferred over raising funds internally. 
C)  debt issues are good omens. 
D)  they have insufficient internal funds. 
A)  equity issues are more expensive. 
B)  leverage is preferred over raising funds internally. 
C)  debt issues are good omens. 
D)  they have insufficient internal funds.

Question 6

Even after relaxing the MM assumption of no taxes,it can be observed that restructuring does not affect the value of the firm.

Accepted Answer

A) True 
 B)False

Question 7

Financial risk is the risk to shareholders that results from debt financing.

Accepted Answer

A) True 
 B)False

Question 8

A 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 operating income increases to $2.0 million?

Accepted Answer

A)  EPS increase to $15.63. 
B)  EPS increase to $16.67. 
C)  EPS increase to $17.50. 
D)  EPS increase to $20.00. 
A)  EPS increase to $15.63. 
B)  EPS increase to $16.67. 
C)  EPS increase to $17.50. 
D)  EPS increase to $20.00.

Question 9

According to MM,if individuals cannot obtain the same borrowing terms as firms,then:

Accepted Answer

A)  capital structure may be relevant. 
B)  capital structure may be irrelevant. 
C)  individuals should not invest in levered firms. 
D)  firms should increase their payments to individuals. 
A)  capital structure may be relevant. 
B)  capital structure may be irrelevant. 
C)  individuals should not invest in levered firms. 
D)  firms should increase their payments to individuals.

Question 10

As the debt-equity ratio decreases when debt is not risk free:

Accepted Answer

A)  debtholders demand a higher expected return. 
B)  debtholders demand a lower expected return. 
C)  the expected return on equity increases. 
D)  the expected return on assets increases. 
A)  debtholders demand a higher expected return. 
B)  debtholders demand a lower expected return. 
C)  the expected return on equity increases. 
D)  the expected return on assets increases.

Question 11

A firm's capital structure is represented by its mix of:

Accepted Answer

A)  assets. 
B)  liabilities and equity. 
C)  assets and liabilities. 
D)  assets, liabilities, and equity. 
A)  assets. 
B)  liabilities and equity. 
C)  assets and liabilities. 
D)  assets, liabilities, and equity.

Question 12

What is the expected rate of return to equityholders if the firm has a 35% tax rate,a 10% rate of interest paid on debt,a 15% WACC,and a 60% debt-asset ratio?

Accepted Answer

A)  12.50% 
B)  21.25% 
C)  22.50% 
D)  27.75% 
A)  12.50% 
B)  21.25% 
C)  22.50% 
D)  27.75%

Question 13

The interest tax shield is equal to the:

Accepted Answer

A)  difference between interest expense and income taxes. 
B)  amount of interest paid in a given year. 
C)  product of the interest expense and the tax rate. 
D)  product of the debt principal and the interest rate on debt. 
A)  difference between interest expense and income taxes. 
B)  amount of interest paid in a given year. 
C)  product of the interest expense and the tax rate. 
D)  product of the debt principal and the interest rate on debt.

Question 14

What is the goal of the capital structure decision? What is the financial manager trying to do?

Accepted Answer

The goal is to maximize the overall mark

Question 15

Calculate the annual value of an interest tax shield under the assumption that a firm maintains debt at a permanent $1,000,000 level and rate of 12%.The corporate tax rate is 35%.If there is no chance of financial distress,how does the value of the firm change as a result of this debt?

Accepted Answer

Annual tax shield = debt *interest rate

Question 16

What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt,which totals 70% of assets?

Accepted Answer

A)  16.14% 
B)  17.00% 
C)  19.00% 
D)  25.67% 
A)  16.14% 
B)  17.00% 
C)  19.00% 
D)  25.67%

Question 17

Financial leverage describes debt financing's amplification of the effects of changes in operating income on the returns to stockholders.

Accepted Answer

A) True 
 B)False

Question 18

At some debt-equity ratio,the costs of financial distress are expected to overcome the value of the tax shield for a firm.

Accepted Answer

A) True 
 B)False

Question 19

MM's proposition II states that the expected return on equity increases as the firm's debt-equity ratio increases.

Accepted Answer

A) True 
 B)False

Question 20

Leverage will __________ shareholders' expected return and _________ their risk.

Accepted Answer

A)  increase; decrease 
B)  decrease; increase 
C)  increase; increase 
D)  increase; do nothing to 
A)  increase; decrease 
B)  decrease; increase 
C)  increase; increase 
D)  increase; do nothing to

Exam 16: Debt Policy

The reason that financial leverage increases shareholder risk is that there is:

An increase in a firm's financial leverage will:

An implicit cost of adding debt to the capital structure is that it:

What happens to an all-equity firm's EPS when $1 million of 20% debt is issued and proceeds used to repurchase two-thirds of the stock if operating income equals $1.5 million and EPS were $2 when the firm was all-equity-financed? Ignore taxes.

The pecking order theory suggests that less profitable firms borrow more because:

Even after relaxing the MM assumption of no taxes,it can be observed that restructuring does not affect the value of the firm.

Financial risk is the risk to shareholders that results from debt financing.

A 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 operating income increases to $2.0 million?

According to MM,if individuals cannot obtain the same borrowing terms as firms,then:

As the debt-equity ratio decreases when debt is not risk free:

A firm's capital structure is represented by its mix of:

What is the expected rate of return to equityholders if the firm has a 35% tax rate,a 10% rate of interest paid on debt,a 15% WACC,and a 60% debt-asset ratio?

The interest tax shield is equal to the:

What is the goal of the capital structure decision? What is the financial manager trying to do?

Calculate the annual value of an interest tax shield under the assumption that a firm maintains debt at a permanent $1,000,000 level and rate of 12%.The corporate tax rate is 35%.If there is no chance of financial distress,how does the value of the firm change as a result of this debt?

What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt,which totals 70% of assets?

Financial leverage describes debt financing's amplification of the effects of changes in operating income on the returns to stockholders.

At some debt-equity ratio,the costs of financial distress are expected to overcome the value of the tax shield for a firm.

MM's proposition II states that the expected return on equity increases as the firm's debt-equity ratio increases.

Leverage will __________ shareholders' expected return and _________ their risk.

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

Leverage will __ shareholders' expected return and _ their risk.