Question 1

Other things being equal,as the tax deductibility of depreciation on assets increases:

Accepted Answer

A) the firm borrows more. 
B) the firm borrows less. 
C) there will be no effect on the firm's borrowings. 
D) the firm's effective tax rate decreases. 
A) the firm borrows more. 
B) the firm borrows less. 
C) there will be no effect on the firm's borrowings. 
D) the firm's effective tax rate decreases.

Question 2

Borrowing can add value for companies with high effective tax rates because:

Accepted Answer

A) borrowing increases total taxes. 
B) the company is likely to use tax savings associated with debt. 
C) the company tax saved from borrowing is equal to the additional personal tax paid. 
D) the company tax saved from borrowing is less than the additional personal tax paid. 
A) borrowing increases total taxes. 
B) the company is likely to use tax savings associated with debt. 
C) the company tax saved from borrowing is equal to the additional personal tax paid. 
D) the company tax saved from borrowing is less than the additional personal tax paid.

Question 3

Earnings before interest = $0.5 million,D = $1 million,cost of debt = 10%,and company tax rate = 30%.What is the present value of the tax saving on interest?

Accepted Answer

A) $700 000 
B) $300 000 
C) $30 000 
D) $70 000 
A) $700 000 
B) $300 000 
C) $30 000 
D) $70 000

Question 4

A company is said to be in a state of financial distress:

Accepted Answer

A) when its cost of equity capital is too high. 
B) when its cost of debt capital is high. 
C) when the D/E exceeds 25 per cent. 
D) when it incurs problems in meeting its commitments to lenders. 
A) when its cost of equity capital is too high. 
B) when its cost of debt capital is high. 
C) when the D/E exceeds 25 per cent. 
D) when it incurs problems in meeting its commitments to lenders.

Question 5

A false example of financial distress is:

Accepted Answer

A) problems in meeting debt commitments. 
B) company liquidation. 
C) introduction of new competitors. 
D) appointment of receiver/manager. 
A) problems in meeting debt commitments. 
B) company liquidation. 
C) introduction of new competitors. 
D) appointment of receiver/manager.

Question 6

All companies are subject to:

Accepted Answer

A) financial risk. 
B) technology risk. 
C) business risk. 
D) all of the given options. 
A) financial risk. 
B) technology risk. 
C) business risk. 
D) all of the given options.

Question 7

The separation of ownership from control creates agency costs because:

Accepted Answer

A) schemes,such as employee ownership schemes,align employee interests with those of the owners. 
B) employees are likely to act in their own interest rather than that of the owners. 
C) the threat of retrenchment serves to align the interests of management and owners. 
D) the threat of a possible takeover serves to align the interests of management and owners. 
A) schemes,such as employee ownership schemes,align employee interests with those of the owners. 
B) employees are likely to act in their own interest rather than that of the owners. 
C) the threat of retrenchment serves to align the interests of management and owners. 
D) the threat of a possible takeover serves to align the interests of management and owners.

Question 8

Financial leverage is the relationship between:

Accepted Answer

A) borrowings and equity. 
B) borrowings and liabilities. 
C) debt to assets. 
D) gearing and assets. 
A) borrowings and equity. 
B) borrowings and liabilities. 
C) debt to assets. 
D) gearing and assets.

Question 9

A trade-off between the benefits of debt finance and the costs of financial distress may lead to a company increasing its debt/equity ratio because:

Accepted Answer

A) of the low probability of encountering severe financial difficulties. 
B) its existing debt/equity ratio is high. 
C) the expected increase in financial distress is expected to outweigh the tax benefits. 
D) agency costs of equity increase as the level of debt increases. 
A) of the low probability of encountering severe financial difficulties. 
B) its existing debt/equity ratio is high. 
C) the expected increase in financial distress is expected to outweigh the tax benefits. 
D) agency costs of equity increase as the level of debt increases.

Question 10

Which statement is false regarding capital structure under dividend imputation?

Accepted Answer

A) Misleading results regarding the gain from leverage may appear if a company is not at its optimal dividend policy. 
B) Dividend policy decisions are probably more important than capital structure decisions. 
C) It is not possible to have a negative gain from leverage. 
D) If the dividend payout ratio is 1,a gain from leverage may result,providing that investors with equal marginal tax rates hold equity and debt. 
A) Misleading results regarding the gain from leverage may appear if a company is not at its optimal dividend policy. 
B) Dividend policy decisions are probably more important than capital structure decisions. 
C) It is not possible to have a negative gain from leverage. 
D) If the dividend payout ratio is 1,a gain from leverage may result,providing that investors with equal marginal tax rates hold equity and debt.

Question 11

From the following data,calculate the total market value of the firm.Earnings before interest = $0.1 million,D = $0.2 million,interest on debt = 10% p.a. ,cost of equity capital = 20%,the dividend payout ratio = 0.5,and assume no taxes.

Accepted Answer

A) $200 000 
B) $500 000 
C) $473 684 
D) $400 000 
A) $200 000 
B) $500 000 
C) $473 684 
D) $400 000

Question 12

Which theory proposes that companies follow a hierarchy of financing sources?

Accepted Answer

A) Trade-off theory. 
B) Reverse pecking order theory. 
C) Pecking order theory. 
D) Information asymmetry theory. 
A) Trade-off theory. 
B) Reverse pecking order theory. 
C) Pecking order theory. 
D) Information asymmetry theory.

Question 13

____________ costs are costs associated with a formal transfer of control to lenders.

Accepted Answer

The answer of ____________ costs are costs associated with a...

Question 14

Lenders may seek to protect themselves from agency costs by requiring that ____________ be included in loan agreements.

Accepted Answer

The answer of Lenders may seek to protect themselves from...

Question 15

MM Proposition II is based on the:

Accepted Answer

A) law of conservation of value. 
B) expected return theory. 
C) risk-return theory. 
D) natural conservation of risk. 
A) law of conservation of value. 
B) expected return theory. 
C) risk-return theory. 
D) natural conservation of risk.

Question 16

The agency costs of equity increase:

Accepted Answer

A) when management acts in its own interest. 
B) as the fraction of debt in a company's capital structure increases. 
C) as the fraction of equity owned by outside shareholders increases. 
D) when management acts in the interest of debtholders. 
A) when management acts in its own interest. 
B) as the fraction of debt in a company's capital structure increases. 
C) as the fraction of equity owned by outside shareholders increases. 
D) when management acts in the interest of debtholders.

Question 17

Which of the following statements is false?

Accepted Answer

A) With all-equity companies,the rate of return to shareholders is always equal to the rate of return on assets. 
B) With debt,the rate of return to shareholders is always equal to the rate of return on assets providing the rate of return on assets is equal to the interest rate. 
C) If the rate of return on assets is greater than the interest on debt,then leverage results in lower rates of return on equity. 
D) If the rate of return on assets is less than the interest rate on debt,then leverage results in lower rates of return on equity. 
A) With all-equity companies,the rate of return to shareholders is always equal to the rate of return on assets. 
B) With debt,the rate of return to shareholders is always equal to the rate of return on assets providing the rate of return on assets is equal to the interest rate. 
C) If the rate of return on assets is greater than the interest on debt,then leverage results in lower rates of return on equity. 
D) If the rate of return on assets is less than the interest rate on debt,then leverage results in lower rates of return on equity.

Question 18

Which of the following is not an example of agency costs between debt and equity?

Accepted Answer

A) A company issues new debt,which ranks equal or higher than existing debt. 
B) A company issues new equity. 
C) A company significantly increases its dividend payout ratio. 
D) A company rejects low-risk investments with positive NPV. 
A) A company issues new debt,which ranks equal or higher than existing debt. 
B) A company issues new equity. 
C) A company significantly increases its dividend payout ratio. 
D) A company rejects low-risk investments with positive NPV.

Question 19

The imputation tax system essentially removes all tax advantages of debt.

Accepted Answer

A) True 
 B)False

Question 20

Given the total value of a levered firm is represented by Vu + tcD,and is equal to $1 million,find D.Assume the total value of an equivalent unlevered firm is $0.8 million and the company tax rate is 30 per cent.

Accepted Answer

A) $0.24 million 
B) $0.30 million 
C) $0.20 million 
D) $0.67 million 
A) $0.24 million 
B) $0.30 million 
C) $0.20 million 
D) $0.67 million

Exam 12: Principles of Capital Structure

Other things being equal,as the tax deductibility of depreciation on assets increases:

Borrowing can add value for companies with high effective tax rates because:

Earnings before interest = $0.5 million,D = $1 million,cost of debt = 10%,and company tax rate = 30%.What is the present value of the tax saving on interest?

A company is said to be in a state of financial distress:

A false example of financial distress is:

All companies are subject to:

The separation of ownership from control creates agency costs because:

Financial leverage is the relationship between:

A trade-off between the benefits of debt finance and the costs of financial distress may lead to a company increasing its debt/equity ratio because:

Which statement is false regarding capital structure under dividend imputation?

From the following data,calculate the total market value of the firm.Earnings before interest = $0.1 million,D = $0.2 million,interest on debt = 10% p.a. ,cost of equity capital = 20%,the dividend payout ratio = 0.5,and assume no taxes.

Which theory proposes that companies follow a hierarchy of financing sources?

____________ costs are costs associated with a formal transfer of control to lenders.

Lenders may seek to protect themselves from agency costs by requiring that ____________ be included in loan agreements.

MM Proposition II is based on the:

The agency costs of equity increase:

Which of the following statements is false?

Which of the following is not an example of agency costs between debt and equity?

The imputation tax system essentially removes all tax advantages of debt.

Given the total value of a levered firm is represented by Vu + tcD,and is equal to $1 million,find D.Assume the total value of an equivalent unlevered firm is $0.8 million and the company tax rate is 30 per cent.

Introduction

Consumption, Investment and the Capital Market

The Time Value of Money: An Introduction to Financial Mathematics

Applying the Time Value of Money to Security Valuation

Project Evaluation: Principles and Methods

The Application of Project Evaluation Methods

Risk and Return

The Capital Market

Sources of Finance: Equity

Sources of Finance: Debt

Payout Policy

Capital Structure Decisions

The Cost of Capital and Taxation Issues in Project Evaluation

Leasing and Other Equipment Finance

Capital Market Efficiency

Futures Contracts

Options and Contingent Claims

Analysis of Takeovers

International Financial Management

Management of Short-Term Assets: Inventory

Management of Short-Term Assets: Liquid Assets and Accounts Receivable

Filters

Given the total value of a levered firm is represented by V_u + t_cD,and is equal to $1 million,find D.Assume the total value of an equivalent unlevered firm is $0.8 million and the company tax rate is 30 per cent.