Question 1

Fluctuations in a firm's operating income represent:

Accepted Answer

A)  financial leverage. 
B)  the weighted-average cost of capital. 
C)  capital structure. 
D)  business risk. 
A)  financial leverage. 
B)  the weighted-average cost of capital. 
C)  capital structure. 
D)  business risk.

Question 2

One advantage of debt financing over equity financing is the:

Accepted Answer

A)  tax-deductible dividends. 
B)  tax-deductible interest. 
C)  tax-deductible principal repayment. 
D)  tax-free interest income. 
A)  tax-deductible dividends. 
B)  tax-deductible interest. 
C)  tax-deductible principal repayment. 
D)  tax-free interest income.

Question 3

The benefit of an interest tax shield is captured by the equity holders.

Accepted Answer

A) True 
 B)False

Question 4

A firm has an expected return on equity of 15% and an after-tax cost of debt of 6%.What debt-equity ratio produces a WACC of 12%?

Accepted Answer

A)  0.50 
B)  0.75 
C)  0.67 
D)  0.33 
A)  0.50 
B)  0.75 
C)  0.67 
D)  0.33

Question 5

Which ranking of financing from most preferred to least preferred is predicted by 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 6

What is the amount of the annual interest tax shield for a firm with $3 million in debt that pays 12% interest if the firm is in the 35% tax bracket?

Accepted Answer

A)  $126,000 
B)  $234,000 
C)  $360,000 
D)  $1,050,000 
A)  $126,000 
B)  $234,000 
C)  $360,000 
D)  $1,050,000

Question 7

According to MM,leverage may increase expected earnings per share but still leave the share price unchanged because:

Accepted Answer

A)  the firm's operating risk decreases. 
B)  the number of shares is decreased. 
C)  the required return on equity increases. 
D)  the firm is less risky. 
A)  the firm's operating risk decreases. 
B)  the number of shares is decreased. 
C)  the required return on equity increases. 
D)  the firm is less risky.

Question 8

When corporate taxes and the cost of financial distress are taken into consideration,the market value of a firm is equal to the value of the all-equity firm _____ the PV of the tax shield _____ the costs of financial distress.

Accepted Answer

A)  plus; plus 
B)  minus; plus 
C)  plus; minus 
D)  minus; minus 
A)  plus; plus 
B)  minus; plus 
C)  plus; minus 
D)  minus; minus

Question 9

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

Accepted Answer

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

Question 10

A firm increases its debt ratio from 50% to 60%.In the absence of taxes,an investor can offset the change in capital structure by:

Accepted Answer

A)  selling part of her holding and buying debt. 
B)  borrowing money and investing it in the firm's equity. 
C)  holding a diversified portfolio. 
D)  switching her investment to convertible bonds. 
A)  selling part of her holding and buying debt. 
B)  borrowing money and investing it in the firm's equity. 
C)  holding a diversified portfolio. 
D)  switching her investment to convertible bonds.

Question 11

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 12

When financial disaster is looming,management may borrow to invest in projects having a negative expected NPV because:

Accepted Answer

A)  the firm's beta is now negative. 
B)  taxes are no longer a concern. 
C)  the interest tax shield will cover the loan costs. 
D)  the lender bears most of the risk. 
A)  the firm's beta is now negative. 
B)  taxes are no longer a concern. 
C)  the interest tax shield will cover the loan costs. 
D)  the lender bears most of the risk.

Question 13

According to the trade-off theory,optimal capital structure occurs 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 increased costs of distress. 
D)  the present value of the tax shield exceeds the value of the 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 increased costs of distress. 
D)  the present value of the tax shield exceeds the value of the all-equity-financed firm.

Question 14

Which of the following pair of firms do you think should be more highly levered: A risky company,or a safe company?

Accepted Answer

The answer of Which of the following pair of firms...

Question 15

According to the 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 a fall in the 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 a fall in the share price. 
C)  debt rather than retained earnings, to lower the WACC. 
D)  new equity rather than debt, to strengthen EPS.

Question 16

Studies suggest that the indirect costs of bankruptcy are typically of a significant magnitude.

Accepted Answer

A) True 
 B)False

Question 17

Any financial benefit derived from the interest tax shield accrues to the:

Accepted Answer

A)  bondholders. 
B)  shareholders. 
C)  bondholders and shareholders equally. 
D)  shareholders and the federal government. 
A)  bondholders. 
B)  shareholders. 
C)  bondholders and shareholders equally. 
D)  shareholders and the federal government.

Question 18

Debt finance does not affect the operating risk but it does add financial risk.

Accepted Answer

A) True 
 B)False

Question 19

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 20

As a firm's debt-equity ratio approaches zero,the firm's expected return on equity approaches:

Accepted Answer

A)  the expected return on debt. 
B)  the expected return on assets. 
C)  its maximum. 
D)  zero. 
A)  the expected return on debt. 
B)  the expected return on assets. 
C)  its maximum. 
D)  zero.

Exam 16: Debt Policy

Fluctuations in a firm's operating income represent:

One advantage of debt financing over equity financing is the:

The benefit of an interest tax shield is captured by the equity holders.

A firm has an expected return on equity of 15% and an after-tax cost of debt of 6%.What debt-equity ratio produces a WACC of 12%?

Which ranking of financing from most preferred to least preferred is predicted by the pecking-order theory?

What is the amount of the annual interest tax shield for a firm with $3 million in debt that pays 12% interest if the firm is in the 35% tax bracket?

According to MM,leverage may increase expected earnings per share but still leave the share price unchanged because:

When corporate taxes and the cost of financial distress are taken into consideration,the market value of a firm is equal to the value of the all-equity firm _____ the PV of the tax shield _____ the costs of financial distress.

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

A firm increases its debt ratio from 50% to 60%.In the absence of taxes,an investor can offset the change in capital structure by:

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

When financial disaster is looming,management may borrow to invest in projects having a negative expected NPV because:

According to the trade-off theory,optimal capital structure occurs when:

Which of the following pair of firms do you think should be more highly levered: A risky company,or a safe company?

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

Studies suggest that the indirect costs of bankruptcy are typically of a significant magnitude.

Any financial benefit derived from the interest tax shield accrues to the:

Debt finance does not affect the operating risk but it does add financial risk.

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

As a firm's debt-equity ratio approaches zero,the firm's expected return on equity approaches:

Goals and Governance of the Firm

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 and Governance

Venture Capital, IPOs, and Seasoned Offerings

Payout Policy

Long-Term Financial Planning

Short-Term Financial Planning

Working Capital Management

Mergers,Acquisitions,and Corporate Control

International Financial Management

Options

Risk Management

Filters

When corporate taxes and the cost of financial distress are taken into consideration,the market value of a firm is equal to the value of the all-equity firm _ the PV of the tax shield _ the costs of financial distress.

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