Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share. 
B)  All else equal,an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio. 
C)  Since debt financing raises the firm's financial risk,increasing a company's debt ratio will always increase its WACC. 
D)  Since debt is cheaper than equity,increasing a company's debt ratio will always reduce its WACC. 
E)  When a company increases its debt ratio,the costs of equity and debt both increase.Therefore,the WACC must also increase. 
A)  The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share. 
B)  All else equal,an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio. 
C)  Since debt financing raises the firm's financial risk,increasing a company's debt ratio will always increase its WACC. 
D)  Since debt is cheaper than equity,increasing a company's debt ratio will always reduce its WACC. 
E)  When a company increases its debt ratio,the costs of equity and debt both increase.Therefore,the WACC must also increase. B

Question 2

Two firms,although they operate in different industries,have the same expected earnings per share and the same standard deviation of expected EPS.Thus,the two firms must have the same business risk.

Accepted Answer

A) True 
 B)False  False

Question 3

Companies HD and LD have identical tax rates,total assets,and return on invested capital (ROIC),and their ROIC exceeds their after-tax cost of debt, (1-T)rd.However,Company HD has a higher debt ratio and thus more interest expense than Company LD.Which of the following statements is CORRECT?

Accepted Answer

A)  Company HD has a lower ROA than Company LD. 
B)  Company HD has a lower ROE than Company LD. 
C)  The two companies have the same ROA. 
D)  The two companies have the same ROE. 
E)  Company HD has a higher net income than Company LD. 
A)  Company HD has a lower ROA than Company LD. 
B)  Company HD has a lower ROE than Company LD. 
C)  The two companies have the same ROA. 
D)  The two companies have the same ROE. 
E)  Company HD has a higher net income than Company LD. A

Question 4

The Miller model begins with the MM model with corporate taxes and then adds personal taxes.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A)  The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. 
B)  The optimal capital structure minimizes the cost of equity,which is a necessary condition for maximizing the stock price. 
C)  The optimal capital structure simultaneously minimizes the cost of debt,the cost of equity,and the WACC. 
D)  The optimal capital structure simultaneously maximizes stock price and minimizes the WACC. 
E)  As a rule,the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. 
A)  The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. 
B)  The optimal capital structure minimizes the cost of equity,which is a necessary condition for maximizing the stock price. 
C)  The optimal capital structure simultaneously minimizes the cost of debt,the cost of equity,and the WACC. 
D)  The optimal capital structure simultaneously maximizes stock price and minimizes the WACC. 
E)  As a rule,the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.

Question 6

A firm's business risk is largely determined by the financial characteristics of its industry,especially by the amount of debt the average firm in the industry uses.

Accepted Answer

A) True 
 B)False

Question 7

Different borrowers have different risks of bankruptcy,and bankruptcy is costly to lenders.Therefore,lenders charge higher rates to borrowers judged to be more at risk of going bankrupt.

Accepted Answer

A) True 
 B)False

Question 8

Firms U and L both have a return on invested capital (ROIC)of 12% and each has the same amount of assets.Firm U is unleveraged,i.e. ,it is 100% equity financed,while Firm L is financed with 50% debt and 50% equity.Firm L's debt has an after-tax cost of 4.8%.Both firms have positive net income.Which of the following statements is CORRECT?

Accepted Answer

A)  Firm L has a lower ROA than Firm U. 
B)  Firm L has a lower ROE than Firm U. 
C)  Firm L has the higher times interest earned (TI
E) ratio. 
D)  Firm L has a higher EBIT than Firm U. 
E)  The two companies have the same times interest earned (TI
E) ratio. 
A)  Firm L has a lower ROA than Firm U. 
B)  Firm L has a lower ROE than Firm U. 
C)  Firm L has the higher times interest earned (TI
E) ratio. 
D)  Firm L has a higher EBIT than Firm U. 
E)  The two companies have the same times interest earned (TI
E) ratio.

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A)  There is no reason to think that changes in the personal tax rate would affect firms' capital structure decisions. 
B)  A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk,assuming all else equal. 
C)  If a firm's after-tax cost of equity exceeds its after-tax cost of debt,it can always reduce its WACC by increasing its use of debt. 
D)  Suppose a firm has less than its optimal amount of debt.Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity financing. 
E)  In general,a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs. 
A)  There is no reason to think that changes in the personal tax rate would affect firms' capital structure decisions. 
B)  A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk,assuming all else equal. 
C)  If a firm's after-tax cost of equity exceeds its after-tax cost of debt,it can always reduce its WACC by increasing its use of debt. 
D)  Suppose a firm has less than its optimal amount of debt.Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity financing. 
E)  In general,a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)  The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. 
B)  The capital structure that minimizes the required return on equity also maximizes the stock price. 
C)  The capital structure that minimizes the WACC also maximizes the price per share of common stock. 
D)  The capital structure that gives the firm the best credit rating also maximizes the stock price. 
E)  The capital structure that maximizes expected EPS also maximizes the price per share of common stock. 
A)  The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. 
B)  The capital structure that minimizes the required return on equity also maximizes the stock price. 
C)  The capital structure that minimizes the WACC also maximizes the price per share of common stock. 
D)  The capital structure that gives the firm the best credit rating also maximizes the stock price. 
E)  The capital structure that maximizes expected EPS also maximizes the price per share of common stock.

Question 11

A firm's capital structure does not affect its calculated free cash flows,because FCF reflects only operating cash flows.

Accepted Answer

A) True 
 B)False

Question 12

Which of the following statements is CORRECT?

Accepted Answer

A)  The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price. 
B)  The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes its earnings per share. 
C)  If a firm finds that the cost of debt is less than the cost of equity,increasing its debt ratio must reduce its WACC. 
D)  Other things held constant,if corporate tax rates declined,then the Modigliani-Miller tax-adjusted tradeoff theory would suggest that firms should increase their use of debt. 
E)  A firm can use retained earnings without paying a flotation cost.Therefore,while the cost of retained earnings is not zero,its cost is generally lower than the after-tax cost of debt. 
A)  The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price. 
B)  The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes its earnings per share. 
C)  If a firm finds that the cost of debt is less than the cost of equity,increasing its debt ratio must reduce its WACC. 
D)  Other things held constant,if corporate tax rates declined,then the Modigliani-Miller tax-adjusted tradeoff theory would suggest that firms should increase their use of debt. 
E)  A firm can use retained earnings without paying a flotation cost.Therefore,while the cost of retained earnings is not zero,its cost is generally lower than the after-tax cost of debt.

Question 13

If debt financing is used,which of the following is CORRECT?

Accepted Answer

A)  The percentage change in net operating income will be equal to a given percentage change in net income. 
B)  The percentage change in net income relative to the percentage change in net operating income will depend on the interest rate charged on debt. 
C)  The percentage change in net income will be greater than the percentage change in net operating income. 
D)  The percentage change in sales will be greater than the percentage change in EBIT,which in turn will be greater than the percentage change in net income. 
E)  The percentage change in net operating income will be greater than a given percentage change in net income. 
A)  The percentage change in net operating income will be equal to a given percentage change in net income. 
B)  The percentage change in net income relative to the percentage change in net operating income will depend on the interest rate charged on debt. 
C)  The percentage change in net income will be greater than the percentage change in net operating income. 
D)  The percentage change in sales will be greater than the percentage change in EBIT,which in turn will be greater than the percentage change in net income. 
E)  The percentage change in net operating income will be greater than a given percentage change in net income.

Question 14

Bailey and Sons has a levered beta of 1.10,its capital structure consists of 40% debt and 60% equity,and its tax rate is 40%.What would Bailey's beta be if it used no debt,i.e. ,what is its unlevered beta?

Accepted Answer

A)  0.64 
B)  0.67 
C)  0.71 
D)  0.75 
E)  0.79 
A)  0.64 
B)  0.67 
C)  0.71 
D)  0.75 
E)  0.79

Question 15

Which of the following would increase the likelihood that a company would increase its debt ratio,other things held constant?

Accepted Answer

A)  An increase in the corporate tax rate. 
B)  An increase in the personal tax rate. 
C)  The Federal Reserve tightens interest rates in an effort to fight inflation. 
D)  The company's stock price hits a new low. 
E)  An increase in costs incurred when filing for bankruptcy. 
A)  An increase in the corporate tax rate. 
B)  An increase in the personal tax rate. 
C)  The Federal Reserve tightens interest rates in an effort to fight inflation. 
D)  The company's stock price hits a new low. 
E)  An increase in costs incurred when filing for bankruptcy.

Question 16

Other things held constant,which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Accepted Answer

A)  The costs that would be incurred in the event of bankruptcy increase. 
B)  Management believes that the firm's stock has become overvalued. 
C)  Its degree of operating leverage increases. 
D)  The corporate tax rate increases. 
E)  Its sales become less stable over time. 
A)  The costs that would be incurred in the event of bankruptcy increase. 
B)  Management believes that the firm's stock has become overvalued. 
C)  Its degree of operating leverage increases. 
D)  The corporate tax rate increases. 
E)  Its sales become less stable over time.

Question 17

Based on the information below for Benson Corporation,what is the optimal capital structure?

Accepted Answer

A)  Debt = 50%;Equity = 50%;EPS = $3.05;Stock price = $28.90. 
B)  Debt = 60%;Equity = 40%;EPS = $3.18;Stock price = $31.20. 
C)  Debt = 80%;Equity = 20%;EPS = $3.42;Stock price = $30.40. 
D)  Debt = 70%;Equity = 30%;EPS = $3.31;Stock price = $30.00. 
E)  Debt = 40%;Equity = 60%;EPS = $2.95;Stock price = $26.50. 
A)  Debt = 50%;Equity = 50%;EPS = $3.05;Stock price = $28.90. 
B)  Debt = 60%;Equity = 40%;EPS = $3.18;Stock price = $31.20. 
C)  Debt = 80%;Equity = 20%;EPS = $3.42;Stock price = $30.40. 
D)  Debt = 70%;Equity = 30%;EPS = $3.31;Stock price = $30.00. 
E)  Debt = 40%;Equity = 60%;EPS = $2.95;Stock price = $26.50.

Question 18

The MM model is the same as the Miller model,but with zero corporate taxes.

Accepted Answer

A) True 
 B)False

Question 19

Which of the following statements best describes the optimal capital structure? The optimal capital structure is the mix of debt,equity,and preferred stock that maximizes the company's ____.

Accepted Answer

A)  stock price. 
B)  cost of equity. 
C)  cost of debt. 
D)  cost of preferred stock. 
E)  earnings per share (EPS). 
A)  stock price. 
B)  cost of equity. 
C)  cost of debt. 
D)  cost of preferred stock. 
E)  earnings per share (EPS).

Question 20

Financial risk refers to the extra risk stockholders bear as a result of using debt as compared with the risk they would bear if no debt were used.

Accepted Answer

A) True 
 B)False

Exam 15: Capital Structure Decisions

Which of the following statements is CORRECT?

Two firms,although they operate in different industries,have the same expected earnings per share and the same standard deviation of expected EPS.Thus,the two firms must have the same business risk.

Companies HD and LD have identical tax rates,total assets,and return on invested capital (ROIC),and their ROIC exceeds their after-tax cost of debt, (1-T)rd.However,Company HD has a higher debt ratio and thus more interest expense than Company LD.Which of the following statements is CORRECT?

The Miller model begins with the MM model with corporate taxes and then adds personal taxes.

Which of the following statements is CORRECT?

A firm's business risk is largely determined by the financial characteristics of its industry,especially by the amount of debt the average firm in the industry uses.

Different borrowers have different risks of bankruptcy,and bankruptcy is costly to lenders.Therefore,lenders charge higher rates to borrowers judged to be more at risk of going bankrupt.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

A firm's capital structure does not affect its calculated free cash flows,because FCF reflects only operating cash flows.

Which of the following statements is CORRECT?

If debt financing is used,which of the following is CORRECT?

Bailey and Sons has a levered beta of 1.10,its capital structure consists of 40% debt and 60% equity,and its tax rate is 40%.What would Bailey's beta be if it used no debt,i.e. ,what is its unlevered beta?

Which of the following would increase the likelihood that a company would increase its debt ratio,other things held constant?

Other things held constant,which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Based on the information below for Benson Corporation,what is the optimal capital structure?

The MM model is the same as the Miller model,but with zero corporate taxes.

Which of the following statements best describes the optimal capital structure? The optimal capital structure is the mix of debt,equity,and preferred stock that maximizes the company's ____.

Financial risk refers to the extra risk stockholders bear as a result of using debt as compared with the risk they would bear if no debt were used.

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risk and Return

Corporate Valuation and Stock Valuation

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Financial Planning and Applications to Corporate Valuation

Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Dynamic Capital Structures and Corporate Valuation

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, Reorganization, and Liquidation

Portfolio Theory and Asset Pricing Models

Real Options

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not-For-Profit Businesses

Filters

Companies HD and LD have identical tax rates,total assets,and return on invested capital (ROIC),and their ROIC exceeds their after-tax cost of debt, (1-T)r_d.However,Company HD has a higher debt ratio and thus more interest expense than Company LD.Which of the following statements is CORRECT?