Question 1

To reduce agency costs, issuing debt instead of equity provides incentives for managers to run a firm efficiently because ________.

Accepted Answer

A) debt increases the funds available to managers to run the firm 
B) ownership of managers may remain more concentrated 
C) managers may take actions that benefit shareholders but harm creditors and lower the value of the firm 
D) shareholders prefer to decline new projects to save cash, even if their NPVs are positive 
A) debt increases the funds available to managers to run the firm 
B) ownership of managers may remain more concentrated 
C) managers may take actions that benefit shareholders but harm creditors and lower the value of the firm 
D) shareholders prefer to decline new projects to save cash, even if their NPVs are positive

Question 2

Which of the following is NOT one of Modigliani and Miller's set of conditions referred to as perfect capital markets?

Accepted Answer

A) All investors hold the efficient portfolio of assets. 
B) There are no taxes, transaction costs, or issuance costs associated with security trading. 
C) A firm's financing decisions neither change the cash flows generated by its investments, nor do they reveal new information about them. 
D) Investors and firms can trade the same set of securities at competitive market prices equal to the present value (PV)of their future cash flows. 
A) All investors hold the efficient portfolio of assets. 
B) There are no taxes, transaction costs, or issuance costs associated with security trading. 
C) A firm's financing decisions neither change the cash flows generated by its investments, nor do they reveal new information about them. 
D) Investors and firms can trade the same set of securities at competitive market prices equal to the present value (PV)of their future cash flows.

Question 3

In general, issuing equity may not dilute the ownership of existing shareholders if ________.

Accepted Answer

A) the value of new shares is equal to the value of debt 
B) the new shares are sold at a fair price 
C) the firm has no debt financing 
D) the firm uses debt conservatively 
A) the value of new shares is equal to the value of debt 
B) the new shares are sold at a fair price 
C) the firm has no debt financing 
D) the firm uses debt conservatively

Question 4

Use the information for the question(s)below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share.
-The market value of Luther's non-cash assets is closest to ________.

Accepted Answer

A) $20 billion 
B) $19 billion 
C) $25 billion 
D) $24 billion 
A) $20 billion 
B) $19 billion 
C) $25 billion 
D) $24 billion

Question 5

The probability of financial distress depends on the ________.

Accepted Answer

A) likelihood that a firm will be unable to meet its debt commitments 
B) chance that a firm's raw material costs will increase 
C) likelihood of dividend payments 
D) likelihood of asset growth 
A) likelihood that a firm will be unable to meet its debt commitments 
B) chance that a firm's raw material costs will increase 
C) likelihood of dividend payments 
D) likelihood of asset growth

Question 6

The presence of financial distress costs can explain why firms choose debt levels that are too low to exploit the interest tax shield.

Accepted Answer

A) True 
 B)False

Question 7

Aside from direct costs of bankruptcy, a firm may also incur other indirect costs such as ________.

Accepted Answer

A) loss of customers and loss of suppliers 
B) loss of interest receipts 
C) loss of dividend receipts 
D) increase in raw material costs 
A) loss of customers and loss of suppliers 
B) loss of interest receipts 
C) loss of dividend receipts 
D) increase in raw material costs

Question 8

Equity in a firm with no debt is called ________.

Accepted Answer

A) levered equity 
B) unlevered equity 
C) risk-free equity 
D) preferred equity 
A) levered equity 
B) unlevered equity 
C) risk-free equity 
D) preferred equity

Question 9

By adding leverage, the returns on a firm are split between debt holders and equity holders, but equity holder risk increases because ________.

Accepted Answer

A) interest payments can be rolled over 
B) dividends are paid first 
C) debt and equity have equal priority 
D) interest payments have first priority 
A) interest payments can be rolled over 
B) dividends are paid first 
C) debt and equity have equal priority 
D) interest payments have first priority

Question 10

What are the issues in determining the optimal leverage for a firm?

Accepted Answer

While interest tax shield tends to incre

Question 11

Use the information for the question(s)below.
Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at an interest rate of 5%.
-According to MM Proposition I, the stock price for Firm X is closest to ________.

Accepted Answer

A) $8.00 
B) $24.00 
C) $6.00 
D) $12.00 
A) $8.00 
B) $24.00 
C) $6.00 
D) $12.00

Question 12

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company uses no leverage, what is expected return to equity holders?

Accepted Answer

A) 8.0% 
B) 11.6% 
C) 9.33% 
D) 30.0% 
A) 8.0% 
B) 11.6% 
C) 9.33% 
D) 30.0%

Question 13

Managerial entrenchment means that managers ________ and run the firm for their own best interests.

Accepted Answer

A) may face little threat of being fired 
B) are overseen by equity holders 
C) are overseen by debt holders 
D) are well compensated 
A) may face little threat of being fired 
B) are overseen by equity holders 
C) are overseen by debt holders 
D) are well compensated

Question 14

With perfect capital markets, what is the market value of Luther's equity after the share repurchase?

Accepted Answer

A) $15 billion 
B) $10 billion 
C) $25 billion 
D) $20 billion 
A) $15 billion 
B) $10 billion 
C) $25 billion 
D) $20 billion

Question 15

The tradeoff theory of optimal capital structure weighs the benefits of debt against the costs of ________.

Accepted Answer

A) financial distress 
B) interest payments 
C) dividend reinvestment 
D) input factors 
A) financial distress 
B) interest payments 
C) dividend reinvestment 
D) input factors

Question 16

A firm will give a one-time cash flow of $24,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?

Accepted Answer

A) $17,454.55 
B) $26,181.82 
C) $21,818.18 
D) more information needed 
A) $17,454.55 
B) $26,181.82 
C) $21,818.18 
D) more information needed

Question 17

Under-investment problems refers to the problem that equity holders prefer not to invest in positive-NPV projects in highly levered firms because ________.

Accepted Answer

A) future investments are contingent on debt financing 
B) projects are contingent on equity financing 
C) gains are evenly shared between all stakeholders 
D) most of the gains from the investment accrue to debt holders 
A) future investments are contingent on debt financing 
B) projects are contingent on equity financing 
C) gains are evenly shared between all stakeholders 
D) most of the gains from the investment accrue to debt holders

Question 18

In a setting where there is no risk that a firm will default, leverage ________ the risk of equity.

Accepted Answer

A) increases 
B) decreases 
C) does not change 
D) cannot say for sure 
A) increases 
B) decreases 
C) does not change 
D) cannot say for sure

Question 19

Market timing means that managers may sell ________ when they believe the stock is over-valued and rely on ________ when the stock is undervalued.

Accepted Answer

A) debt, shares 
B) debt, preferred stock 
C) new shares, debt 
D) debt, debt 
A) debt, shares 
B) debt, preferred stock 
C) new shares, debt 
D) debt, debt

Question 20

A firm requires an investment of $30,000 and borrows $15,000 at 7%. If the return on equity is 19%, what is the firm's pretax WACC?

Accepted Answer

A) 13% 
B) 6.5% 
C) 15.6% 
D) 18.2% 
A) 13% 
B) 6.5% 
C) 15.6% 
D) 18.2%

Exam 16: Capital Structure

To reduce agency costs, issuing debt instead of equity provides incentives for managers to run a firm efficiently because ________.

Which of the following is NOT one of Modigliani and Miller's set of conditions referred to as perfect capital markets?

In general, issuing equity may not dilute the ownership of existing shareholders if ________.

The probability of financial distress depends on the ________.

The presence of financial distress costs can explain why firms choose debt levels that are too low to exploit the interest tax shield.

Aside from direct costs of bankruptcy, a firm may also incur other indirect costs such as ________.

Equity in a firm with no debt is called ________.

By adding leverage, the returns on a firm are split between debt holders and equity holders, but equity holder risk increases because ________.

What are the issues in determining the optimal leverage for a firm?

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company uses no leverage, what is expected return to equity holders?

Managerial entrenchment means that managers ________ and run the firm for their own best interests.

With perfect capital markets, what is the market value of Luther's equity after the share repurchase?

The tradeoff theory of optimal capital structure weighs the benefits of debt against the costs of ________.

A firm will give a one-time cash flow of $24,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?

Under-investment problems refers to the problem that equity holders prefer not to invest in positive-NPV projects in highly levered firms because ________.

In a setting where there is no risk that a firm will default, leverage ________ the risk of equity.

Market timing means that managers may sell ________ when they believe the stock is over-valued and rely on ________ when the stock is undervalued.

A firm requires an investment of $30,000 and borrows $15,000 at 7%. If the return on equity is 19%, what is the firm's pretax WACC?

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

Time Value of Money: an Introduction

Time Value of Money: Valuing Cash Flow Streams

Interest Rates

Bonds

Stock Valuation

Investment Decision Rules

Fundamentals of Capital Budgeting

Stock Valuation: a Second Look

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

The Cost of Capital

Raising Equity Capital

Debt Financing

Payout Policy

Financial Modeling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Option Applications and Corporate Finance

Mergers and Acquisitions

International Corporate Finance

Leasing

Insurance and Risk Management

Corporate Governance

Filters

Market timing means that managers may sell when they believe the stock is over-valued and rely on when the stock is undervalued.