Question 1

With perfect capital markets, what is the market price per share of Luther's stock after the share repurchase?

Accepted Answer

A) $20 
B) $24 
C) $15 
D) $25 
A) $20 
B) $24 
C) $15 
D) $25

Question 2

Differences in the magnitude of financial distress costs and volatility of cash flows across industries do not impact the choice of leverage.

Accepted Answer

A) True 
 B)False

Question 3

What role do industries play in the capital structure choice for a firm?

Accepted Answer

Industries are found to have distinct pa

Question 4

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%.
-Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as Firm X. You have $5,000 of your own money to invest and you plan on buying Firm X stock. Using homemade (un)leverage, how much do you need to invest at the risk-free rate so that the payoff of your account will be the same as a $5,000 investment in Firm Y stock?

Accepted Answer

A) $5,000 
B) $0 
C) $2,500 
D) $4,000 
A) $5,000 
B) $0 
C) $2,500 
D) $4,000

Question 5

What are some implications of market imperfections?

Accepted Answer

Market imperfections such as c

Question 6

The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its ________.

Accepted Answer

A) capital structure 
B) dividend expense 
C) retained earnings 
D) paid out capital 
A) capital structure 
B) dividend expense 
C) retained earnings 
D) paid out capital

Question 7

Equity-debt holder conflicts are more likely to arise if the risk of financial distress is high.

Accepted Answer

A) True 
 B)False

Question 8

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%.
-Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as Firm X. You have $5,000 of your own money to invest and you plan on buying Firm Y stock. Using homemade leverage you borrow enough in your margin account so that the payoff of your margined purchase of Firm Y stock will be the same as a $5,000 investment in Firm X stock. The number of shares of Firm Y stock you purchased is closest to ________.

Accepted Answer

A) 425 
B) 1,650 
C) 2,000 
D) 825 
A) 425 
B) 1,650 
C) 2,000 
D) 825

Question 9

The Tradeoff Theory suggests that ________.

Accepted Answer

A) a firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress 
B) with higher costs of financial distress, it is optimal for a firm to choose higher leverage 
C) differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries 
D) there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield 
A) a firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress 
B) with higher costs of financial distress, it is optimal for a firm to choose higher leverage 
C) differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries 
D) there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield

Question 10

Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options given to employees valued at $2 billion. After the repurchase how many shares will Luther have outstanding?

Accepted Answer

A) 1.15 billion 
B) 1.2 billion 
C) 0.75 billion 
D) 1.1 billion 
A) 1.15 billion 
B) 1.2 billion 
C) 0.75 billion 
D) 1.1 billion

Question 11

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is the return to equity holders if demand is strong?

Accepted Answer

A) 8.0% 
B) 8.95% 
C) 28.6% 
D) 38.0% 
A) 8.0% 
B) 8.95% 
C) 28.6% 
D) 38.0%

Question 12

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%.
-Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as Firm X. You have $5000 of your own money to invest and you plan on buying Firm Y stock. Using homemade leverage, how much do you need to borrow in your margin account so that the payoff of your margined purchase of Firm Y stock will be the same as a $5,000 investment in Firm X stock?

Accepted Answer

A) $10,000 
B) $5,000 
C) $2,500 
D) $0 
A) $10,000 
B) $5,000 
C) $2,500 
D) $0

Question 13

One of the factors that determine the present value (PV)of financial distress costs is ________.

Accepted Answer

A) costs of unpaid interest arrears 
B) loss of dividend payments 
C) probability of financial distress 
D) employee compensation 
A) costs of unpaid interest arrears 
B) loss of dividend payments 
C) probability of financial distress 
D) employee compensation

Question 14

Managers should not change the capital structure unless it departs significantly from the optimal level because such a change would ________.

Accepted Answer

A) reduce dividends 
B) incur transactions costs 
C) increase fixed costs 
D) change incentives of stakeholders 
A) reduce dividends 
B) incur transactions costs 
C) increase fixed costs 
D) change incentives of stakeholders

Question 15

A firm has a market value of equity of $30,000. It borrows $7500 at 8%. If the unlevered cost of equity is 15%, what is the firm's cost of equity capital?

Accepted Answer

A) 16.75% 
B) 6.70% 
C) 20.10% 
D) 23.45% 
A) 16.75% 
B) 6.70% 
C) 20.10% 
D) 23.45%

Question 16

When investors use leverage in their own portfolios to adjust the leverage choice made by the firm, it is referred to as ________.

Accepted Answer

A) outside debt 
B) retained earnings 
C) homemade leverage 
D) payout ratio 
A) outside debt 
B) retained earnings 
C) homemade leverage 
D) payout ratio

Question 17

Agency costs arise when ________.

Accepted Answer

A) there are high labor costs 
B) input costs are higher than interest costs 
C) interest costs exceed dividend payments 
D) conflicts of interest exist between stakeholders 
A) there are high labor costs 
B) input costs are higher than interest costs 
C) interest costs exceed dividend payments 
D) conflicts of interest exist between stakeholders

Question 18

Which of the following statements is FALSE?

Accepted Answer

A) If we can identify a comparison firm whose assets have the same risk as the project being evaluated, and if the comparison firm is levered, then we can use its cost of debt as the cost of capital for the project. 
B) We can calculate the cost of capital of a firm's assets by computing the weighted average of the firm's equity and debt cost of capital, which we refer to as the firm's weighted average cost of capital. 
C) The portfolio of a firm's equity and debt replicates the returns we would earn if the firm were unlevered. 
D) When evaluating any potential investment project, we must use a discount rate that is appropriate given the risk of the project's free cash flow. 
A) If we can identify a comparison firm whose assets have the same risk as the project being evaluated, and if the comparison firm is levered, then we can use its cost of debt as the cost of capital for the project. 
B) We can calculate the cost of capital of a firm's assets by computing the weighted average of the firm's equity and debt cost of capital, which we refer to as the firm's weighted average cost of capital. 
C) The portfolio of a firm's equity and debt replicates the returns we would earn if the firm were unlevered. 
D) When evaluating any potential investment project, we must use a discount rate that is appropriate given the risk of the project's free cash flow.

Question 19

What considerations should managers have while deciding on firms' capital structure?

Accepted Answer

Managers should first take a look at the

Question 20

A project will give a one-time cash flow of $22,000 after one year. If the project risk requires a return of 11%, what is the levered value of the firm with perfect capital markets?

Accepted Answer

A) $15,855.86 
B) $19,819.82 
C) $23,783.78 
D) more information needed 
A) $15,855.86 
B) $19,819.82 
C) $23,783.78 
D) more information needed

Exam 16: Capital Structure

With perfect capital markets, what is the market price per share of Luther's stock after the share repurchase?

Differences in the magnitude of financial distress costs and volatility of cash flows across industries do not impact the choice of leverage.

What role do industries play in the capital structure choice for a firm?

What are some implications of market imperfections?

The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its ________.

Equity-debt holder conflicts are more likely to arise if the risk of financial distress is high.

The Tradeoff Theory suggests that ________.

Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options given to employees valued at $2 billion. After the repurchase how many shares will Luther have outstanding?

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is the return to equity holders if demand is strong?

One of the factors that determine the present value (PV)of financial distress costs is ________.

Managers should not change the capital structure unless it departs significantly from the optimal level because such a change would ________.

A firm has a market value of equity of $30,000. It borrows $7500 at 8%. If the unlevered cost of equity is 15%, what is the firm's cost of equity capital?

When investors use leverage in their own portfolios to adjust the leverage choice made by the firm, it is referred to as ________.

Agency costs arise when ________.

Which of the following statements is FALSE?

What considerations should managers have while deciding on firms' capital structure?

A project will give a one-time cash flow of $22,000 after one year. If the project risk requires a return of 11%, what is the levered value of the firm with perfect capital markets?

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

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