Question 1

Provided a firm does not use an extreme amount of debt, financial leverage typically affects both EPS and EBIT, while operating leverage only affects EBIT.

Accepted Answer

A) True 
 B)False

Question 2

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

Question 3

Eccles Inc., a zero growth firm, has an expected EBIT of $100,000 and a corporate tax rate of 30%. Eccles uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.
-Refer to the data for Eccles Inc.What is the firm's cost of equity according to MM with corporate taxes?

Accepted Answer

A)  21.0% 
B)  23.3% 
C)  25.9% 
D)  28.8% 
E)  32.0% 
A)  21.0% 
B)  23.3% 
C)  25.9% 
D)  28.8% 
E)  32.0%

Question 4

The following information has been presented to you about the Gibson Corporation. 
$\begin{array}{l}
\begin{array} { l } 
\text { Total assets } & \$ 3,000 \text { million Tax rate } \
\text { Operating income (EBIT) } & \$ 800 \text { million Debt ratio } \
\text { Interest expense } & \$ 0 \text { million WACC } \
\text { Net income } & \$ 480 \text { million M/B ratio } \
\text { Share price } & \$ 32.00 \mathrm{EPS}=\mathrm{DPS}
\end{array}
\begin{array} { l } 
40 \% \
0 \% \
10 \% \
1.00 x\
\$ 3.20
\end{array}
\end{array}$

The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values) that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%. If the company makes this change, what would be the total market value (in millions) of the firm?

Accepted Answer

A)  $3,200 
B)  $3,600 
C)  $4,000 
D)  $4,200 
E)  $4,800 
A)  $3,200 
B)  $3,600 
C)  $4,000 
D)  $4,200 
E)  $4,800

Question 5

When a firm has risky debt, its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.

Accepted Answer

A) True 
 B)False

Question 6

Cartwright Communications is considering making a change to its capital structure to reduce its cost of capital and increase firm value. Right now, Cartwright has a capital structure that consists of 20% debt and 80% equity, based on market values. (Its D/S ratio is 0.25.) The risk-free rate is 6% and the market risk premium, rM σ rRF, is 5%. Currently the company's cost of equity, which is based on the CAPM, is 12% and its tax rate is 40%. What would be Cartwright's estimated cost of equity if it were to change its capital structure to 50% debt and 50% equity?

Accepted Answer

A)  13.00% 
B)  13.64% 
C)  14.35% 
D)  14.72% 
E)  15.60% 
A)  13.00% 
B)  13.64% 
C)  14.35% 
D)  14.72% 
E)  15.60%

Question 7

Which of the following is NOT associated with (or does not contribute to) business risk? Recall that business risk is affected by a firm's operations.

Accepted Answer

A)  sales price variability. 
B)  the extent to which operating costs are fixed. 
C)  the extent to which interest rates on the firm's debt fluctuate. 
D)  input price variability. 
E)  demand variability. 
A)  sales price variability. 
B)  the extent to which operating costs are fixed. 
C)  the extent to which interest rates on the firm's debt fluctuate. 
D)  input price variability. 
E)  demand variability.

Provided a firm does not use an extreme amount of debt, financial leverage typically affects both EPS and EBIT, while operating leverage only affects EBIT.

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.

When a firm has risky debt, its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.

Which of the following is NOT associated with (or does not contribute to) business risk? Recall that business risk is affected by a firm's operations.

An Overview of Financial Management and the Financial Environment

Risk and Return-Part I

Risk and Return-Part II

Bond Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Basic Stock Valuation

Corporate Valuation and Financial Planning

Corporate Governance

Determining the Cost of Capital

Capital Budgeting: Decision Criteria

Capital Budgeting-Estimating Cash Flows and Analyzing Risk

Real Options

Distributions to Shareholders-Dividends and Repurchases

Dynamic Capital Structures and Corporate Valuation

Initial Public Offerings-Investment Banking: and Financial Restructuring

Lease Financing

Hybrid Financing Preferred Stock-Warrants and Convertibles

Supply Chains and Working Capital Management

Providing and Obtaining Credit

Other Topics in Working Capital Management

Enterprise Risk Management

Bankruptcy-Reorganization and Liquidation

Mergers and Corporate Control

Multinational Financial Management

Time Value of Money

Basic Financial Tools: A review

Pension Plan Management

Financial Management in Not for Profit Businesses

Filters

Exam 16: Capital Structure Decisions

Provided a firm does not use an extreme amount of debt, financial leverage typically affects both EPS and EBIT, while operating leverage only affects EBIT.

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.

When a firm has risky debt, its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.

Which of the following is NOT associated with (or does not contribute to) business risk? Recall that business risk is affected by a firm's operations.

An Overview of Financial Management and the Financial Environment

Risk and Return-Part I

Risk and Return-Part II

Bond Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Basic Stock Valuation

Corporate Valuation and Financial Planning

Corporate Governance

Determining the Cost of Capital

Capital Budgeting: Decision Criteria

Capital Budgeting-Estimating Cash Flows and Analyzing Risk

Real Options

Distributions to Shareholders-Dividends and Repurchases

Dynamic Capital Structures and Corporate Valuation

Initial Public Offerings-Investment Banking: and Financial Restructuring

Lease Financing

Hybrid Financing Preferred Stock-Warrants and Convertibles

Supply Chains and Working Capital Management

Providing and Obtaining Credit

Other Topics in Working Capital Management

Enterprise Risk Management

Bankruptcy-Reorganization and Liquidation

Mergers and Corporate Control

Multinational Financial Management

Time Value of Money

Basic Financial Tools: A review

Pension Plan Management

Financial Management in Not for Profit Businesses

Filters