Exam 14: Capital Structure and Dividend Policy Decisions

Debt has benefits for firms because interest is tax deductible.As long as a firm has positive earnings it can receive the full benefit of the tax deductibility of debt interest expense.

Calculate the current price per share (P₀) for Olson Corporation, given the following information.The data all pertain to the year just ended.

A firm that follows a residual dividend policy must believe that the dividend irrelevance theory is correct.

Strategic Systems Inc.expects to have net income of $800,000 during the next year.Its target, and current, capital structure is 40 percent debt and 60 percent common equity.The Director of Capital Budgeting has determined that the optimal capital budget for next year is $1.2 million.If Strategic uses the residual dividend model to determine next year's dividend payout, what is the expected payout ratio?

As a general rule, the capital structure that

Growth Rate Copybold Corporation Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive.The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75.Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine.The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000.Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent.The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share. -Refer to Copybold Corporation.What is the coefficient of variation of expected EPS under the conservative capital structure plan?

If a firm utilizes debt financing, a decrease in earnings before interest and taxes (EBIT) will result in a more than proportionate decrease in earnings per share.

An all equity firm has some risk inherent in its operations.When the firm decides to finance some of its operations with debt, it exposes itself to financial risk and it increases its business risk.

If investors do, in fact, prefer that firms retain most of their earnings, then firms that want to maximize stock price should hold dividend payments to low levels.

In the real world, we find that dividends

If the shape of the curve depicting a firm's WACC versus its debt-to-assets ratio is more like a sharp "V", as opposed to a shallow "U", it will be easier for the firm to maintain a steady dividend in the face of varying investment opportunities from year to year.

Which of the following is correct?

What is the single most important determinant of capital structure for a company?

Business risk depends on all of the following factors except ____.

Stargell Industries follows a strict residual dividend policy.The company has a capital budget of $3,000,000.It has a target capital structure which consists of 30 percent debt and 70 percent equity.The company forecasts that its net income will be $3,500,000.What will be the company's payout ratio this year?

How a firm splits its income between retained earnings and dividends does not affect its rate of growth, which is determined by the firm's basic earning power.

Financial leverage affects both EPS and EBIT, while operating leverage only affects EBIT.

Growth Rate Copybold Corporation Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive.The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75.Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine.The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000.Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent.The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share. -Refer to Copybold Corporation.What is the difference between the EPS forecasts for Feast and Famine under the conservative capital structure?

If a firm uses no debt, the uncertainty inherent in projections of future returns on equity can be described as business risk.

The ability of a firm to raise sufficient capital on competitive terms under adverse conditions in order to sustain steady operations is referred to as financial flexibility.