Exam 14: Capital Structure and Dividend Policy Decisions

The most commonly held view of capital structure, according to the text, is that the weighted average cost of capital

In signaling theory, when a manager has better information than outside investors about the firm, this is called asymmetric information.

Which of the following factors does not affect a firm's business risk?

____ information is the situation in which managers have better information about the firm's prospects.

The central result from the work of Miller and Modigliani (MM) and subsequent researchers, is that it is now possible to precisely identify a firm's optimal capital structure.

If the information content, or signaling, hypothesis is correct, then changes in dividend policy can be important with respect to firm value and capital costs.

Changing the capital structure of the firm will affect the riskiness inherent in the firm's common stock, which will affect the return demanded by stockholders and the stock's

Once the target capital structure for a firm is decided, managerial decisions can result in the actual capital structure differing from the target structure, but operating conditions will have a negligible effect on actual capital structure.

The benefit to the firm of the tax deductibility of interest can be lowered if the firm's marginal tax rate is reduced by accumulated depreciation or tax-loss carry-forwards.

Generally, the more stable a firm's operations, the more debt it can handle in its capital structure.

If we include the cost of bankruptcy in the MM analysis of capital structure in a world with taxes, we would tend to believe that the cost of debt increases as leverage increases and that there is probably an optimal capital structure.

If you were to argue that the firm's cost of equity, r_s, increases as the dividend payout decreases, you would be making an argument ____ with MM's dividend irrelevance theory, and ____ with the theory that investors prefer dividends received in the current period rather than capital gains received in the future.

An increase in the financial leverage of a firm will generally increase the variability in EPS for the firm.

Business risk will not affect a firm's beta, because beta is determined by the market and thus is outside the control of the firm.

Modigliani and Miller (MM) argued that dividend policy is irrelevant.On the other hand, others, such as Gordon and Lintner (GL), argued that dividend policy does matter.GL's argument rests on the contention that

From the information below, select the optimal capital structure for Minnow Entertainment Company.

Which of the following statements is correct?

Asymmetric information involves a situation where the firm's managers have different (better) information about their firm's prospects than do investors.

The optimal capital structure is that capital structure which strikes a balance between risk and return such that the firm's stock price is maximized.

If the debt-to-assets ratio is 50 percent, the interest rate on all debt is 8 percent, the tax rate is 50 percent, and the return on equity is 10 percent, then the ratio of earnings before interest and taxes (EBIT) to total assets, or the basic earning power ratio, must be