Question 1

Which of the following statements is correct?

Accepted Answer

A)  A firm's business risk is solely determined by the financial characteristics of its industry. 
B)  The factors which affect a firm's business risk are determined partly by industry characteristics and partly by economic conditions.Unfortunately, these and other factors which affect a firm's business risk are not subject to any degree of managerial control. 
C)  One of the benefits to a firm of being at or near its target capital structure is that financial flexibility becomes much less important. 
D)  The firm's financial risk may have both market risk and diversifiable risk components. 
E)  The above statements are all false. 
A)  A firm's business risk is solely determined by the financial characteristics of its industry. 
B)  The factors which affect a firm's business risk are determined partly by industry characteristics and partly by economic conditions.Unfortunately, these and other factors which affect a firm's business risk are not subject to any degree of managerial control. 
C)  One of the benefits to a firm of being at or near its target capital structure is that financial flexibility becomes much less important. 
D)  The firm's financial risk may have both market risk and diversifiable risk components. 
E)  The above statements are all false.

Question 2

Business risk, which is the risk inherent in a firm's assets if it uses less than its optimal amount of debt, is one important influence in the capital structure decision.

Accepted Answer

A) True 
 B)False

Question 3

Which of the following statements is correct?

Accepted Answer

A)  If the dividend irrelevance theory (which is associated with the names Modigliani and Miller) were exactly correct, and if this theory could be tested with "clean" data, then we would find, in a regression of dividend yield and capital gains, a line with a slope of −1.0. 
B)  The tax preference and bird-in-the-hand theories lead to identical conclusions as to the optimal dividend policy. 
C)  If a company raises its dividend by an unexpectedly large amount, the announcement of this new and higher dividend is generally accompanied by an increase in the stock price.This is consistent with the bird-in-the-hand theory, and Modigliani and Miller used these findings to support their position on dividend theory. 
D)  If it could be demonstrated that a clientele effect exists, this would suggest that firms could alter their dividend payment policies from year to year to take advantage of investment opportunities without having to worry about the effects of changing dividends on capital costs. 
E)  Each of the above statements is false. 
A)  If the dividend irrelevance theory (which is associated with the names Modigliani and Miller) were exactly correct, and if this theory could be tested with "clean" data, then we would find, in a regression of dividend yield and capital gains, a line with a slope of −1.0. 
B)  The tax preference and bird-in-the-hand theories lead to identical conclusions as to the optimal dividend policy. 
C)  If a company raises its dividend by an unexpectedly large amount, the announcement of this new and higher dividend is generally accompanied by an increase in the stock price.This is consistent with the bird-in-the-hand theory, and Modigliani and Miller used these findings to support their position on dividend theory. 
D)  If it could be demonstrated that a clientele effect exists, this would suggest that firms could alter their dividend payment policies from year to year to take advantage of investment opportunities without having to worry about the effects of changing dividends on capital costs. 
E)  Each of the above statements is false.

Question 4

One of the implications of signaling theory for capital structure decisions is that firms should normally seek to maintain a reserve borrowing capacity.

Accepted Answer

A) True 
 B)False

Question 5

A firm's capital structure and dividend policy can affect the firm's cash position but has no impact on the market value of the firm's stock.

Accepted Answer

A) True 
 B)False

Question 6

The higher a firm's time-interest-earned ratio, the higher the probability that the firm will default on its debt and experience financial distress.

Accepted Answer

A) True 
 B)False

Question 7

It has been shown that a firm's beta ____ an increase in its degree of financial leverage.

Accepted Answer

A)  increases with 
B)  decreases with 
C)  remains constant with 
D)  is not related to 
A)  increases with 
B)  decreases with 
C)  remains constant with 
D)  is not related to

Question 8

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 aggressive capital structure?

Accepted Answer

A)  $0 
B)  $1.48 
C)  $0.62 
D)  $0.98 
E)  $2.40 
A)  $0 
B)  $1.48 
C)  $0.62 
D)  $0.98 
E)  $2.40

Question 9

Because creditors can foresee, to at least some extent, the costs of bankruptcy, they charge an interest rate that has a premium built into it to compensate for the present value of bankruptcy costs.

Accepted Answer

A) True 
 B)False

Question 10

The Altman Company has a debt-to-assets ratio of 33.33 percent, and it needs to raise $100,000 to expand.Management feels that an optimal debt-to-assets ratio would be 16.67 percent.Sales are currently $750,000, and the total assets turnover is 7.5.How should the expansion be financed so as to produce the desired debt-to-assets ratio?

Accepted Answer

A)  Finance it all with equity. 
B)  Finance it all with debt. 
C)  Finance 20% debt, 80% equity. 
D)  Finance 40% debt, 60% equity. 
E)  Finance 50% debt, 50% equity. 
A)  Finance it all with equity. 
B)  Finance it all with debt. 
C)  Finance 20% debt, 80% equity. 
D)  Finance 40% debt, 60% equity. 
E)  Finance 50% debt, 50% equity.

Question 11

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Accepted Answer

A) True 
 B)False

Question 12

Which of the following would not have an influence on the optimal dividend policy?

Accepted Answer

A)  The possibility of accelerating or delaying investment projects. 
B)  A strong shareholders' preference for current income versus capital gains. 
C)  Bond indenture constraints. 
D)  The costs associated with selling new common stock. 
E)  All of the above can have an effect on dividend policy. 
A)  The possibility of accelerating or delaying investment projects. 
B)  A strong shareholders' preference for current income versus capital gains. 
C)  Bond indenture constraints. 
D)  The costs associated with selling new common stock. 
E)  All of the above can have an effect on dividend policy.

Question 13

The announcement of a stock offering by a mature firm that seems to have financing alternatives is taken as a signal that the firm's prospects are very good.

Accepted Answer

A) True 
 B)False

Question 14

Your company has decided that its capital budget during the coming year will be $20 million.Its optimal capital structure is 60 percent equity and 40 percent debt.Its earnings before interest and taxes (EBIT) are projected to be $34.667 million for the year.The company has $200 million of assets; its average interest rate on outstanding debt is 10 percent; and its tax rate is 40 percent.If the company follows the residual dividend policy and maintains the same capital structure, what will its dividend payout ratio be?

Accepted Answer

A)  15% 
B)  20% 
C)  25% 
D)  30% 
E)  35% 
A)  15% 
B)  20% 
C)  25% 
D)  30% 
E)  35%

Question 15

The weighted average cost of capital (WACC) declines as more of the lowest cost component is added.What limits a firm from using nearly all debt is that as the debt-to-assets ratio rises, the absolute interest expense gets very large.The large interest expense reduces income and results in a debt-to-assets ratio limit even though the WACC continues to decline.

Accepted Answer

A) True 
 B)False

Question 16

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 aggressive capital structure plan?

Accepted Answer

A)  1.00 
B)  1.18 
C)  2.45 
D)  2.88 
E)  3.76 
A)  1.00 
B)  1.18 
C)  2.45 
D)  2.88 
E)  3.76

Question 17

The mix of debt, preferred stock, and common equity with which the firm plans to support its asset structure is known as the target capital structure.

Accepted Answer

A) True 
 B)False

Question 18

The following facts apply to your company:   Based on the residual dividend policy, the payout ratio is 60 percent.How large (in millions of dollars) will the capital budget be?

Accepted Answer

A)  $43.2 
B)  $50.0 
C)  $64.8 
D)  $86.4 
E)  $108.0 
A)  $43.2 
B)  $50.0 
C)  $64.8 
D)  $86.4 
E)  $108.0

Question 19

Modigliani and Miller's dividend irrelevance theory says that dividend policy does not affect a firm's value but can affect its cost of capital.

Accepted Answer

A) True 
 B)False

Question 20

As the debt-to-assets ratio rises, the WACC is reduced because the after-tax cost of debt is usually lower than the cost of equity.What limits the substitution of debt for equity in the capital structure is that as the debt-to-assets ratio rises, the costs of both components eventually increase.

Accepted Answer

A) True 
 B)False

Which of the following statements is correct?

Business risk, which is the risk inherent in a firm's assets if it uses less than its optimal amount of debt, is one important influence in the capital structure decision.

Which of the following statements is correct?

One of the implications of signaling theory for capital structure decisions is that firms should normally seek to maintain a reserve borrowing capacity.

A firm's capital structure and dividend policy can affect the firm's cash position but has no impact on the market value of the firm's stock.

The higher a firm's time-interest-earned ratio, the higher the probability that the firm will default on its debt and experience financial distress.

It has been shown that a firm's beta ____ an increase in its degree of financial leverage.

Because creditors can foresee, to at least some extent, the costs of bankruptcy, they charge an interest rate that has a premium built into it to compensate for the present value of bankruptcy costs.

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Which of the following would not have an influence on the optimal dividend policy?

The announcement of a stock offering by a mature firm that seems to have financing alternatives is taken as a signal that the firm's prospects are very good.

The mix of debt, preferred stock, and common equity with which the firm plans to support its asset structure is known as the target capital structure.

The following facts apply to your company: Based on the residual dividend policy, the payout ratio is 60 percent.How large (in millions of dollars) will the capital budget be?

Modigliani and Miller's dividend irrelevance theory says that dividend policy does not affect a firm's value but can affect its cost of capital.

As the debt-to-assets ratio rises, the WACC is reduced because the after-tax cost of debt is usually lower than the cost of equity.What limits the substitution of debt for equity in the capital structure is that as the debt-to-assets ratio rises, the costs of both components eventually increase.

An Overview of Finance

Financial Assets Instruments

Financial Markets and the Investment Banking Process

Financial Intermediaries and the Banking System

The Cost of Money Interest Rates

Business Organizations and the Tax Environment

Analysis of Financial Statements

Financial Planning and Control

Time Value of Money

Valuation Concepts

Risk and Rates of Return

The Cost of Capital

Capital Budgeting

Working Capital Management

Investment Concepts

Security Valuation and Selection

Filters

Exam 14: Capital Structure and Dividend Policy Decisions

Which of the following statements is correct?

Business risk, which is the risk inherent in a firm's assets if it uses less than its optimal amount of debt, is one important influence in the capital structure decision.

Which of the following statements is correct?

One of the implications of signaling theory for capital structure decisions is that firms should normally seek to maintain a reserve borrowing capacity.

A firm's capital structure and dividend policy can affect the firm's cash position but has no impact on the market value of the firm's stock.

The higher a firm's time-interest-earned ratio, the higher the probability that the firm will default on its debt and experience financial distress.

It has been shown that a firm's beta ____ an increase in its degree of financial leverage.

Because creditors can foresee, to at least some extent, the costs of bankruptcy, they charge an interest rate that has a premium built into it to compensate for the present value of bankruptcy costs.

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Which of the following would not have an influence on the optimal dividend policy?

The announcement of a stock offering by a mature firm that seems to have financing alternatives is taken as a signal that the firm's prospects are very good.

The mix of debt, preferred stock, and common equity with which the firm plans to support its asset structure is known as the target capital structure.

The following facts apply to your company: Based on the residual dividend policy, the payout ratio is 60 percent.How large (in millions of dollars) will the capital budget be?

Modigliani and Miller's dividend irrelevance theory says that dividend policy does not affect a firm's value but can affect its cost of capital.

As the debt-to-assets ratio rises, the WACC is reduced because the after-tax cost of debt is usually lower than the cost of equity.What limits the substitution of debt for equity in the capital structure is that as the debt-to-assets ratio rises, the costs of both components eventually increase.

An Overview of Finance

Financial Assets Instruments

Financial Markets and the Investment Banking Process

Financial Intermediaries and the Banking System

The Cost of Money Interest Rates

Business Organizations and the Tax Environment

Analysis of Financial Statements

Financial Planning and Control

Time Value of Money

Valuation Concepts

Risk and Rates of Return

The Cost of Capital

Capital Budgeting

Working Capital Management

Investment Concepts

Security Valuation and Selection

Filters