Question 1

Which of the following is a good reason for a company to have higher than average debt ratios.

Accepted Answer

A) The company's cash flows are difficult to predict. 
B) The company generates little taxable income. 
C) Customer support is an important aspect of the company's business. 
D) The company faces high marginal tax rates. 
A) The company's cash flows are difficult to predict. 
B) The company generates little taxable income. 
C) Customer support is an important aspect of the company's business. 
D) The company faces high marginal tax rates.

Question 2

Rising bankruptcy costs should cause most firms to use less debt and more equity.

Accepted Answer

A) True 
 B)False

Question 3

Weaknesses of the EBIT-EPS analysis include

Accepted Answer

A) that it disregards the implicit costs of debt financing. 
B) that it ignores the effect of the specific financing decision on the firm's cost of common equity capital. 
C) that it considers only the level of the earnings stream and ignores the variability inherent in it. 
D) all of the above. 
A) that it disregards the implicit costs of debt financing. 
B) that it ignores the effect of the specific financing decision on the firm's cost of common equity capital. 
C) that it considers only the level of the earnings stream and ignores the variability inherent in it. 
D) all of the above.

Question 4

The objective of capital structure management is to maximize the market value of the firm's equity.

Accepted Answer

A) True 
 B)False

Question 5

As a general rule,the optimal capital structure

Accepted Answer

A) maximizes expected EPS and also maximizes the price per share of common stock. 
B) minimizes the interest rate on debt and also maximizes the expected EPS. 
C) minimizes the required rate on equity and also maximizes the stock price. 
D) maximizes the price per share of common stock and also minimizes the weighted average cost of capital. 
A) maximizes expected EPS and also maximizes the price per share of common stock. 
B) minimizes the interest rate on debt and also maximizes the expected EPS. 
C) minimizes the required rate on equity and also maximizes the stock price. 
D) maximizes the price per share of common stock and also minimizes the weighted average cost of capital.

Question 6

Use the following information to answer the following question(s).
Your firm is trying to determine whether it should finance a project requiring $800,000 with new common stock or with debt.The firm is faced with the following financing alternatives:
I: Issue new common stock.Sale price of the common stock is expected to be $40 per share.
II: Issue new bonds with a coupon rate of 12%.
The firm has a marginal tax rate of 34%,the company currently has 40,000 shares of common stock outstanding,and $90,000 face value of 10% debt outstanding.
-The total interest obligation will be

Accepted Answer

A) $105,000 under alternative I and $9,000 under alternative II. 
B) $9,000 under alternative I and $105,000 under alternative II. 
C) zero under alternative I and $96,000 under alternative II. 
D) $105,000 under both alternative I and alternative II. 
A) $105,000 under alternative I and $9,000 under alternative II. 
B) $9,000 under alternative I and $105,000 under alternative II. 
C) zero under alternative I and $96,000 under alternative II. 
D) $105,000 under both alternative I and alternative II.

Question 7

The inclusion of bankruptcy costs and taxes in firm valuation

Accepted Answer

A) causes the cost of capital curve to be umbrella shaped. 
B) is consistent with a saucer-shaped cost of capital curve. 
C) is consistent with a cost of capital curve that slopes downward. 
D) causes the cost of capital to rise in a linear fashion as more debt is added to the capital structure. 
A) causes the cost of capital curve to be umbrella shaped. 
B) is consistent with a saucer-shaped cost of capital curve. 
C) is consistent with a cost of capital curve that slopes downward. 
D) causes the cost of capital to rise in a linear fashion as more debt is added to the capital structure.

Question 8

Suppose we calculate a times interest earned ratio of 29 for Colgate-Palmolive.We can conclude

Accepted Answer

A) Colgate-Palmolive may experience some difficulty meeting its interest payments. 
B) Colgate-Palmolive is very unlikely to have difficulty meeting its interest payments. 
C) Colgate-Palmolive has $29 of operating cash flow for every dollar of interest expense. 
D) Colgate-Palmolive's EBITDA is 29 times larger than its interest expense. 
A) Colgate-Palmolive may experience some difficulty meeting its interest payments. 
B) Colgate-Palmolive is very unlikely to have difficulty meeting its interest payments. 
C) Colgate-Palmolive has $29 of operating cash flow for every dollar of interest expense. 
D) Colgate-Palmolive's EBITDA is 29 times larger than its interest expense.

Question 9

Fibonacci Property Management's balance sheet shows total liabilities of $5 million and total assets of $13 million.Interest bearing liabilities total $3 million (book value).Excess cash $500,000.The market value of Fibonnacci's equity is $21 million.What is Fibonacci's Debt to Enterprise Value ratio?

Accepted Answer

A) .38 
B) .23 
C) .125 
D) .106 
A) .38 
B) .23 
C) .125 
D) .106

Question 10

Given the existence of taxes and bankruptcy costs,the optimal capital structure is 100% debt.

Accepted Answer

A) True 
 B)False

Question 11

Roberts,Inc.is trying to decide how best to finance a proposed $10 million capital investment.Under Plan I,the project will be financed entirely with long-term 9% bonds.The firm currently has no debt or preferred stock.Under Plan II,common stock will be sold to net the firm $20 a share;presently,1 million shares are outstanding.The corporate tax rate for Roberts is 40%.
a.Calculate the indifference level of EBIT associated with the two financing plans.
b.Which financing plan would you expect to cause the greatest change in EPS relative to a change in EBIT? Why?
c.If EBIT is expected to be $3.1 million,which plan will result in a higher EPS?

Accepted Answer

a.(EBIT)(1 - 0.4)/1,500,000 =
(EBIT - $9

Question 12

Cheshire Corporation is now financed 100% with equity.The cost of equity is 15%.Cheshire is considering a proposal to borrow enough money at 7% to buy back half of its common stock.It would then be financed 50% with debt and 50% with equity.Assume that this does not affect the cost of equity.Cheshire's tax rate is 40%.What is Cheshire's cost of capital without and with the stock repurchase?

Accepted Answer

Cheshire's cost of capital is

Question 13

Cornucopia's liabilities and equity are shown below:
 
What is Cornucopia's debt ratio?

Accepted Answer

A) .48 
B) .32 
C) .21 
D) .30 
A) .48 
B) .32 
C) .21 
D) .30

Question 14

Which of the following is consistent with the original formulation of the Modigliani and Miller Capital Structure Theorem?

Accepted Answer

A) A firm's composite cost of capital decreases as financial leverage is used. 
B) A firm's common stock price falls as financial leverage is used. 
C) A firm's composite cost of capital and common stock price are unaffected by the amount of financial leverage used by the firm. 
D) A firm's composite cost of capital increases as operating leverage is used. 
A) A firm's composite cost of capital decreases as financial leverage is used. 
B) A firm's common stock price falls as financial leverage is used. 
C) A firm's composite cost of capital and common stock price are unaffected by the amount of financial leverage used by the firm. 
D) A firm's composite cost of capital increases as operating leverage is used.

Question 15

An increase in the ________ is likely to encourage a corporation to increase its debt ratio.

Accepted Answer

A) corporate tax rate 
B) personal tax rate 
C) company's degree of operating leverage 
D) expected cost of bankruptcy 
A) corporate tax rate 
B) personal tax rate 
C) company's degree of operating leverage 
D) expected cost of bankruptcy

Question 16

Which of the following is the most important factor that affects a firm's financing mix?

Accepted Answer

A) The amount of EPS 
B) The amount of operating income 
C) The number of shares that are outstanding 
D) The predictability of cash flows 
A) The amount of EPS 
B) The amount of operating income 
C) The number of shares that are outstanding 
D) The predictability of cash flows

Question 17

The tradeoff theory of capital structure management assumes

Accepted Answer

A) no corporate income taxes. 
B) cost of equity remains constant with an increase in financial leverage. 
C) firms might fail. 
D) none of the above. 
A) no corporate income taxes. 
B) cost of equity remains constant with an increase in financial leverage. 
C) firms might fail. 
D) none of the above.

Question 18

Optimal capital structure is

Accepted Answer

A) the funding mix that will maximize the company's common stock price. 
B) the mix of all items that appear on the right-hand side of the company's balance sheet. 
C) the mix of funds that will minimize the firm's beta. 
D) the mix of securities that will maximize EPS. 
A) the funding mix that will maximize the company's common stock price. 
B) the mix of all items that appear on the right-hand side of the company's balance sheet. 
C) the mix of funds that will minimize the firm's beta. 
D) the mix of securities that will maximize EPS.

Question 19

When benchmarking a firm's capital structure,management should compare it to

Accepted Answer

A) firms in S&P 500. 
B) firms in the same geographic region. 
C) firms recognized for the quality of their management. 
D) firms in similar lines of business. 
A) firms in S&P 500. 
B) firms in the same geographic region. 
C) firms recognized for the quality of their management. 
D) firms in similar lines of business.

Question 20

Allston-Brighton Corp.has total assets of $10 million,total liabilities of $4 million,of which $1 million are non-interest bearing.Interest expense was $180,000.Earnings before interest and taxes were $2.5 million.Depreciation was $1.5 million.Compute the following ratios: Debt ratio,Interest-bearing debt ratio,Times interest earned ratio,and EBITDA coverage ratio.

Accepted Answer

Debt ratio = $4,000,000/$10,000,000 = .4

Which of the following is a good reason for a company to have higher than average debt ratios.

Rising bankruptcy costs should cause most firms to use less debt and more equity.

Weaknesses of the EBIT-EPS analysis include

The objective of capital structure management is to maximize the market value of the firm's equity.

As a general rule,the optimal capital structure

The inclusion of bankruptcy costs and taxes in firm valuation

Suppose we calculate a times interest earned ratio of 29 for Colgate-Palmolive.We can conclude

Given the existence of taxes and bankruptcy costs,the optimal capital structure is 100% debt.

Cornucopia's liabilities and equity are shown below: What is Cornucopia's debt ratio?

Which of the following is consistent with the original formulation of the Modigliani and Miller Capital Structure Theorem?

An increase in the ________ is likely to encourage a corporation to increase its debt ratio.

Which of the following is the most important factor that affects a firm's financing mix?

The tradeoff theory of capital structure management assumes

Optimal capital structure is

When benchmarking a firm's capital structure,management should compare it to

Getting Started-Principles of Finance

Firms and the Financial Market

Understanding Financial Statements,taxes,and Cash Flows

Financial Analysis-Sizing up Firm Performance

Time Value of Money-The Basics

The Time Value of Money-Annuities and Other Topics

An Introduction to Risk and Return-History of Financial Market Returns

Risk and Return-Capital Market Theory

Debt Valuation and Interest Rates

Stock Valuation

Investment Decision Criteria

Analyzing Project Cash Flows

Risk Analysis and Project Evaluation

The Cost of Capital

Dividend Policy

Financial Forecasting and Planning

Working Capital Management

International Business Finance

Corporate Risk Management

Filters

Exam 15: Capital Structure Policy

Which of the following is a good reason for a company to have higher than average debt ratios.

Rising bankruptcy costs should cause most firms to use less debt and more equity.

Weaknesses of the EBIT-EPS analysis include

The objective of capital structure management is to maximize the market value of the firm's equity.

As a general rule,the optimal capital structure

The inclusion of bankruptcy costs and taxes in firm valuation

Suppose we calculate a times interest earned ratio of 29 for Colgate-Palmolive.We can conclude

Given the existence of taxes and bankruptcy costs,the optimal capital structure is 100% debt.

Cornucopia's liabilities and equity are shown below: What is Cornucopia's debt ratio?

Which of the following is consistent with the original formulation of the Modigliani and Miller Capital Structure Theorem?

An increase in the ________ is likely to encourage a corporation to increase its debt ratio.

Which of the following is the most important factor that affects a firm's financing mix?

The tradeoff theory of capital structure management assumes

Optimal capital structure is

When benchmarking a firm's capital structure,management should compare it to

Getting Started-Principles of Finance

Firms and the Financial Market

Understanding Financial Statements,taxes,and Cash Flows

Financial Analysis-Sizing up Firm Performance

Time Value of Money-The Basics

The Time Value of Money-Annuities and Other Topics

An Introduction to Risk and Return-History of Financial Market Returns

Risk and Return-Capital Market Theory

Debt Valuation and Interest Rates

Stock Valuation

Investment Decision Criteria

Analyzing Project Cash Flows

Risk Analysis and Project Evaluation

The Cost of Capital

Dividend Policy

Financial Forecasting and Planning

Working Capital Management

International Business Finance

Corporate Risk Management

Filters