Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. 
B)  Drug companies (prescription, not illegal!)generally have high debt-to-equity ratios because their earnings are very stable and, thus, they can cover the high interest costs associated with high debt levels. 
C)  Wide variations in capital structures exist both between industries and among individual firms within given industries.These differences are caused by differing business risks and also managerial attitudes. 
D)  Since most stocks sell at or very close to their book values, book value capital structures are almost always adequate for use in estimating firms' costs of capital. 
E)  Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry. 
A)  Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. 
B)  Drug companies (prescription, not illegal!)generally have high debt-to-equity ratios because their earnings are very stable and, thus, they can cover the high interest costs associated with high debt levels. 
C)  Wide variations in capital structures exist both between industries and among individual firms within given industries.These differences are caused by differing business risks and also managerial attitudes. 
D)  Since most stocks sell at or very close to their book values, book value capital structures are almost always adequate for use in estimating firms' costs of capital. 
E)  Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry. C

Question 2

Refer to Exhibit 15.2.Now assume that VF is considering changing from its original zero debt capital structure to a new capital structure with even more debt.This results in changes in the cost of debt and equity, and thus to a new WACC and a new value of operations.Assume VF raises the amount of new debt indicated below and uses the funds to purchase and hold T-bills until it makes the stock repurchase.What is the stock price per share immediately after issuing the debt but prior to the repurchase?

Accepted Answer

A)  $50.67 
B)  $53.33 
C)  $56.00 
D)  $58.80 
E)  $61.74 
A)  $50.67 
B)  $53.33 
C)  $56.00 
D)  $58.80 
E)  $61.74 B

Question 3

Firm A has a higher degree of business risk than Firm B.Firm A can offset this by using less financial leverage.Therefore, the variability of both firms' expected EBITs could actually be identical.

Accepted Answer

A) True 
 B)False  False

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)  The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. 
B)  The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. 
C)  The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. 
D)  The optimal capital structure simultaneously maximizes stock price and minimizes the WACC. 
E)  As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. 
A)  The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. 
B)  The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. 
C)  The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. 
D)  The optimal capital structure simultaneously maximizes stock price and minimizes the WACC. 
E)  As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.

Question 5

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Accepted Answer

A) True 
 B)False

Question 6

Which of the following statements is CORRECT?

Accepted Answer

A)  The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price. 
B)  The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes its earnings per share. 
C)  If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio must reduce its WACC. 
D)  Other things held constant, if corporate tax rates declined, then the Modigliani-Miller tax-adjusted tradeoff theory would suggest that firms should increase their use of debt. 
E)  A firm can use retained earnings without paying a flotation cost.Therefore, while the cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of debt. 
A)  The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price. 
B)  The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes its earnings per share. 
C)  If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio must reduce its WACC. 
D)  Other things held constant, if corporate tax rates declined, then the Modigliani-Miller tax-adjusted tradeoff theory would suggest that firms should increase their use of debt. 
E)  A firm can use retained earnings without paying a flotation cost.Therefore, while the cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of debt.

Question 7

Which of the following statements is CORRECT?

Accepted Answer

A)  A change in the personal tax rate should not affect firms' capital structure decisions. 
B)  "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage. 
C)  The optimal capital structure is the one that simultaneously (1)maximizes the price of the firm's stock, (2)minimizes its WACC, and (3)maximizes its EPS. 
D)  If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation. 
E)  If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt. 
A)  A change in the personal tax rate should not affect firms' capital structure decisions. 
B)  "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage. 
C)  The optimal capital structure is the one that simultaneously (1)maximizes the price of the firm's stock, (2)minimizes its WACC, and (3)maximizes its EPS. 
D)  If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation. 
E)  If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.

Question 8

A new company to produce state-of-the-art car stereo systems is being considered by Jagger Enterprises.The sales price would be set at 1.5 times the variable cost per unit; the VC/unit is estimated to be $2.50; and fixed costs are estimated at $120, 000.What sales volume would be required in order to break even, i.e., to have an EBIT of zero for the stereo business?

Accepted Answer

A)  86, 640 
B)  91, 200 
C)  96, 000 
D)  100, 800 
E)  105, 840 
A)  86, 640 
B)  91, 200 
C)  96, 000 
D)  100, 800 
E)  105, 840

Question 9

Blueline Publishers is considering a recapitalization plan.It is currently 100% equity financed but under the plan it would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock.The recapitalization would not change the company's total assets, nor would it affect the firm's basic earning power, which is currently 15%.The CFO believes that this recapitalization would reduce the WACC and increase stock price.Which of the following would also be likely to occur if the company goes ahead with the recapitalization plan?

Accepted Answer

A)  The company's earnings per share would decline. 
B)  The company's cost of equity would increase. 
C)  The company's ROA would increase. 
D)  The company's ROE would decline. 
E)  The company's net income would increase. 
A)  The company's earnings per share would decline. 
B)  The company's cost of equity would increase. 
C)  The company's ROA would increase. 
D)  The company's ROE would decline. 
E)  The company's net income would increase.

Question 10

Morales Publishing's tax rate is 40%, its beta is 1.10, and it uses no debt.However, the CFO is considering moving to a capital structure with 30% debt and 70% equity.If the risk-free rate is 5.0% and the market risk premium is 6.0%, by how much would the capital structure shift change the firm's cost of equity?

Accepted Answer

A)  1.53% 
B)  1.70% 
C)  1.87% 
D)  2.05% 
E)  2.26% 
A)  1.53% 
B)  1.70% 
C)  1.87% 
D)  2.05% 
E)  2.26%

Question 11

Serendipity Inc.is re-evaluating its debt level.Its current capital structure consists of 80% debt and 20% common equity, its beta is 1.60, and its tax rate is 35%.However, the CFO thinks the company has too much debt, and he is considering moving to a capital structure with 40% debt and 60% equity.The risk-free rate is 5.0% and the market risk premium is 6.0%.By how much would the capital structure shift change the firm's cost of equity?

Accepted Answer

A)  -5.20% 
B)  -5.78% 
C)  -6.36% 
D)  -6.99% 
E)  -7.69% 
A)  -5.20% 
B)  -5.78% 
C)  -6.36% 
D)  -6.99% 
E)  -7.69%

Question 12

Larsen Films' is analyzing its cost structure.Its fixed operating costs are $470, 000, its variable costs of $2.80 per unit produced, and its products sell for $4.00 per unit.What is the company's breakeven point, i.e., at what unit sales volume would income equal costs?

Accepted Answer

A)  391, 667 
B)  411, 250 
C)  431, 813 
D)  453, 403 
E)  476, 073 
A)  391, 667 
B)  411, 250 
C)  431, 813 
D)  453, 403 
E)  476, 073

Question 13

Which of the following statements is CORRECT?

Accepted Answer

A)  The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share. 
B)  The capital structure that maximizes the stock price is also the capital structure that maximizes the firm's times interest earned (TI
E) ratio. 
C)  Increasing a company's debt ratio will typically reduce the marginal costs of both debt and equity financing; however, this still may raise the company's WACC. 
D)  If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios. 
E)  The capital structure that maximizes the stock price is also the capital structure that minimizes the weighted average cost of capital (WAC
C) . 
A)  The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share. 
B)  The capital structure that maximizes the stock price is also the capital structure that maximizes the firm's times interest earned (TI
E) ratio. 
C)  Increasing a company's debt ratio will typically reduce the marginal costs of both debt and equity financing; however, this still may raise the company's WACC. 
D)  If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios. 
E)  The capital structure that maximizes the stock price is also the capital structure that minimizes the weighted average cost of capital (WAC
C) .

Question 14

If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal.

Accepted Answer

A) True 
 B)False

Question 15

Firms U and L both have a basic earning power ratio of 20% and each has the same amount of assets.Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity.Firm L's debt has a before-tax cost of 8%.Both firms have positive net income.Which of the following statements is CORRECT?

Accepted Answer

A)  Firm L has a lower ROA than Firm U. 
B)  Firm L has a lower ROE than Firm U. 
C)  Firm L has the higher times interest earned (TI
E) ratio. 
D)  Firm L has a higher EBIT than Firm U. 
E)  The two companies have the same times interest earned (TI
E) ratio. 
A)  Firm L has a lower ROA than Firm U. 
B)  Firm L has a lower ROE than Firm U. 
C)  Firm L has the higher times interest earned (TI
E) ratio. 
D)  Firm L has a higher EBIT than Firm U. 
E)  The two companies have the same times interest earned (TI
E) ratio.

Question 16

Refer to Exhibit 15.3.Now assume that BB is considering changing from its original capital structure to a new capital structure with 45% debt and 55% equity.This results in a weighted average cost of capital equal to 10.4% and a new value of operations of $576, 923.Assume BB raises $259, 615 in new debt and purchases T-bills to hold until it makes the stock repurchase.What is the stock price per share immediately after issuing the debt but prior to the repurchase?

Accepted Answer

A)  $14.42 
B)  $19.36 
C)  $23.91 
D)  $28.85 
E)  $35.62 
A)  $14.42 
B)  $19.36 
C)  $23.91 
D)  $28.85 
E)  $35.62

Question 17

A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.

Accepted Answer

A) True 
 B)False

Question 18

Which of these items will not generally be affected by an increase in the debt ratio?

Accepted Answer

A)  Total risk. 
B)  Financial risk. 
C)  Market risk. 
D)  The firm's beta. 
E)  Business risk. 
A)  Total risk. 
B)  Financial risk. 
C)  Market risk. 
D)  The firm's beta. 
E)  Business risk.

Question 19

The firm's target capital structure should be consistent with which of the following statements?

Accepted Answer

A)  Minimize the cost of debt (rd). 
B)  Obtain the highest possible bond rating. 
C)  Minimize the cost of equity (rs). 
D)  Minimize the weighted average cost of capital (WAC
C) . 
E)  Maximize the earnings per share (EPS). 
A)  Minimize the cost of debt (rd). 
B)  Obtain the highest possible bond rating. 
C)  Minimize the cost of equity (rs). 
D)  Minimize the weighted average cost of capital (WAC
C) . 
E)  Maximize the earnings per share (EPS).

Question 20

Firms HD and LD are identical except for their level of debt and the interest rates they pay on debt¾HD has more debt and pays a higher interest rate on that debt.Based on the data given below, what is the difference between the two firms' ROEs?

Accepted Answer

A)  2.18% 
B)  2.29% 
C)  2.41% 
D)  2.54% 
E)  2.66% 
A)  2.18% 
B)  2.29% 
C)  2.41% 
D)  2.54% 
E)  2.66%

Which of the following statements is CORRECT?

Firm A has a higher degree of business risk than Firm B.Firm A can offset this by using less financial leverage.Therefore, the variability of both firms' expected EBITs could actually be identical.

Which of the following statements is CORRECT?

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Larsen Films' is analyzing its cost structure.Its fixed operating costs are $470, 000, its variable costs of $2.80 per unit produced, and its products sell for $4.00 per unit.What is the company's breakeven point, i.e., at what unit sales volume would income equal costs?

Which of the following statements is CORRECT?

If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal.

A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.

Which of these items will not generally be affected by an increase in the debt ratio?

The firm's target capital structure should be consistent with which of the following statements?

Firms HD and LD are identical except for their level of debt and the interest rates they pay on debt¾HD has more debt and pays a higher interest rate on that debt.Based on the data given below, what is the difference between the two firms' ROEs?

An overview of financial management and the financial environment

Financial statements, cash flow, and taxes

Analysis of financial statements

Time value of money

Bonds, bond valuation, and interest rates

Risk and return

Valuation of stocks and corporations

Financial options and applications in corporate finance

The cost of capital

The basics of capital budgeting: evaluating cash flows

Cash flow estimation and risk analysis

Corporate valuation and financial planning

Agency conflicts and corporate governance

Distributions to shareholders: dividends and repurchases

Supply chains and working capital management

Multinational financial management

Filters

Exam 15: Capital structure decisions

Which of the following statements is CORRECT?

Firm A has a higher degree of business risk than Firm B.Firm A can offset this by using less financial leverage.Therefore, the variability of both firms' expected EBITs could actually be identical.

Which of the following statements is CORRECT?

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Larsen Films' is analyzing its cost structure.Its fixed operating costs are $470, 000, its variable costs of $2.80 per unit produced, and its products sell for $4.00 per unit.What is the company's breakeven point, i.e., at what unit sales volume would income equal costs?

Which of the following statements is CORRECT?

If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal.

A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.

Which of these items will not generally be affected by an increase in the debt ratio?

The firm's target capital structure should be consistent with which of the following statements?

Firms HD and LD are identical except for their level of debt and the interest rates they pay on debt¾HD has more debt and pays a higher interest rate on that debt.Based on the data given below, what is the difference between the two firms' ROEs?

An overview of financial management and the financial environment

Financial statements, cash flow, and taxes

Analysis of financial statements

Time value of money

Bonds, bond valuation, and interest rates

Risk and return

Valuation of stocks and corporations

Financial options and applications in corporate finance

The cost of capital

The basics of capital budgeting: evaluating cash flows

Cash flow estimation and risk analysis

Corporate valuation and financial planning

Agency conflicts and corporate governance

Distributions to shareholders: dividends and repurchases

Supply chains and working capital management

Multinational financial management

Filters