Exam 15: Capital structure decisions

Two operationally similar companies, HD and LD, have the same total assets, operating income (EBIT), tax rate, and business risk.Company HD, however, has a much higher debt ratio than LD.Also HD's basic earning power (BEP)exceeds its cost of debt (rd).Which of the following statements is CORRECT?

Two firms, although they operate in different industries, have the same expected earnings per share and the same standard deviation of expected EPS.Thus, the two firms must have the same business risk.

Different borrowers have different risks of bankruptcy, and bankruptcy is costly to lenders.Therefore, lenders charge higher rates to borrowers judged to be more at risk of going bankrupt.

If a firm utilizes debt financing, an X% decline in earnings before interest and taxes (EBIT)will result in a decline in earnings per share that is larger than X.

Which of the following statements is CORRECT? As a firm increases the operating leverage used to produce a given quantity of output, this will

Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant?

The following information has been presented to you about the Gibson Corporation. The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS).The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values)that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%.If the company makes this change, what would be the total market value (in millions)of the firm?

Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant?

The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant.

Refer to Exhibit 15.2.If this plan were carried out, what would be VF's new WACC and its new value of operations? WACC Value

Which of the following statements is CORRECT?

Merriwether Building has operating income of $20 million, a tax rate of 40%, and no debt.It pays out all of its net income as dividends and has a zero growth rate.The current stock price is $40 per share, and it has 2.5 million shares of stock outstanding.If it moves to a capital structure that has 40% debt and 60% equity (based on market values), its investment bankers believe its weighted average cost of capital would be 10%.What would its stock price be if it changes to the new capital structure?