Question 1

By adding leverage, the returns on a firm are split between debt holders and equity holders, but equity holder risk increases because ________.

Accepted Answer

A)  interest payments can be rolled over 
B)  dividends are paid first 
C)  debt and equity have equal priority 
D)  interest payments have first priority 
A)  interest payments can be rolled over 
B)  dividends are paid first 
C)  debt and equity have equal priority 
D)  interest payments have first priority D

Question 2

Which of the following statements is FALSE?

Accepted Answer

A)  The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its capital structure. 
B)  The most common choices are financing through equity alone and financing through a combination of debt and equity. 
C)  A project's net present value (NPV) represents the value to the new investors of a firm created by the project. 
D)  When corporations raise funds from outside investors, they must choose which type of security to issue. 
A)  The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its capital structure. 
B)  The most common choices are financing through equity alone and financing through a combination of debt and equity. 
C)  A project's net present value (NPV) represents the value to the new investors of a firm created by the project. 
D)  When corporations raise funds from outside investors, they must choose which type of security to issue. C

Question 3

The probability of financial distress depends on the ________.

Accepted Answer

A)  likelihood that a firm will be unable to meet its debt commitments 
B)  chance that a firm's raw material costs will increase 
C)  likelihood of dividend payments 
D)  likelihood of asset growth 
A)  likelihood that a firm will be unable to meet its debt commitments 
B)  chance that a firm's raw material costs will increase 
C)  likelihood of dividend payments 
D)  likelihood of asset growth A

Question 4

A firm that does not have trouble meeting its debt obligations is said to be in financial distress.

Accepted Answer

A) True 
 B)False

Question 5

Under-investment problems refers to the problem that equity holders prefer not to invest in positive-NPV projects in highly levered firms because ________.

Accepted Answer

A)  future investments are contingent on debt financing 
B)  projects are contingent on equity financing 
C)  gains are evenly shared between all stakeholders 
D)  most of the gains from the investment accrue to debt holders 
A)  future investments are contingent on debt financing 
B)  projects are contingent on equity financing 
C)  gains are evenly shared between all stakeholders 
D)  most of the gains from the investment accrue to debt holders

Question 6

In general, issuing equity may not dilute the ownership of existing shareholders if ________.

Accepted Answer

A)  the value of new shares is equal to the value of debt 
B)  the new shares are sold at a fair price 
C)  the firm has no debt financing 
D)  the firm uses debt conservatively 
A)  the value of new shares is equal to the value of debt 
B)  the new shares are sold at a fair price 
C)  the firm has no debt financing 
D)  the firm uses debt conservatively

Question 7

Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share.
-The market value of Luther's non-cash assets is closest to ________.

Accepted Answer

A)  $20 billion 
B)  $19 billion 
C)  $25 billion 
D)  $24 billion 
A)  $20 billion 
B)  $19 billion 
C)  $25 billion 
D)  $24 billion

Question 8

Even if two firms operate in the same industry, they may prefer different choices of debt-equity ratios.

Accepted Answer

A) True 
 B)False

Question 9

With perfect capital markets, because different choices of capital structure offer a benefit to investors, the capital structure affects the value of a firm.

Accepted Answer

A) True 
 B)False

Question 10

A firm requires an investment of $30,000 and borrows $15,000 at 7%. If the return on equity is 19%, what is the firm's pretax WACC?

Accepted Answer

A)  13% 
B)  6.5% 
C)  15.6% 
D)  18.2% 
A)  13% 
B)  6.5% 
C)  15.6% 
D)  18.2%

Question 11

Which of the following statements is FALSE?

Accepted Answer

A)  The Law of One Price implies that leverage will affect the total value of a firm under perfect capital market conditions. 
B)  In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the firm's assets. 
C)  With perfect capital markets, leverage merely changes the allocation of cash flows between debt and equity, without altering the total cash flows of a firm. 
D)  In a perfect capital market, the total value of a firm is equal to the market value of the total cash flows generated by its assets and is not affected by its choice of capital structure. 
A)  The Law of One Price implies that leverage will affect the total value of a firm under perfect capital market conditions. 
B)  In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the firm's assets. 
C)  With perfect capital markets, leverage merely changes the allocation of cash flows between debt and equity, without altering the total cash flows of a firm. 
D)  In a perfect capital market, the total value of a firm is equal to the market value of the total cash flows generated by its assets and is not affected by its choice of capital structure.

Question 12

Managers should not change the capital structure unless it departs significantly from the optimal level because such a change would ________.

Accepted Answer

A)  reduce dividends 
B)  incur transactions costs 
C)  increase fixed costs 
D)  change incentives of stakeholders 
A)  reduce dividends 
B)  incur transactions costs 
C)  increase fixed costs 
D)  change incentives of stakeholders

Question 13

The pecking order hypothesis states that managers will have a preference to fund investment by using ________, followed by ________, and will issue ________ as a last resort.

Accepted Answer

A)  debt, equity, retained earnings 
B)  retained earnings, equity, debt 
C)  retained earnings, debt, equity 
D)  debt, retained earnings, equity 
A)  debt, equity, retained earnings 
B)  retained earnings, equity, debt 
C)  retained earnings, debt, equity 
D)  debt, retained earnings, equity

Question 14

A firm's ________ ratio is the fraction of the firm's total value that corresponds to debt.

Accepted Answer

A)  debt-to-equity 
B)  equity-to-debt 
C)  debt-to-value 
D)  liability 
A)  debt-to-equity 
B)  equity-to-debt 
C)  debt-to-value 
D)  liability

Question 15

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company uses no leverage, what is expected return to equity holders?

Accepted Answer

A)  8.0% 
B)  11.6% 
C)  9.33% 
D)  30.0% 
A)  8.0% 
B)  11.6% 
C)  9.33% 
D)  30.0%

Question 16

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is the return to equity holders if demand is weak?

Accepted Answer

A)  8.0% 
B)  -37.5% 
C)  -58.6% 
D)  10.28% 
A)  8.0% 
B)  -37.5% 
C)  -58.6% 
D)  10.28%

Question 17

What effect does debt have on a firm's weighted average cost of capital?

Accepted Answer

In a world with taxes, interes

Question 18

A firm requires an investment of $20,000 and will return $26,500 after one year. If the firm borrows $6000 at 7%, what is the return on levered equity?

Accepted Answer

A)  35% 
B)  52% 
C)  43% 
D)  61% 
A)  35% 
B)  52% 
C)  43% 
D)  61%

Question 19

Which of the following does a firm consider in the choice of securities issued?

Accepted Answer

A)  the tax consequences of the chosen security 
B)  the transactions costs of the chosen security 
C)  whether the chosen security will have a fair price in the market 
D)  All of the above are considered. 
A)  the tax consequences of the chosen security 
B)  the transactions costs of the chosen security 
C)  whether the chosen security will have a fair price in the market 
D)  All of the above are considered.

Question 20

What are the issues in determining the optimal leverage for a firm?

Accepted Answer

While interest tax shield tends to incre

Exam 16: Capital Structure

By adding leverage, the returns on a firm are split between debt holders and equity holders, but equity holder risk increases because ________.

Which of the following statements is FALSE?

The probability of financial distress depends on the ________.

A firm that does not have trouble meeting its debt obligations is said to be in financial distress.

Under-investment problems refers to the problem that equity holders prefer not to invest in positive-NPV projects in highly levered firms because ________.

In general, issuing equity may not dilute the ownership of existing shareholders if ________.

Even if two firms operate in the same industry, they may prefer different choices of debt-equity ratios.

With perfect capital markets, because different choices of capital structure offer a benefit to investors, the capital structure affects the value of a firm.

A firm requires an investment of $30,000 and borrows $15,000 at 7%. If the return on equity is 19%, what is the firm's pretax WACC?

Which of the following statements is FALSE?

Managers should not change the capital structure unless it departs significantly from the optimal level because such a change would ________.

The pecking order hypothesis states that managers will have a preference to fund investment by using ________, followed by ________, and will issue ________ as a last resort.

A firm's ________ ratio is the fraction of the firm's total value that corresponds to debt.

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company uses no leverage, what is expected return to equity holders?

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is the return to equity holders if demand is weak?

What effect does debt have on a firm's weighted average cost of capital?

A firm requires an investment of $20,000 and will return $26,500 after one year. If the firm borrows $6000 at 7%, what is the return on levered equity?

Which of the following does a firm consider in the choice of securities issued?

What are the issues in determining the optimal leverage for a firm?

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

Time Value of Money: an Introduction

Time Value of Money: Valuing Cash Flow Streams

Interest Rates

Bonds

Stock Valuation

Investment Decision Rules

Fundamentals of Capital Budgeting

Stock Valuation: a Second Look

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

The Cost of Capital

Raising Equity Capital

Debt Financing

Payout Policy

Financial Modeling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Option Applications and Corporate Finance

Mergers and Acquisitions

International Corporate Finance

Leasing

Insurance and Risk Management

Corporate Governance

Filters

The pecking order hypothesis states that managers will have a preference to fund investment by using , followed by , and will issue as a last resort.