Question 1

Which of the following is a difference between acquiring an asset with a capital lease or using debt to purchase the asset?

Accepted Answer

A)  The lease does not appear as a liability on the balance sheet. 
B)  The lessee can depreciate the asset over the length of the lease rather than over its useful life. 
C)  The lessee does not retain the salvage value of the asset. 
D)  The lessee is not responsible for repairs, maintenance and insurance on the asset. 
A)  The lease does not appear as a liability on the balance sheet. 
B)  The lessee can depreciate the asset over the length of the lease rather than over its useful life. 
C)  The lessee does not retain the salvage value of the asset. 
D)  The lessee is not responsible for repairs, maintenance and insurance on the asset.

Question 2

Which of the following will happen if the original Modigliani and Miller Theorem is relaxed to include taxes, but not bankruptcy costs?

Accepted Answer

A)  Increased usage of financial leverage will increase a firm's weighted average cost of capital indefinitely. 
B)  Increased usage of financial leverage will lower a firm's weighted average cost of capital indefinitely. 
C)  Increased usage of financial leverage will not affect a firm's weighted average cost of capital. 
D)  Increased usage of operating leverage will increase a firm's weighted average cost of capital indefinitely. 
A)  Increased usage of financial leverage will increase a firm's weighted average cost of capital indefinitely. 
B)  Increased usage of financial leverage will lower a firm's weighted average cost of capital indefinitely. 
C)  Increased usage of financial leverage will not affect a firm's weighted average cost of capital. 
D)  Increased usage of operating leverage will increase a firm's weighted average cost of capital indefinitely.

Question 3

Using the original Modigliani and Miller assumptions if a firm's cost of capital is 12% when it is all equity financed and it's cost of debt is 8%, the cost of equity will be ________% when the firm is financed with equal amount of debt and equity.

Accepted Answer

A)  12% 
B)  24% 
C)  16% 
D)  cannot be determined with the information given. 
A)  12% 
B)  24% 
C)  16% 
D)  cannot be determined with the information given.

Question 4

A firm's capital structure consists of which of the following?

Accepted Answer

A)  The amount of debt that a firm utilizes 
B)  The amount of debt and preferred stock that a firm utilizes 
C)  The amount of interest-bearing debt, preferred stock, and common stock that a firm utilizes 
D)  The mix of long and short-term debt used by the firm. 
A)  The amount of debt that a firm utilizes 
B)  The amount of debt and preferred stock that a firm utilizes 
C)  The amount of interest-bearing debt, preferred stock, and common stock that a firm utilizes 
D)  The mix of long and short-term debt used by the firm.

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

The Modigliani and Miller Capital Structure Theorem, in its original form

Accepted Answer

A)  uses unrealistic assumptions. 
B)  provided important insights into capital structure policy. 
C)  concludes that how a firm is financed is not important. 
D)  all of the above. 
A)  uses unrealistic assumptions. 
B)  provided important insights into capital structure policy. 
C)  concludes that how a firm is financed is not important. 
D)  all of the above.

Question 7

Which of the following is part of a firm's financial structure but NOT a component of its capital structure?

Accepted Answer

A)  Retained earnings 
B)  Mortgage bonds 
C)  Accounts payable 
D)  Both A and C 
A)  Retained earnings 
B)  Mortgage bonds 
C)  Accounts payable 
D)  Both A and C

Question 8

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 9

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 it's interest payments. 
B)  Colgate-Palmolive is very unlikely to have difficulty meeting it's 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 it's interest payments. 
B)  Colgate-Palmolive is very unlikely to have difficulty meeting it's 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 10

A company whose rate of return on investments is higher than the interest rate on its debt is said to have

Accepted Answer

A)  unfavorable financial leverage. 
B)  a sub-optimal capital structure. 
C)  favorable financial leverage. 
D)  negative financial leverage. 
A)  unfavorable financial leverage. 
B)  a sub-optimal capital structure. 
C)  favorable financial leverage. 
D)  negative financial leverage.

Question 11

An optimal capital structure is achieved

Accepted Answer

A)  when a firm's expected profits are maximized. 
B)  when a firm's expected EPS are maximized. 
C)  when a firm's expected stock price is maximized. 
D)  when a firm's break-even point is achieved. 
A)  when a firm's expected profits are maximized. 
B)  when a firm's expected EPS are maximized. 
C)  when a firm's expected stock price is maximized. 
D)  when a firm's break-even point is achieved.

Question 12

Sunshine Candy Company's capital structure for the past year of operation is shown below.
First mortgage bonds at 12% $2,000,000
Debentures at 15% 1,500,000
Common stock (1 million shares) 5,000,000
Retained earnings 500,000
Total $9,000,000
The federal tax rate is 50%. Sunshine Candy Company, home-based in Orlando, wants to raise an additional $1 million to open new facilities in Tampa and Miami. The firm can accomplish this via two alternatives: (1) it can sell a new issue of 20-year debentures with 16% interest; or (2) 20,000 new shares of common stock can be sold to the public to net the candy company $50 per share. A recent study, performed by an outside consulting organization, projected Sunshine Candy Company's long-term EBIT level at approximately $6.8 million. Find the indifference level of EBIT (with regard to EPS) between the suggested financing plans.

Accepted Answer

[(EBIT - 465,000)(0.5)]/1,020,000 =
[(EB

Question 13

When using an EPS-EBIT chart to evaluate a pure debt financing and pure equity financing plan, the debt financing plan line will have

Accepted Answer

A)  a steeper slope than the equity financing plan line. 
B)  a slower rate of change as EBIT increases. 
C)  a downward slope. 
D)  the same slope as the equity plan, but a higher intercept. 
A)  a steeper slope than the equity financing plan line. 
B)  a slower rate of change as EBIT increases. 
C)  a downward slope. 
D)  the same slope as the equity plan, but a higher intercept.

Question 14

A firm's financial structure is defined by the Debt Ratio, while it's capital structure is defined by the Debt to Value ratio.

Accepted Answer

A) True 
 B)False

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

If interest expense lowers taxes, why does the WACC not decrease indefinitely with the addition of more debt?

Accepted Answer

A)  The tax shield effect of debt will result in a lower cost of equity. 
B)  Increasing debt too much can result in a greater likelihood of firm failure (financial distress). 
C)  A firm's common stock price will not be affected by the amount of debt a firm uses. 
D)  Too much common equity increases the probability of bankruptcy. 
A)  The tax shield effect of debt will result in a lower cost of equity. 
B)  Increasing debt too much can result in a greater likelihood of firm failure (financial distress). 
C)  A firm's common stock price will not be affected by the amount of debt a firm uses. 
D)  Too much common equity increases the probability of bankruptcy.

Which of the following is a difference between acquiring an asset with a capital lease or using debt to purchase the asset?

Which of the following will happen if the original Modigliani and Miller Theorem is relaxed to include taxes, but not bankruptcy costs?

Using the original Modigliani and Miller assumptions if a firm's cost of capital is 12% when it is all equity financed and it's cost of debt is 8%, the cost of equity will be ________% when the firm is financed with equal amount of debt and equity.

A firm's capital structure consists of which of the following?

As a general rule, the optimal capital structure

The Modigliani and Miller Capital Structure Theorem, in its original form

Which of the following is part of a firm's financial structure but NOT a component of its capital structure?

Weaknesses of the EBIT-EPS analysis include

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

A company whose rate of return on investments is higher than the interest rate on its debt is said to have

An optimal capital structure is achieved

When using an EPS-EBIT chart to evaluate a pure debt financing and pure equity financing plan, the debt financing plan line will have

A firm's financial structure is defined by the Debt Ratio, while it's capital structure is defined by the Debt to Value ratio.

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

If interest expense lowers taxes, why does the WACC not decrease indefinitely with the addition of more debt?

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 difference between acquiring an asset with a capital lease or using debt to purchase the asset?

Which of the following will happen if the original Modigliani and Miller Theorem is relaxed to include taxes, but not bankruptcy costs?

Using the original Modigliani and Miller assumptions if a firm's cost of capital is 12% when it is all equity financed and it's cost of debt is 8%, the cost of equity will be ________% when the firm is financed with equal amount of debt and equity.

A firm's capital structure consists of which of the following?

As a general rule, the optimal capital structure

The Modigliani and Miller Capital Structure Theorem, in its original form

Which of the following is part of a firm's financial structure but NOT a component of its capital structure?

Weaknesses of the EBIT-EPS analysis include

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

A company whose rate of return on investments is higher than the interest rate on its debt is said to have

An optimal capital structure is achieved

When using an EPS-EBIT chart to evaluate a pure debt financing and pure equity financing plan, the debt financing plan line will have

A firm's financial structure is defined by the Debt Ratio, while it's capital structure is defined by the Debt to Value ratio.

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

If interest expense lowers taxes, why does the WACC not decrease indefinitely with the addition of more debt?

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