Question 1

In a world with corporate taxes but no possibility of financial distress,the value of the firm is maximized when the:

Accepted Answer

A)   firm uses no debt in its capital structure.
B)   firm uses no equity in its capital structure.
C)   firm uses a debt-equity ratio of 1.0.
D)   corporate tax rate approaches 100%.E) B) and C)
F) A) and D)

Question 2

The "trade-off theory" of capital structure suggests that:

Accepted Answer

A)   Firms add leverage whenever interest rates are low.
B)   Firms with higher risk should use less debt.
C)   Firms should use 50% debt and 50% equity.
D)   Firms should use debt to overcome high par values of stock.E) A) and D)
F) A) and C)

Question 3

The pecking-order theory suggests that less profitable firms borrow more because:

Accepted Answer

A)   equity issues are more expensive.
B)   leverage is preferred over raising funds internally.
C)   debt issues are good omens.
D)   they have insufficient internal funds.E) None of the above
F) B) and D)

Question 4

The present value of a perpetual tax shield increases as the firm's tax rate _____ and the amount of principal _____.

Accepted Answer

A)   increases; increases
B)   increases; decreases
C)   decreases; decreases
D)   decreases; increasesE) A) and C)
F) A) and D)

Question 5

When large firms file for bankruptcy:

Accepted Answer

A)   the proceedings involve costly delays and legal tangles, and the business continues to deteriorate.
B)   their purpose is usually to nurse the firm back to health and enable it to face the world again.
C)   their benefit is that their creditors will be forced by law to give up their claims on the firm.
D)   their creditors often try to seize the assets as soon as possible.E) C) and D)
F) A) and B)

Question 6

Calculate the required return on the debt.

Accepted Answer

The answer of Calculate the required return on the debt....

Question 7

Which of the following is an example of restructuring the firm?

Accepted Answer

A)   dividends are increased from $1 to $2 per share.
B)   a new investment increases the firm's business risk.
C)   new equity is issued and the proceeds repay debt.
D)   a new board of directors is elected to the firm.E) A) and B)
F) None of the above

Question 8

Management's perceived signals to investors form an important component of pecking-order theory.

Accepted Answer

A) True 
 B)False

Question 9

The interest tax shield is equal to the:

Accepted Answer

A)   difference between interest expense and income taxes.
B)   amount of interest paid in a given year.
C)   product of the interest expense and the tax rate.
D)   product of the debt principal and the interest rate on debt.E) None of the above
F) All of the above

Question 10

As the debt to equity ratio decreases when debt is not risk free:

Accepted Answer

A)   debt holders demand a higher expected return.
B)   debt holders demand a lower expected return.
C)   the expected return on equity increases.
D)   the expected return on assets increases.E) A) and B)
F) A) and D)

Question 11

Ignoring taxes,a firm's weighted-average cost of capital is equal to:

Accepted Answer

A)   its expected return on assets.
B)   its expected return on equity.
C)   the sum of expected return on equity and expected return on debt.
D)   its expected return on assets times the debt-equity ratio.E) C) and D)
F) A) and D)

Question 12

A decrease of debt in the capital structure tends to reduce a firm's EPS when the firm:

Accepted Answer

A)   faces high interest rates.
B)   faces strong growth in business conditions.
C)   pays taxes.
D)   does not reinvest its earnings.E) C) and D)
F) B) and C)

Question 13

A decrease in the possible range of percentage stock returns can be achieved by:

Accepted Answer

A)   a decrease in the firm's financial leverage.
B)   an increase in the firm's asset risk.
C)   an increase in the firm's business risk.
D)   a decrease in the firm's debt beta.E) B) and C)
F) A) and B)

Question 14

Leverage will __________ shareholders' expected return and _________ their risk.

Accepted Answer

A)   increase; decrease
B)   decrease; increase
C)   increase; increase
D)   increase; do nothing toE) B) and D)
F) A) and D)

Question 15

According to MM II,if the expected return on assets decreases,what happens to the expected return on equity?

Accepted Answer

A)   depends on the firm's capital structure
B)   decreases
C)   remains constant
D)   increasesE) A) and C)
F) A) and B)

Question 16

What is the proportion of debt financing for a firm that expects a 35% return on equity,a 20% return on assets,and a 15% return on debt? Ignore taxes.

Accepted Answer

A)   15%
B)   25%
C)   75%
D)   80%E) All of the above
F) B) and D)

Question 17

Discuss how agency problems can develop between shareholders and bondholders when the firm is experiencing financial distress.

Accepted Answer

Managers/owners may not have the proper ...

Question 18

Equity Inc.is currently an all-equity financed firm.It has 10,000 shares outstanding that sell for $20 each.The firm has an operating income of $30,000 and pays no taxes.The firm contemplates a restructuring that would issue $50,000 in 8% debt,which will be used to repurchase stock.Assuming that individuals have the same borrowing opportunities as corporations,explain how an investor can undo the leverage that is proposed by Equity Inc.Under these conditions,what is the value of restructuring to a firm?

Accepted Answer

Since Equity Inc.will have a debt ratio ...

Question 19

Those who benefit from the interest tax shield are:

Accepted Answer

A)   debt holders.
B)   equity holders.
C)   both debt holders and equity holders.
D)   only the firm's customers benefit from the interest tax shield.E) C) and D)
F) B) and C)

Question 20

A firm issues 100,000 equity shares with a total market value of $5,000,000.The firm's market value of debt is also of equal amount,i.e.,$5,000,000.The firm is expected to generate $1.5 million in operating income and pay $250,000 in interest.Ignoring taxes,this will generate $12.50 earnings per share.What will happen to EPS if the firm's borrowing and interest expense increases by 50% and the number of shares in circulation is cut by 50% (assuming that the share price remains unchanged with this change in capital structure) ?(Use values in dollar.)

Accepted Answer

A)   EPS decrease to $10.00
B)   EPS decrease to $11.67
C)   EPS increase to $15.00
D)   EPS increase to $22.50E) B) and D)
F) None of the above

Exam 16: Debt and Payout Policy

The pecking-order theory suggests that less profitable firms borrow more because:

Correct Answer
verified

Which of the following is an example of restructuring the firm?

Correct Answer
verified

Management's perceived signals to investors form an important component of pecking-order theory.

Correct Answer
verified

Calculate the required return on the debt.

Correct Answer
verified

A decrease of debt in the capital structure tends to reduce a firm's EPS when the firm:

Correct Answer
verified

What is the proportion of debt financing for a firm that expects a 35% return on equity,a 20% return on assets,and a 15% return on debt? Ignore taxes.

Correct Answer
verified

The interest tax shield is equal to the:

Correct Answer
verified

Correct Answer
verified

Ignoring taxes,a firm's weighted-average cost of capital is equal to:

Correct Answer
verified

Discuss how agency problems can develop between shareholders and bondholders when the firm is experiencing financial distress.

Correct Answer
verified
Managers/owners may not have the proper ...
View Answer

Those who benefit from the interest tax shield are:

Correct Answer
verified

The present value of a perpetual tax shield increases as the firm's tax rate _ and the amount of principal _.

Correct Answer
verified

When large firms file for bankruptcy:

Correct Answer
verified

The "trade-off theory" of capital structure suggests that:

Correct Answer
verified

Correct Answer
verified
Since Equity Inc.will have a debt ratio ...
View Answer

In a world with corporate taxes but no possibility of financial distress,the value of the firm is maximized when the:

Correct Answer
verified

According to MM II,if the expected return on assets decreases,what happens to the expected return on equity?

Correct Answer
verified

Leverage will __ shareholders' expected return and _ their risk.

Correct Answer
verified

A decrease in the possible range of percentage stock returns can be achieved by:

Correct Answer
verified

As the debt to equity ratio decreases when debt is not risk free:

Correct Answer
verified

Exam 16: Debt and Payout Policy

The pecking-order theory suggests that less profitable firms borrow more because:

Correct AnswerverifiedShow Answer

Which of the following is an example of restructuring the firm?

Correct AnswerverifiedShow Answer

Management's perceived signals to investors form an important component of pecking-order theory.

Correct AnswerverifiedShow Answer

Calculate the required return on the debt.

Correct AnswerverifiedShow Answer

A decrease of debt in the capital structure tends to reduce a firm's EPS when the firm:

Correct AnswerverifiedShow Answer

What is the proportion of debt financing for a firm that expects a 35% return on equity,a 20% return on assets,and a 15% return on debt? Ignore taxes.

Correct AnswerverifiedShow Answer

The interest tax shield is equal to the:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Ignoring taxes,a firm's weighted-average cost of capital is equal to:

Correct AnswerverifiedShow Answer

Discuss how agency problems can develop between shareholders and bondholders when the firm is experiencing financial distress.

Correct AnswerverifiedManagers/owners may not have the proper ...View AnswerShow Answer

Those who benefit from the interest tax shield are:

Correct AnswerverifiedShow Answer

The present value of a perpetual tax shield increases as the firm's tax rate _____ and the amount of principal _____.

Correct AnswerverifiedShow Answer

When large firms file for bankruptcy:

Correct AnswerverifiedShow Answer

The "trade-off theory" of capital structure suggests that:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedSince Equity Inc.will have a debt ratio ...View AnswerShow Answer

In a world with corporate taxes but no possibility of financial distress,the value of the firm is maximized when the:

Correct AnswerverifiedShow Answer

According to MM II,if the expected return on assets decreases,what happens to the expected return on equity?

Correct AnswerverifiedShow Answer

Leverage will __________ shareholders' expected return and _________ their risk.

Correct AnswerverifiedShow Answer

A decrease in the possible range of percentage stock returns can be achieved by:

Correct AnswerverifiedShow Answer

As the debt to equity ratio decreases when debt is not risk free:

Correct AnswerverifiedShow Answer

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Managers/owners may not have the proper ...
View Answer

Correct Answer
verified

The present value of a perpetual tax shield increases as the firm's tax rate _ and the amount of principal _.

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
Since Equity Inc.will have a debt ratio ...
View Answer

Correct Answer
verified

Correct Answer
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Leverage will __ shareholders' expected return and _ their risk.

Correct Answer
verified

Correct Answer
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Correct Answer
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