Question 1

Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?

Accepted Answer

A)  consumer claim
B)  dividend payment to preferred shareholder
C)  company contribution to the employees' retirement account
D)  payment to an unsecured creditor
E)  payment of employee wagesF) A) and C)
G) A) and D)

Question 2

The interest tax shield is a key reason why:

Accepted Answer

A)  the required rate of return on assets rises when debt is added to the capital structure.
B)  the value of an unlevered firm is equal to the value of a levered firm.
C)  the net cost of debt to a firm is generally less than the cost of equity.
D)  the cost of debt is equal to the cost of equity for a levered firm.
E)  firms prefer equity financing over debt financing.F) A) and B)
G) None of the above

Question 3

The static theory of capital structure advocates that the optimal capital structure for a firm:

Accepted Answer

A)  is dependent on a constant debt-equity ratio over time.
B)  remains fixed over time.
C)  is independent of the firm's tax rate.
D)  is independent of the firm's weighted average cost of capital.
E)  equates the tax savings from an additional dollar of debt to the increased bankruptcy costs related to that additional dollar of debt.F) C) and D)
G) None of the above

Question 4

You have computed the break-even point between a levered and an unlevered capital structure.Assume there are no taxes.At the break-even level,the:

Accepted Answer

A)  firm is just earning enough to pay for the cost of the debt.
B)  firm's earnings before interest and taxes are equal to zero.
C)  earnings per share for the levered option are exactly double those of the unlevered option.
D)  advantages of leverage exceed the disadvantages of leverage.
E)  firm has a debt-equity ratio of .50.F) C) and E)
G) B) and C)

Question 5

The interest tax shield has no value when a firm has a:
I.tax rate of zero.
II.debt-equity ratio of 1.
III.zero debt.
IV.zero leverage.

Accepted Answer

A)  I and III only
B)  II and IV only
C)  I, III, and IV only
D)  II, III, and IV only
E)  I, II, and IV onlyF) B) and D)
G) C) and D)

Question 6

Based on M & M Proposition II with taxes,the weighted average cost of capital:

Accepted Answer

A)  is equal to the aftertax cost of debt.
B)  has a linear relationship with the cost of equity capital.
C)  is unaffected by the tax rate.
D)  decreases as the debt-equity ratio increases.
E)  is equal to RU × (1 - T
C)  .F) A) and E)
G) A) and D)

Question 7

Which of the following statements are correct in relation to M & M Proposition II with no taxes?
I.The required return on assets is equal to the weighted average cost of capital.
II.Financial risk is determined by the debt-equity ratio.
III.Financial risk determines the return on assets.
IV.The cost of equity declines when the amount of leverage used by a firm rises.

Accepted Answer

A)  I and III only
B)  II and IV only
C)  I and II only
D)  III and IV only
E)  I and IV onlyF) A) and D)
G) C) and D)

Question 8

The capital structure that maximizes the value of a firm also:

Accepted Answer

A)  minimizes financial distress costs.
B)  minimizes the cost of capital.
C)  maximizes the present value of the tax shield on debt.
D)  maximizes the value of the debt.
E)  maximizes the value of the unlevered firm.F) B) and E)
G) C) and D)

Question 9

Holly's is currently an all equity firm that has 9,000 shares of stock outstanding at a market price of $45 a share.The firm has decided to leverage its operations by issuing $120,000 of debt at an interest rate of 9.5 percent.This new debt will be used to repurchase shares of the outstanding stock.The restructuring is expected to increase the earnings per share.What is the minimum level of earnings before interest and taxes that the firm is expecting? Ignore taxes.

Accepted Answer

A)  $38,475
B)  $40,516
C)  $42,000
D)  $44,141
E)  $45,020F) None of the above
G) C) and D)

Question 10

Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by $1,000.Which of the following terms is used to describe this tax savings?

Accepted Answer

A)  interest tax shield
B)  interest credit
C)  financing shield
D)  current tax yield
E)  tax-loss interestF) All of the above
G) A) and B)

Question 11

Which one of the following has the greatest tendency to increase the percentage of debt included in the optimal capital structure of a firm?

Accepted Answer

A)  exceptionally high depreciation expenses
B)  very low marginal tax rate
C)  substantial tax shields from other sources
D)  low probabilities of financial distress
E)  minimal taxable incomeF) A) and B)
G) A) and C)

Question 12

Jefferson & Daughter has a cost of equity of 14.6 percent and a pre-tax cost of debt of 7.8 percent.The required return on the assets is 13.2 percent.What is the firm's debt-equity ratio based on M & M II with no taxes?

Accepted Answer

A)  0.26
B)  0.33
C)  0.37
D)  0.43
E)  0.45F) A) and B)
G) A) and C)

Question 13

By definition,which of the following costs are included in the term "financial distress costs"?
I.direct bankruptcy costs
II.indirect bankruptcy costs
III.direct costs related to being financially distressed,but not bankrupt
IV.indirect costs related to being financially distressed,but not bankrupt

Accepted Answer

A)  I only
B)  III only
C)  I and II only
D)  III and IV only
E)  I, II, III, and IVF) B) and C)
G) C) and D)

Question 14

Which one of the following is the equity risk related to a firm's capital structure policy?

Accepted Answer

A)  market
B)  systematic
C)  extrinsic
D)  business
E)  financialF) A) and D)
G) C) and E)

Question 15

Stacy owns 38 percent of The Town Centre.She has decided to retire and wants to sell all of her shares in this closely held,all equity firm.The other shareholders have agreed to have the firm borrow $650,000 to purchase her shares of stock.What is the total market value of The Town Centre? Ignore taxes.

Accepted Answer

A)  $1,710,526
B)  $1,748,219
C)  $1,771,089
D)  $1,801,406
E)  $1,808,649F) C) and D)
G) A) and E)

Question 16

Which one of the following is the equity risk that is most related to the daily operations of a firm?

Accepted Answer

A)  market risk
B)  systematic risk
C)  extrinsic risk
D)  business risk
E)  financial riskF) A) and C)
G) A) and E)

Question 17

M & M Proposition I with taxes is based on the concept that:

Accepted Answer

A)  the optimal capital structure is the one that is totally financed with equity.
B)  the capital structure of a firm does not matter because investors can use homemade leverage.
C)  a firm's WACC is unaffected by a change in the firm's capital structure.
D)  the value of a firm increases as the firm's debt increases because of the interest tax shield.
E)  the cost of equity increases as the debt-equity ratio of a firm increases.F) B) and E)
G) D) and E)

Question 18

The basic lesson of M & M Theory is that the value of a firm is dependent upon:

Accepted Answer

A)  the firm's capital structure.
B)  the total cash flow of the firm.
C)  minimizing the marketed claims.
D)  the amount of marketed claims to that firm.
E)  size of the stockholders' claims.F) B) and D)
G) B) and C)

Question 19

Hanover Tech is currently an all equity firm that has 320,000 shares of stock outstanding with a market price of $19 a share.The current cost of equity is 15.4 percent and the tax rate is 34 percent.The firm is considering adding $1.2 million of debt with a coupon rate of 8 percent to its capital structure.The debt will be sold at par value.What is the levered value of the equity?

Accepted Answer

A)  $5.209 million
B)  $5.288 million
C)  $5.312 million
D)  $6.512 million
E)  $6.708 millionF) A) and C)
G) B) and C)

Question 20

An unlevered firm has a cost of capital of 17.5 percent and earnings before interest and taxes of $327,500.A levered firm with the same operations and assets has both a book value and a face value of debt of $650,000 with a 7.5 percent annual coupon.The applicable tax rate is 38 percent.What is the value of the levered firm?

Accepted Answer

A)  $1,397,212
B)  $1,398,256
C)  $1,402,509
D)  $1,407,286
E)  $1,414,414F) A) and B)
G) A) and C)

Exam 16: Financial Leverage and Capital Structure Policy

Correct Answer
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Correct Answer
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Based on M & M Proposition II with taxes,the weighted average cost of capital:

Correct Answer
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Which one of the following is the equity risk related to a firm's capital structure policy?

Correct Answer
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Jefferson & Daughter has a cost of equity of 14.6 percent and a pre-tax cost of debt of 7.8 percent.The required return on the assets is 13.2 percent.What is the firm's debt-equity ratio based on M & M II with no taxes?

Correct Answer
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Which one of the following is the equity risk that is most related to the daily operations of a firm?

Correct Answer
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Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?

Correct Answer
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The interest tax shield is a key reason why:

Correct Answer
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Correct Answer
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Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by $1,000.Which of the following terms is used to describe this tax savings?

Correct Answer
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The static theory of capital structure advocates that the optimal capital structure for a firm:

Correct Answer
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Correct Answer
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By definition,which of the following costs are included in the term "financial distress costs"? I.direct bankruptcy costs II.indirect bankruptcy costs III.direct costs related to being financially distressed,but not bankrupt IV.indirect costs related to being financially distressed,but not bankrupt

Correct Answer
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You have computed the break-even point between a levered and an unlevered capital structure.Assume there are no taxes.At the break-even level,the:

Correct Answer
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The interest tax shield has no value when a firm has a: I.tax rate of zero. II.debt-equity ratio of 1. III.zero debt. IV.zero leverage.

Correct Answer
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Which one of the following has the greatest tendency to increase the percentage of debt included in the optimal capital structure of a firm?

Correct Answer
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M & M Proposition I with taxes is based on the concept that:

Correct Answer
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The basic lesson of M & M Theory is that the value of a firm is dependent upon:

Correct Answer
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The capital structure that maximizes the value of a firm also:

Correct Answer
verified

Correct Answer
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Exam 16: Financial Leverage and Capital Structure Policy

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Based on M & M Proposition II with taxes,the weighted average cost of capital:

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Which one of the following is the equity risk related to a firm's capital structure policy?

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Jefferson & Daughter has a cost of equity of 14.6 percent and a pre-tax cost of debt of 7.8 percent.The required return on the assets is 13.2 percent.What is the firm's debt-equity ratio based on M & M II with no taxes?

Correct AnswerverifiedShow Answer

Which one of the following is the equity risk that is most related to the daily operations of a firm?

Correct AnswerverifiedShow Answer

Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?

Correct AnswerverifiedShow Answer

The interest tax shield is a key reason why:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by $1,000.Which of the following terms is used to describe this tax savings?

Correct AnswerverifiedShow Answer

The static theory of capital structure advocates that the optimal capital structure for a firm:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

By definition,which of the following costs are included in the term "financial distress costs"? I.direct bankruptcy costs II.indirect bankruptcy costs III.direct costs related to being financially distressed,but not bankrupt IV.indirect costs related to being financially distressed,but not bankrupt

Correct AnswerverifiedShow Answer

You have computed the break-even point between a levered and an unlevered capital structure.Assume there are no taxes.At the break-even level,the:

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The interest tax shield has no value when a firm has a: I.tax rate of zero. II.debt-equity ratio of 1. III.zero debt. IV.zero leverage.

Correct AnswerverifiedShow Answer

Which one of the following has the greatest tendency to increase the percentage of debt included in the optimal capital structure of a firm?

Correct AnswerverifiedShow Answer

M & M Proposition I with taxes is based on the concept that:

Correct AnswerverifiedShow Answer

The basic lesson of M & M Theory is that the value of a firm is dependent upon:

Correct AnswerverifiedShow Answer

The capital structure that maximizes the value of a firm also:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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Correct Answer
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