Question 1

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.

Accepted Answer

A) True 
 B)False

Question 2

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?

Accepted Answer

A)   $3, 200
B)   $3, 600
C)   $4, 000
D)   $4, 200
E)   $4, 800F) B) and C)
G) A) and B)

Question 3

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?

Accepted Answer

A)   $40
B)   $48
C)   $52
D)   $54
E)   $60F) None of the above
G) B) and C)

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)   There is no reason to think that changes in the personal tax rate would affect firms' capital structure decisions.
B)   A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.
C)   If a firm's after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt.
D)   Suppose a firm has less than its optimal amount of debt.Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity financing.
E)   In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.F) All of the above
G) B) and C)

Question 5

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

Accepted Answer

A)   An increase in the corporate tax rate.
B)   An increase in the personal tax rate.
C)   The Federal Reserve tightens interest rates in an effort to fight inflation.
D)   The company's stock price hits a new low.
E)   An increase in costs incurred when filing for bankruptcy.F) A) and B)
G) A) and D)

Question 6

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

Accepted Answer

A)   An increase in the personal tax rate.
B)   An increase in the company's operating leverage.
C)   The Federal Reserve tightens interest rates in an effort to fight inflation.
D)   The company's stock price hits a new high.
E)   An increase in the corporate tax rate.F) C) and D)
G) None of the above

Question 7

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?

Accepted Answer

A)   HD should have a higher times interest earned (TI
E)  ratio than LD.
B)   HD should have a higher return on equity (RO
E)  than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD's.
C)   Given that BEP > rd, HD's stock price must exceed that of LD.
D)   Given that BEP > rd, LD's stock price must exceed that of HD.
E)   HD should have a higher return on assets (RO
A)  than LD.F) All of the above
G) C) and E)

Question 8

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

Accepted Answer

A)   9.64% $497, 925
B)   9.83% $507, 884
C)   10.03% $518, 041
D)   10.23% $528, 402
E)   10.74% $538, 970F) C) and D)
G) A) and B)

Question 9

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.

Accepted Answer

A) True 
 B)False

Question 10

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

Accepted Answer

A)   normally lead to a decrease in its business risk.
B)   normally lead to a decrease in the standard deviation of its expected EBIT.
C)   normally lead to a decrease in the variability of its expected EPS.
D)   normally lead to a reduction in its fixed assets turnover ratio.
E)   normally lead to an increase in its fixed assets turnover ratio.F) A) and B)
G) A) and C)

Question 11

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.

Accepted Answer

A) True 
 B)False

Question 12

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.

Accepted Answer

A) True 
 B)False

Exam 15: Capital structure decisions

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.

Correct Answer
verified

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.

Correct Answer
verified

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.

Correct Answer
verified

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.

Correct Answer
verified

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

Correct Answer
verified

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

Correct Answer
verified

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

Correct Answer
verified

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?

Correct Answer
verified

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

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

Correct Answer
verified

Correct Answer
verified

Exam 15: Capital structure decisions

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.

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct Answer
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