Question 1

Which of the following statements is CORRECT?

Accepted Answer

A) As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. 
B) The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. 
C) The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. 
D) The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. 
E) The optimal capital structure simultaneously maximizes stock price and minimizes the WACC. 
A) As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. 
B) The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. 
C) The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. 
D) The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. 
E) The optimal capital structure simultaneously maximizes stock price and minimizes the WACC.

Question 2

firm's target capital structure should be consistent with which of the following statements?

Accepted Answer

A) Maximize the earnings per share (EPS). 
B) Minimize the cost of debt (rd). 
C) Obtain the highest possible bond rating. 
D) Minimize the cost of equity (rs). 
E) Minimize the weighted average cost of capital (WAC
C) . 
A) Maximize the earnings per share (EPS). 
B) Minimize the cost of debt (rd). 
C) Obtain the highest possible bond rating. 
D) Minimize the cost of equity (rs). 
E) Minimize the weighted average cost of capital (WAC
C) .

Question 3

is possible that two firms could have identical financial and operating leverage, yet have different degrees of risk as measured by the variability of EPS.

Accepted Answer

A) True 
 B)False

Question 4

trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A) Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC. 
B) Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC. 
C) Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing.However, this action still may raise the company's WACC. 
D) Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing.However, this action still may lower the company's WACC. 
E) Since a firm's beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity. 
A) Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC. 
B) Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC. 
C) Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing.However, this action still may raise the company's WACC. 
D) Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing.However, this action still may lower the company's WACC. 
E) Since a firm's beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity.

Question 6

Congress Company has identified two methods for producing playing cards.One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards.The other method would use a less expensive machine If the selling price per deck of cards will be the same under each method, at what level of output will the two methods produce the same net operating income (EBIT)?

Accepted Answer

A) 5,000 decks 
B) 10,000 decks 
C) 15,000 decks 
D) 20,000 decks 
E) 25,000 decks 
A) 5,000 decks 
B) 10,000 decks 
C) 15,000 decks 
D) 20,000 decks 
E) 25,000 decks

Question 7

Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Accepted Answer

A) Its sales become less stable over time. 
B) The costs that would be incurred in the event of bankruptcy increase. 
C) Management believes that the firm's stock has become overvalued. 
D) Its degree of operating leverage increases. 
E) The corporate tax rate increases. 
A) Its sales become less stable over time. 
B) The costs that would be incurred in the event of bankruptcy increase. 
C) Management believes that the firm's stock has become overvalued. 
D) Its degree of operating leverage increases. 
E) The corporate tax rate increases.

Question 8

Stephens Electronics is considering a change in its target capital structure, which currently consists of 25% debt and 75% equity.The CFO believes the firm should use more debt, but the CEO is reluctant to increase the debt ratio.The risk-free rate, rRF, is 5.0%, the market risk premium, RPM, is 6.0%, and the firm's tax rate is 40%.Currently, the cost of equity, rs, is 11.5% as determined by the CAPM.What would be the estimated cost of equity if the firm used 60% debt? (Hint: You must first find the current beta and then the unlevered beta to solve the problem.)

Accepted Answer

A) 10.95% 
B) 11.91% 
C) 12.94% 
D) 14.07% 
E) 15.29% 
A) 10.95% 
B) 11.91% 
C) 12.94% 
D) 14.07% 
E) 15.29%

Question 9

Based on the information below, what is Ezzel Enterprises' optimal capital structure?

Accepted Answer

A) Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50. 
B) Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90. 
C) Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20. 
D) Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40. 
E) Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00. 
A) Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50. 
B) Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90. 
C) Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20. 
D) Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40. 
E) Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.

Question 10

Which of the following statements is CORRECT, holding other things constant?

Accepted Answer

A) Firms whose assets are relatively liquid tend to have relatively low bankruptcy costs, hence they tend to use relatively little debt. 
B) An increase in the personal tax rate is likely to increase the debt ratio of the average corporation. 
C) If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation. 
D) An increase in the company's degree of operating leverage is likely to encourage a company to use more debt in its capital structure. 
E) An increase in the corporate tax rate is likely to encourage a company to use more debt in its capital structure. 
A) Firms whose assets are relatively liquid tend to have relatively low bankruptcy costs, hence they tend to use relatively little debt. 
B) An increase in the personal tax rate is likely to increase the debt ratio of the average corporation. 
C) If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation. 
D) An increase in the company's degree of operating leverage is likely to encourage a company to use more debt in its capital structure. 
E) An increase in the corporate tax rate is likely to encourage a company to use more debt in its capital structure.

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A) A firm's business risk is determined solely by the financial characteristics of its industry. 
B) The factors that affect a firm's business risk are affected by industry characteristics and economic conditions.Unfortunately, these factors are generally beyond the control of the firm's management. 
C) One of the benefits to a firm of being at or near its target capital structure is that this eliminates any risk of bankruptcy. 
D) A firm's financial risk can be minimized by diversification. 
E) The amount of debt in its capital structure can under no circumstances affect a company's business risk. 
A) A firm's business risk is determined solely by the financial characteristics of its industry. 
B) The factors that affect a firm's business risk are affected by industry characteristics and economic conditions.Unfortunately, these factors are generally beyond the control of the firm's management. 
C) One of the benefits to a firm of being at or near its target capital structure is that this eliminates any risk of bankruptcy. 
D) A firm's financial risk can be minimized by diversification. 
E) The amount of debt in its capital structure can under no circumstances affect a company's business risk.

Question 12

Which of the following statements is CORRECT?

Accepted Answer

A) Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry. 
B) Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. 
C) Drug companies (prescription, not illegal!) generally have high debt-to-equity ratios because their earnings are very stable and, thus, they can cover the high interest costs associated with high debt levels. 
D) Wide variations in capital structures exist both between industries and among individual firms within given industries.These differences are caused by differing business risks and also managerial attitudes. 
E) Since most stocks sell at or very close to their book values, book value capital structures are almost always adequate for use in estimating firms' costs of capital. 
A) Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry. 
B) Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. 
C) Drug companies (prescription, not illegal!) generally have high debt-to-equity ratios because their earnings are very stable and, thus, they can cover the high interest costs associated with high debt levels. 
D) Wide variations in capital structures exist both between industries and among individual firms within given industries.These differences are caused by differing business risks and also managerial attitudes. 
E) Since most stocks sell at or very close to their book values, book value capital structures are almost always adequate for use in estimating firms' costs of capital.

Question 13

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 14

Enterprises expects to have the following data during the coming year.What is Vu's expected ROE?

Accepted Answer

A) 12.51% 
B) 13.14% 
C) 13.80% 
D) 14.49% 
E) 15.21% 
A) 12.51% 
B) 13.14% 
C) 13.80% 
D) 14.49% 
E) 15.21%

Question 15

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 16

Which of the following statements is CORRECT?

Accepted Answer

A) The capital structure that maximizes expected EPS also maximizes the price per share of common stock. 
B) The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. 
C) The capital structure that minimizes the required return on equity also maximizes the stock price. 
D) The capital structure that minimizes the WACC also maximizes the price per share of common stock. 
E) The capital structure that gives the firm the best credit rating also maximizes the stock price. 
A) The capital structure that maximizes expected EPS also maximizes the price per share of common stock. 
B) The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. 
C) The capital structure that minimizes the required return on equity also maximizes the stock price. 
D) The capital structure that minimizes the WACC also maximizes the price per share of common stock. 
E) The capital structure that gives the firm the best credit rating also maximizes the stock price.

Question 17

is considering moving to a capital structure that is comprised of 20% debt and 80% equity, based on market values.The debt would have an interest rate of 7%.The new funds would be used to repurchase stock.It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise to 14%.If this plan were carried out, what would BB's new value of operations be?

Accepted Answer

A) $498,339 
B) $512,188 
C) $525,237 
D) $540,239 
E) $590,718 
A) $498,339 
B) $512,188 
C) $525,237 
D) $540,239 
E) $590,718

Question 18

Senbet Ventures is considering starting a new company to produce stereos.The sales price would be set at 1.5 times the variable cost per unit; the VC/unit is estimated to be $2.50; and fixed costs are estimated at $120,000.What sales volume would be required in order to break even, i.e., to have an EBIT of zero for the stereo business?

Accepted Answer

A) 86,640 
B) 91,200 
C) 96,000 
D) 100,800 
E) 105,840 
A) 86,640 
B) 91,200 
C) 96,000 
D) 100,800 
E) 105,840

Question 19

Reynolds Resorts is currently 100% equity financed.The CFO is considering a recapitalization plan under which the firm would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock.The recapitalization would not change the company's total assets, nor would it affect the firm's basic earning power, which is currently 15%.The CFO believes that this recapitalization would reduce the WACC and increase stock price.Which of the following would also be likely to occur if the company goes ahead with the recapitalization plan?

Accepted Answer

A) The company's net income would increase. 
B) The company's earnings per share would decline. 
C) The company's cost of equity would increase. 
D) The company's ROA would increase. 
E) The company's ROE would decline. 
A) The company's net income would increase. 
B) The company's earnings per share would decline. 
C) The company's cost of equity would increase. 
D) The company's ROA would increase. 
E) The company's ROE would decline.

Question 20

assume that VF is considering changing from its original zero debt capital structure to a new capital structure with even more debt.This results in changes in the cost of debt and equity, and thus to a new WACC and a new value of operations.Assume VF raises the amount of new debt indicated below and uses the funds to purchase and hold T-bills until it makes the stock repurchase.What is the stock price per share immediately after issuing the debt but prior to the repurchase?
EBIT =$80,000
New Debt/Value =20%
Growth =0%
New Equity/Value =80%
Orig cost of equity, rs =10.0%
No. of shares =10,000
New cost of equity = rs =11.0%
Price per share =$48.00
Tax rate =40%
Interest rate = rd =7.0%

Accepted Answer

A) $50.67 
B) $53.33 
C) $56.00 
D) $58.80 
E) $61.74 
A) $50.67 
B) $53.33 
C) $56.00 
D) $58.80 
E) $61.74

Which of the following statements is CORRECT?

firm's target capital structure should be consistent with which of the following statements?

is possible that two firms could have identical financial and operating leverage, yet have different degrees of risk as measured by the variability of EPS.

trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

Which of the following statements is CORRECT?

Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Based on the information below, what is Ezzel Enterprises' optimal capital structure?

Which of the following statements is CORRECT, holding other things constant?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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.

Enterprises expects to have the following data during the coming year.What is Vu's expected ROE?

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.

Which of the following statements is CORRECT?

Overview

Statements, CF, Taxes

Financial Analysis

Time Value of Money

Bonds

Risk and Return

Stocks

Financial Options

Cost of Capital

Capital Budgeting

Cash Flow and Risk

Forecasting

Valuation, Governanc

Dividends

Working Capital

Multinational

Filters

Exam 15: CAP Structure

Which of the following statements is CORRECT?

firm's target capital structure should be consistent with which of the following statements?

is possible that two firms could have identical financial and operating leverage, yet have different degrees of risk as measured by the variability of EPS.

trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

Which of the following statements is CORRECT?

Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Based on the information below, what is Ezzel Enterprises' optimal capital structure?

Which of the following statements is CORRECT, holding other things constant?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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.

Enterprises expects to have the following data during the coming year.What is Vu's expected ROE?

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.

Which of the following statements is CORRECT?

Overview

Statements, CF, Taxes

Financial Analysis

Time Value of Money

Bonds

Risk and Return

Stocks

Financial Options

Cost of Capital

Capital Budgeting

Cash Flow and Risk

Forecasting

Valuation, Governanc

Dividends

Working Capital

Multinational

Filters