Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share. 
B)  All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio. 
C)  Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC. 
D)  Since debt is cheaper than equity, increasing a company's debt ratio will always reduce its WACC. 
E)  When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase. 
A)  The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share. 
B)  All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio. 
C)  Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC. 
D)  Since debt is cheaper than equity, increasing a company's debt ratio will always reduce its WACC. 
E)  When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase. B

Question 2

Which of the following statements is CORRECT?

Accepted Answer

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

Question 3

Blueline Publishers is considering a recapitalization planIt is currently 100% equity financed but under the plan it 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 priceWhich of the following would also be likely to occur if the company goes ahead with the recapitalization plan?

Accepted Answer

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

Question 4

Which of the following is NOT associated with (or does not contribute to) business risk? Recall that business risk is affected by a firm's operations.

Accepted Answer

A)  Sales price variability. 
B)  The extent to which operating costs are fixed. 
C)  The extent to which interest rates on the firm's debt fluctuate. 
D)  Input price variability. 
E)  Demand variability. 
A)  Sales price variability. 
B)  The extent to which operating costs are fixed. 
C)  The extent to which interest rates on the firm's debt fluctuate. 
D)  Input price variability. 
E)  Demand variability.

Question 5

Which of the following statements is CORRECT?

Accepted Answer

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

Question 6

Morales Publishing's tax rate is 40%, its beta is 1.10, and it uses no debt However, the CFO is considering moving to a capital structure with 30% debt and 70% equity If the risk-free rate is 5.0% and the market risk premium is 6.0%, by how much would the capital structure shift change the firm's cost of equity?

Accepted Answer

A)  1.53% 
B)  1.70% 
C)  1.87% 
D)  2.05% 
E)  2.26% 
A)  1.53% 
B)  1.70% 
C)  1.87% 
D)  2.05% 
E)  2.26%

Question 7

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. 
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.

Question 8

Based on the information below for Benson Corporation, what is the optimal capital structure?

Accepted Answer

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

Question 9

firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)  Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. 
B)  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. 
C)  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. 
D)  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. 
E)  Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry. 
A)  Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. 
B)  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. 
C)  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. 
D)  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. 
E)  Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry.

Question 11

Companies HD and LD have identical tax rates, total assets, and basic earning power ratios, and their basic earning power exceeds their before-tax cost of debt, rd However, Company HD has a higher debt ratio and thus more interest expense than Company LD Which of the following statements is CORRECT?

Accepted Answer

A)  Company HD has a lower ROA than Company LD. 
B)  Company HD has a lower ROE than Company LD. 
C)  The two companies have the same ROA. 
D)  The two companies have the same ROE. 
E)  Company HD has a higher net income than Company LD. 
A)  Company HD has a lower ROA than Company LD. 
B)  Company HD has a lower ROE than Company LD. 
C)  The two companies have the same ROA. 
D)  The two companies have the same ROE. 
E)  Company HD has a higher net income than Company LD.

Question 12

A has a higher degree of business risk than Firm B Firm A can offset this by using less financial leverage Therefore, the variability of both firms' expected EBITs could actually be identical.

Accepted Answer

A) True 
 B)False

Question 13

assume that AJC is considering changing from its original capital structure to a new capital structure that results in a stock price of $64 per share The resulting capital structure would have a $336,000 total market value of equity and a $504,000 market value of debt How many shares would AJC repurchase in the recapitalization?

Accepted Answer

A)  4,250 
B)  4,500 
C)  4,750 
D)  5,000 
E)  5,250 
A)  4,250 
B)  4,500 
C)  4,750 
D)  5,000 
E)  5,250

Question 14

Bailey and Sons has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40% What would Bailey's beta be if it used no debt, i.e., what is its unlevered beta?

Accepted Answer

A)  0.64 
B)  0.67 
C)  0.71 
D)  0.75 
E)  0.79 
A)  0.64 
B)  0.67 
C)  0.71 
D)  0.75 
E)  0.79

Question 15

Serendipity Incis re-evaluating its debt levelIts current capital structure consists of 80% debt and 20% common equity, its beta is 1.60, and its tax rate is 35% However, the CFO thinks the company has too much debt, and he is considering moving to a capital structure with 40% debt and 60% equity The risk-free rate is 5.0% and the market risk premium is 6.0% By how much would the capital structure shift change the firm's cost of equity?

Accepted Answer

A)  -5.20% 
B)  -5.78% 
C)  -6.36% 
D)  -6.99% 
E)  -7.69% 
A)  -5.20% 
B)  -5.78% 
C)  -6.36% 
D)  -6.99% 
E)  -7.69%

Question 16

Laramie Trucking's CEO is considering a change to the company's 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 17

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 18

Which of the following statements is CORRECT?

Accepted Answer

A)  Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC. 
B)  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. 
C)  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. 
D)  Since a firm's beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity. 
E)  Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC. 
A)  Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC. 
B)  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. 
C)  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. 
D)  Since a firm's beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity. 
E)  Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.

Question 19

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 20

Barette Consulting currently has no debt in its capital structure, has $500 million of total assets, and its basic earning power is 15% The CFO is contemplating a recapitalization where it will issue debt at a cost of 10% and use the proceeds to buy back shares of the company's common stock, paying book value If the company proceeds with the recapitalization, its operating income, total assets, and tax rate will remain unchanged Which of the following is most likely to occur as a result of the recapitalization?

Accepted Answer

A)  The ROA would remain unchanged. 
B)  The basic earning power ratio would decline. 
C)  The basic earning power ratio would increase. 
D)  The ROE would increase. 
E)  The ROA would increase. 
A)  The ROA would remain unchanged. 
B)  The basic earning power ratio would decline. 
C)  The basic earning power ratio would increase. 
D)  The ROE would increase. 
E)  The ROA would increase.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following is NOT associated with (or does not contribute to) business risk? Recall that business risk is affected by a firm's operations.

Which of the following statements is CORRECT?

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

Based on the information below for Benson Corporation, what is the optimal capital structure?

firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Which of the following statements is CORRECT?

Companies HD and LD have identical tax rates, total assets, and basic earning power ratios, and their basic earning power exceeds their before-tax cost of debt, rd However, Company HD has a higher debt ratio and thus more interest expense than Company LD Which of the following statements is CORRECT?

A has a higher degree of business risk than Firm B Firm A can offset this by using less financial leverage Therefore, the variability of both firms' expected EBITs could actually be identical.

Bailey and Sons has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40% What would Bailey's beta be if it used no debt, i.e., what is its unlevered beta?

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?

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.

Overview

Risk and Return: Part I

Risk and Return: Part II

Bonds

Stocks

Financial Options

Financial Analysis

Forecasting

Cost of Capital

Corporate Valuation

Capital Budgeting

Cash Flows and Risk

Real Options

Cap Structure II

Dividends

Ipos, Invsmt Banking

Leasing

Hybrids

Working Capital

Derivatives

Bankruptcy, Reorganization, and Liquidation

Mergers

Filters

Exam 15: Cap Structure

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following is NOT associated with (or does not contribute to) business risk? Recall that business risk is affected by a firm's operations.

Which of the following statements is CORRECT?

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

Based on the information below for Benson Corporation, what is the optimal capital structure?

firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Which of the following statements is CORRECT?

A has a higher degree of business risk than Firm B Firm A can offset this by using less financial leverage Therefore, the variability of both firms' expected EBITs could actually be identical.

Bailey and Sons has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40% What would Bailey's beta be if it used no debt, i.e., what is its unlevered beta?

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?

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.

Overview

Risk and Return: Part I

Risk and Return: Part II

Bonds

Stocks

Financial Options

Financial Analysis

Forecasting

Cost of Capital

Corporate Valuation

Capital Budgeting

Cash Flows and Risk

Real Options

Cap Structure II

Dividends

Ipos, Invsmt Banking

Leasing

Hybrids

Working Capital

Derivatives

Bankruptcy, Reorganization, and Liquidation

Mergers

Filters