Question 1

____ structure represents the permanent sources of the firm's financing.

Accepted Answer

A)  Financial 
B)  Capital 
C)  Equity 
D)  Cost 
A)  Financial 
B)  Capital 
C)  Equity 
D)  Cost B

Question 2

Generally the ____ a firm's business risk, the ____ the amount of financial leverage that will be used in the optimal capital structure.

Accepted Answer

A)  greater; greater 
B)  smaller; less 
C)  greater; less 
D)  smaller; greater 
A)  greater; greater 
B)  smaller; less 
C)  greater; less 
D)  smaller; greater C

Question 3

There are many benefits to a leveraged buy-out. However, the benefits from LBOs come with significant costs. Explain the down-side of LBOs.

Accepted Answer

LBOs offer increased operating efficiency but this is achieved by eliminating jobs, reducing payroll expenses, and closing inefficient plants. Even when laid-off employees are rehired, they are often rehired at lower wages. Communities and civic organizations lose the support of a "corporate benefactor" if the acquiring company has other commitments and chooses not to continue the previous support level. Bondholders of the acquired firm often experience a loss in value of their bonds.

Question 4

Due to both financial distress and agency costs, a firm should have a capital structure that contains ____.

Accepted Answer

A)  all debt 
B)  all equity 
C)  both debt and equity 
D)  only long-term debt 
A)  all debt 
B)  all equity 
C)  both debt and equity 
D)  only long-term debt

Question 5

As more debt is added to the capital structure of a firm, the cost of debt capital ____.

Accepted Answer

A)  initially rises slowly, then falls beyond some point 
B)  increases at a steady rate throughout the entire range 
C)  becomes greater than the cost of equity beyond a certain point 
D)  initially rises slowly, then increases rapidly beyond some point 
A)  initially rises slowly, then falls beyond some point 
B)  increases at a steady rate throughout the entire range 
C)  becomes greater than the cost of equity beyond a certain point 
D)  initially rises slowly, then increases rapidly beyond some point

Question 6

Technico has determined that its optimal capital structure is 40% debt, at which point its weighted cost of capital, ka, is 13.7%. Due to financial problems, the firm has decided to raise the proportion of debt to 50%, which will increase its weighted cost of capital to 14.4%. What is the effect on the stock price of Technico? The current dividend is $1.60 and the long-term growth rate of dividends is expected to be 8.5%.

Accepted Answer

A)  Decrease $3.65 
B)  Decrease $3.96 
C)  Increase $3.65 
D)  Increase $3.96 
A)  Decrease $3.65 
B)  Decrease $3.96 
C)  Increase $3.65 
D)  Increase $3.96

Question 7

The market value of a levered firm can be represented by the following equation: Market value of levered firm = Market value of unlevered firm ____ Present value of tax shield ____ Present value of financial distress costs ____ Present value of agency costs

Accepted Answer

A)  minus; plus; plus 
B)  plus; plus; plus 
C)  plus; minus; minus 
D)  minus, plus, minus 
A)  minus; plus; plus 
B)  plus; plus; plus 
C)  plus; minus; minus 
D)  minus, plus, minus

Question 8

Financial leverage benefits shareholders when the return on ____.

Accepted Answer

A)  assets is greater than the cost of debt 
B)  equity is greater than the cost of debt 
C)  investments is less than the weighted cost of capital 
D)  equity is less than the cost of debt 
A)  assets is greater than the cost of debt 
B)  equity is greater than the cost of debt 
C)  investments is less than the weighted cost of capital 
D)  equity is less than the cost of debt

Question 9

All except which of the following factors influence a firm's business risk?

Accepted Answer

A)  Degree of operating leverage 
B)  Variability of interest rates 
C)  Variability of operating costs 
D)  Variability of selling prices 
A)  Degree of operating leverage 
B)  Variability of interest rates 
C)  Variability of operating costs 
D)  Variability of selling prices

Question 10

Calculate the market value of a firm with total assets of $105 million and $50 million of 10% perpetual debt in the capital structure. The firm's cost of equity is 14% on the $55 million in equity in the capital structure. The perpetual EBIT is expected to be $9 million, and the marginal tax rate is 40%.

Accepted Answer

A)  $88.6 million 
B)  $67.1 million 
C)  $114.3 million 
D)  $78.6 million 
A)  $88.6 million 
B)  $67.1 million 
C)  $114.3 million 
D)  $78.6 million

Question 11

In considering a firm's capital structure, the firm should increase its ____, which will maximize its value.

Accepted Answer

A)  stock outstanding 
B)  earnings 
C)  cash flow from investing 
D)  debt 
A)  stock outstanding 
B)  earnings 
C)  cash flow from investing 
D)  debt

Question 12

In analyzing the value of a firm as a function of capital structure, the present value of the tax shield benefit is offset by the present value of the expected ____, resulting in an interior optimal capital structure.

Accepted Answer

A)  financial distress costs 
B)  agency costs 
C)  holding costs 
D)  financial distress costs and agency costs 
A)  financial distress costs 
B)  agency costs 
C)  holding costs 
D)  financial distress costs and agency costs

Question 13

Protection for debt holders takes the form of protective covenants in the bond indenture. These covenants place restrictions on which of the following activities?

Accepted Answer

A)  The sale of assets 
B)  Payment of dividends 
C)  The issuance of additional debt 
D)  All other choices are typical protective covenants. 
A)  The sale of assets 
B)  Payment of dividends 
C)  The issuance of additional debt 
D)  All other choices are typical protective covenants.

Question 14

With financial leverage, a change in EBIT results in a change in ____.

Accepted Answer

A)  fixed costs 
B)  EPS 
C)  financial risk 
D)  EBT 
A)  fixed costs 
B)  EPS 
C)  financial risk 
D)  EBT

Question 15

A survey of Fortune 500 firms indicates that they prefer internal financing (retained earnings) to external financing. This preference is known as ____.

Accepted Answer

A)  financial slack 
B)  the pecking order theory 
C)  capital structure theory 
D)  asymmetric capital 
A)  financial slack 
B)  the pecking order theory 
C)  capital structure theory 
D)  asymmetric capital

Question 16

What is the annual tax shield to a firm that has total assets of $80 million and a net worth of $55 million, if the average interest rate on debt is 8.5%, the average return on equity is 14%, and the marginal tax rate is 35%?

Accepted Answer

A)  $2.125 million 
B)  $1.87 million 
C)  $0.85 million 
D)  $0.744 million 
A)  $2.125 million 
B)  $1.87 million 
C)  $0.85 million 
D)  $0.744 million

Question 17

What is the annual tax shield to a firm that has a capital structure consisting of $100 million of debt and $180 million of equity, if the average interest rate on debt is 9%, the return on equity is 13%, and the marginal tax rate is 40%?

Accepted Answer

A)  $9.0 million 
B)  $5.4 million 
C)  $9.36 million 
D)  $3.6 million 
A)  $9.0 million 
B)  $5.4 million 
C)  $9.36 million 
D)  $3.6 million

Question 18

The managerial implications of capital structure theory include all except which of the following?

Accepted Answer

A)  Capital structure changes transmit important information to investors. 
B)  Changes in capital structure result in changes in the market value of the firm's equity. 
C)  Optimal capital structure is influenced heavily by the business risk facing the firm. 
D)  Tax shield benefits from equity lead to increased firm value. 
A)  Capital structure changes transmit important information to investors. 
B)  Changes in capital structure result in changes in the market value of the firm's equity. 
C)  Optimal capital structure is influenced heavily by the business risk facing the firm. 
D)  Tax shield benefits from equity lead to increased firm value.

Question 19

Biotec has estimated the costs of debt and equity capital for various proportions of debt in its capital structure:$\begin{array}{lll}\% \text { of Debt } & \text { Cost of Debt }(\%) &\text { Cost of Equity }(\%)\
35 & 5.4 & 13.8 \
40 & 5.6 & 14.0 \
45 & 5.9 & 14.3 \
50 & 6.4 & 14.7
\end{array}$
If Biotec pays a current dividend of $1.00 and expects dividends to grow at a constant rate of 7%, what is Biotec's stock price if it obtains its optimal capital structure?

Accepted Answer

A)  $14.66 
B)  $30.40 
C)  $30.14 
D)  $29.40 
A)  $14.66 
B)  $30.40 
C)  $30.14 
D)  $29.40

Question 20

Modigliani and Miller show that the value of a firm is ____ capital structure given perfect capital markets and no corporate income taxes.

Accepted Answer

A)  maximized by having no debt in the 
B)  independent of 
C)  maximized by having an optimal 
D)  dependent on the 
A)  maximized by having no debt in the 
B)  independent of 
C)  maximized by having an optimal 
D)  dependent on the

Exam 15: Capital Structure Concepts

____ structure represents the permanent sources of the firm's financing.

Generally the ____ a firm's business risk, the ____ the amount of financial leverage that will be used in the optimal capital structure.

There are many benefits to a leveraged buy-out. However, the benefits from LBOs come with significant costs. Explain the down-side of LBOs.

Due to both financial distress and agency costs, a firm should have a capital structure that contains ____.

As more debt is added to the capital structure of a firm, the cost of debt capital ____.

The market value of a levered firm can be represented by the following equation: Market value of levered firm = Market value of unlevered firm ____ Present value of tax shield ____ Present value of financial distress costs ____ Present value of agency costs

Financial leverage benefits shareholders when the return on ____.

All except which of the following factors influence a firm's business risk?

In considering a firm's capital structure, the firm should increase its ____, which will maximize its value.

In analyzing the value of a firm as a function of capital structure, the present value of the tax shield benefit is offset by the present value of the expected ____, resulting in an interior optimal capital structure.

Protection for debt holders takes the form of protective covenants in the bond indenture. These covenants place restrictions on which of the following activities?

With financial leverage, a change in EBIT results in a change in ____.

A survey of Fortune 500 firms indicates that they prefer internal financing (retained earnings) to external financing. This preference is known as ____.

What is the annual tax shield to a firm that has total assets of $80 million and a net worth of $55 million, if the average interest rate on debt is 8.5%, the average return on equity is 14%, and the marginal tax rate is 35%?

What is the annual tax shield to a firm that has a capital structure consisting of $100 million of debt and $180 million of equity, if the average interest rate on debt is 9%, the return on equity is 13%, and the marginal tax rate is 40%?

The managerial implications of capital structure theory include all except which of the following?

Modigliani and Miller show that the value of a firm is ____ capital structure given perfect capital markets and no corporate income taxes.

The Role and Objective of Financial Management

The Domestic and International Financial Marketplace

Evaluation of Financial Performance

Financial Planning and Forecasting

The Time Value of Money

Continuous Compounding and Discounting

Fixed Income Securities: Characteristics and Valuation

Common Stock: Characteristics, Valuation, and Issuance

Analysis of Risk and Return

Capital Budgeting and Cash Flow Analysis

Mutually Exclusive Investments Having Unequal Lives

Capital Budgeting: Decision Criteria and Real Option Considerations

Capital Budgeting and Risk

The Cost of Capital

Breakeven Analysis

Capital Structure Management in Practice

Dividend Policy

Working Capital Policy and Short-Term Financing

The Management of Cash and Marketable Securities

The Management of Accounts Receivable and Inventories

Lease and Intermediate Term Financing

Financing With Derivatives

Bond Refunding Analysis

Risk Management

International Financial Management

Corporate Restructuring

Filters

Generally the a firm's business risk, the the amount of financial leverage that will be used in the optimal capital structure.

The market value of a levered firm can be represented by the following equation: Market value of levered firm = Market value of unlevered firm Present value of tax shield Present value of financial distress costs Present value of agency costs