Question 1

The optimal capital structure of a ﬁrm _____ the marketed claims and _____ the nonmarketed claims against the cash ﬂows of the ﬁrm.

Accepted Answer

A) minimizes; minimizes 
B) minimizes; maximizes 
C) maximizes; minimizes 
D) maximizes; maximizes 
E) equates; (leave blank) 
A) minimizes; minimizes 
B) minimizes; maximizes 
C) maximizes; minimizes 
D) maximizes; maximizes 
E) equates; (leave blank) C

Question 2

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 10%
Personal tax rate on income from equities: 50%

Accepted Answer

A) £-0.050 
B) £-0.188 
C) £0.367 
D) £0.633 
E) None of the above. 
A) £-0.050 
B) £-0.188 
C) £0.367 
D) £0.633 
E) None of the above. D

Question 3

What three factors are important to consider in determining a target debt to equity ratio?

Accepted Answer

A) Taxes, asset types, and pecking order and ﬁnancial slack 
B) Asset types, uncertainty of operating income, and pecking order and ﬁnancial slack 
C) Taxes, ﬁnancial slack and pecking order, and uncertainty of operating income 
D) Taxes, asset types, and uncertainty of operating income 
E) None of the above. 
A) Taxes, asset types, and pecking order and ﬁnancial slack 
B) Asset types, uncertainty of operating income, and pecking order and ﬁnancial slack 
C) Taxes, ﬁnancial slack and pecking order, and uncertainty of operating income 
D) Taxes, asset types, and uncertainty of operating income 
E) None of the above. D

Question 4

The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

Accepted Answer

A) personal tax rate on the distribution of income to shareholders is less than the personal tax
Rate on interest income. 
B) personal tax rate on the distribution of income to shareholders is greater than the personal
Tax rate on interest income. 
C) personal tax rate on the distribution of income to shareholders is equal to the personal tax
Rate on interest income. 
D) personal tax rate on interest income is zero. 
E) None of the above. 
A) personal tax rate on the distribution of income to shareholders is less than the personal tax
Rate on interest income. 
B) personal tax rate on the distribution of income to shareholders is greater than the personal
Tax rate on interest income. 
C) personal tax rate on the distribution of income to shareholders is equal to the personal tax
Rate on interest income. 
D) personal tax rate on interest income is zero. 
E) None of the above.

Question 5

Indirect costs of ﬁnancial distress:

Accepted Answer

A) effectively limit the amount of equity a ﬁrm issues. 
B) serve as an incentive to increase the ﬁnancial leverage of a ﬁrm. 
C) include direct costs such as legal and accounting fees. 
D) tend to increase as the debt-equity ratio decreases. 
E) include the costs incurred by a ﬁrm as it tries to avoid seeking bankruptcy protection. 
A) effectively limit the amount of equity a ﬁrm issues. 
B) serve as an incentive to increase the ﬁnancial leverage of a ﬁrm. 
C) include direct costs such as legal and accounting fees. 
D) tend to increase as the debt-equity ratio decreases. 
E) include the costs incurred by a ﬁrm as it tries to avoid seeking bankruptcy protection.

Question 6

One of the indirect costs to bankruptcy is the incentive toward underinvestment.Following this strategy may result in:

Accepted Answer

A) the ﬁrm always choosing projects with the positive NPVs. 
B) the ﬁrm turning down positive NPV projects that it would clearly accept in an all equity ﬁrm. 
C) shareholders contributing the full amount of the investment, but both shareholders and
Bondholders sharing in the beneﬁts of the project. 
D) Both A and C. 
E) Both B and C. 
A) the ﬁrm always choosing projects with the positive NPVs. 
B) the ﬁrm turning down positive NPV projects that it would clearly accept in an all equity ﬁrm. 
C) shareholders contributing the full amount of the investment, but both shareholders and
Bondholders sharing in the beneﬁts of the project. 
D) Both A and C. 
E) Both B and C.

Question 7

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 30%
Personal tax rate on income from equities: 30%

Accepted Answer

A) £-0.050 
B) £ 0.006 
C) £ 0.246 
D) £ 0.340 
E) £ 0.660 
A) £-0.050 
B) £ 0.006 
C) £ 0.246 
D) £ 0.340 
E) £ 0.660

Question 8

When graphing ﬁrm value against debt levels, the debt level that maximizes the value of the ﬁrm is the level where:

Accepted Answer

A) the increase in the present value of distress costs from an additional pound of debt is greater
Than the increase in the present value of the debt tax shield. 
B) the increase in the present value of distress costs from an additional pound of debt is equal
To the increase in the present value of the debt tax shield. 
C) the increase in the present value of distress costs from an additional pound of debt is less
Than the increase of the present value of the debt tax shield. 
D) distress costs as well as debt tax shields are zero. 
E) distress costs as well as debt tax shields are maximized. 
A) the increase in the present value of distress costs from an additional pound of debt is greater
Than the increase in the present value of the debt tax shield. 
B) the increase in the present value of distress costs from an additional pound of debt is equal
To the increase in the present value of the debt tax shield. 
C) the increase in the present value of distress costs from an additional pound of debt is less
Than the increase of the present value of the debt tax shield. 
D) distress costs as well as debt tax shields are zero. 
E) distress costs as well as debt tax shields are maximized.

Question 9

What are the advantages of a prepackaged bankruptcy for a ﬁrm? What are the disadvantages?

Accepted Answer

A prepack allows a ﬁrm to minimize its s

Question 10

Your ﬁnance textbook tells you that corporations in Europe tend to underutilize debt.What do you expect to happen to the valuations of these corporations if they increase their debt levels and optimize their capital structure?

Accepted Answer

Firms with an optimal capital structure

Question 11

An exchange offer may

Accepted Answer

A) allow customers a 30 day money-back guarantee on the ﬁrm's product. 
B) allow customers a 90 day warranty on the ﬁrm's product from defects. 
C) allow bondholders to exchange some debt for equity. 
D) allow shareholders to exchange some of their equity for debt. 
E) Both C and D. 
A) allow customers a 30 day money-back guarantee on the ﬁrm's product. 
B) allow customers a 90 day warranty on the ﬁrm's product from defects. 
C) allow bondholders to exchange some debt for equity. 
D) allow shareholders to exchange some of their equity for debt. 
E) Both C and D.

Question 12

The value of a ﬁrm is maximized when the:

Accepted Answer

A) cost of equity is maximized. 
B) tax rate is zero. 
C) levered cost of capital is maximized. 
D) weighted average cost of capital is minimized. 
E) debt-equity ratio is minimized. 
A) cost of equity is maximized. 
B) tax rate is zero. 
C) levered cost of capital is maximized. 
D) weighted average cost of capital is minimized. 
E) debt-equity ratio is minimized.

Question 13

The MM theory with taxes implies that ﬁrms should issue maximum debt.In practice, this is not true because:

Accepted Answer

A) debt is more risky than equity. 
B) bankruptcy is a disadvantage to debt. 
C) ﬁrms will incur large agency costs of short term debt by issuing long term debt. 
D) Both A and B. 
E) Both B and C. 
A) debt is more risky than equity. 
B) bankruptcy is a disadvantage to debt. 
C) ﬁrms will incur large agency costs of short term debt by issuing long term debt. 
D) Both A and B. 
E) Both B and C.

Question 14

The free cash ﬂow hypothesis states:

Accepted Answer

A) that ﬁrms with greater free cash ﬂow will pay more in dividends reducing the risk of ﬁnancial
Distress. 
B) that ﬁrms with greater free cash ﬂow should issue new equity to force managers to minimize
Wasting resources and to work harder. 
C) that issuing debt requires interest and principal payments reducing the potential of
Management to waste resources. 
D) Both A and C. 
E) Both B and C. 
A) that ﬁrms with greater free cash ﬂow will pay more in dividends reducing the risk of ﬁnancial
Distress. 
B) that ﬁrms with greater free cash ﬂow should issue new equity to force managers to minimize
Wasting resources and to work harder. 
C) that issuing debt requires interest and principal payments reducing the potential of
Management to waste resources. 
D) Both A and C. 
E) Both B and C.

Question 15

One of the concerns highlighted by the recent ﬁnancial crisis, is the existence of banks that are 'too big to fail'.These banks, it is argued, carry with them an implicit guarantee that they will be saved in times of ﬁnancial distress.How do you think the capital structure of these banks compares to that of the other banks, based on the optimal capital structure theories?

Accepted Answer

Firms with lower probabilities of ﬁnanci

Question 16

Studies have found that ﬁrms with high proportions of intangible assets are likely to use ____________debt compared with ﬁrms with low proportions of intangible assets.

Accepted Answer

A) more 
B) the same amount of 
C) less 
D) either more or the same amount of 
E) any amount of debt 
A) more 
B) the same amount of 
C) less 
D) either more or the same amount of 
E) any amount of debt

Question 17

Conﬂicts of interest between shareholders and bondholders are known as:

Accepted Answer

A) trustee costs. 
B) ﬁnancial distress costs. 
C) dealer costs. 
D) agency costs. 
E) underwriting costs. 
A) trustee costs. 
B) ﬁnancial distress costs. 
C) dealer costs. 
D) agency costs. 
E) underwriting costs.

Question 18

In a world with taxes and ﬁnancial distress, when a ﬁrm is operating with the optimal capital structure: I.the debt-equity ratio will also be optimal.
II)the weighted average cost of capital will be at its minimal point.
III)the required return on assets will be at its maximum point.
IV)the increased beneﬁt from additional debt is equal to the increased bankruptcy costs of that debt.

Accepted Answer

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

Question 19

The All-Mine Corporation is deciding whether to invest in a new project.The project would have to be ﬁnanced by equity, the cost is £2,000 and will return £2,500 or 25% in one year.The discount rate for both bonds and stock is 15% and the tax rate is zero.The predicted cash ﬂows are £4,500 in a good economy, £3,000 in an average, economy and £1,000 in a poor economy.Each economic outcome is equally likely and the promised debt repayment is £3,000.Should the company take the project? What is the value of ﬁrm and its components before and after the project addition?

Accepted Answer

Determine cash flows before the project

Question 20

Although the use of debt provides tax beneﬁts to the ﬁrm, debt also puts pressure on the ﬁrms to:

Accepted Answer

A) meet interest and principal payments which, if not met, can put the company into ﬁnancial
Distress. 
B) make dividend payments which if not met can put the company into ﬁnancial distress. 
C) meet both interest and dividend payments which when met increase the ﬁrm cash ﬂow. 
D) meet increased tax payments thereby increasing ﬁrm value. 
E) None of the above. 
A) meet interest and principal payments which, if not met, can put the company into ﬁnancial
Distress. 
B) make dividend payments which if not met can put the company into ﬁnancial distress. 
C) meet both interest and dividend payments which when met increase the ﬁrm cash ﬂow. 
D) meet increased tax payments thereby increasing ﬁrm value. 
E) None of the above.

Exam 16: Capital Structure: Limits to the Use of Debt

The optimal capital structure of a ﬁrm _____ the marketed claims and _____ the nonmarketed claims against the cash ﬂows of the ﬁrm.

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 10% Personal tax rate on income from equities: 50%

What three factors are important to consider in determining a target debt to equity ratio?

The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

Indirect costs of ﬁnancial distress:

One of the indirect costs to bankruptcy is the incentive toward underinvestment.Following this strategy may result in:

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 30% Personal tax rate on income from equities: 30%

When graphing ﬁrm value against debt levels, the debt level that maximizes the value of the ﬁrm is the level where:

What are the advantages of a prepackaged bankruptcy for a ﬁrm? What are the disadvantages?

Your ﬁnance textbook tells you that corporations in Europe tend to underutilize debt.What do you expect to happen to the valuations of these corporations if they increase their debt levels and optimize their capital structure?

An exchange offer may

The value of a ﬁrm is maximized when the:

The MM theory with taxes implies that ﬁrms should issue maximum debt.In practice, this is not true because:

The free cash ﬂow hypothesis states:

Studies have found that ﬁrms with high proportions of intangible assets are likely to use ____________debt compared with ﬁrms with low proportions of intangible assets.

Conﬂicts of interest between shareholders and bondholders are known as:

Although the use of debt provides tax beneﬁts to the ﬁrm, debt also puts pressure on the ﬁrms to:

Introduction to Corporate Finance

Corporate Governance

Financial Statement Analysis

Discounted Cash Flow Valuation

Bond, Equity and Firm Valuation

Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, Real Options and Capital Budgeting

Risk and Return: Lessons From Market History

Risk and Return: the Capital Asset Pricing Model

Factor Models and the Arbitrage Pricing Theory

Risk, Cost of Capital and Capital Budgeting

Efficient Capital Markets and Behavioural Finance

Long-Term Financing: an Introduction

Capital Structure: Basic Concepts

Valuation and Capital Budgeting for the Levered Firm

Dividends and Other Payouts

Equity Financing

Debt Financing

Leasing

Options and Corporate Finance

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Financial Risk Management With Derivatives

Short-Term Finance and Planning

Short-Term Capital Management

Mergers and Acquisitions

Financial Distress

International Corporate Finance

Filters

The optimal capital structure of a ﬁrm _ the marketed claims and _ the nonmarketed claims against the cash ﬂows of the ﬁrm.