Question 1

All of the following statements regarding capital structure weights in the WACC equation are correct except:

Accepted Answer

A)  The weights represent a variable financing mix. 
B)  These target weights represent a mix of debt and equity that the firm will try to achieve or maintain over the planning horizon. 
C)  As much as possible, the target weights should reflect the combination of debt and equity that management believes will minimize the firm's weighted average cost of capital. 
D)  The firm should make an effort over time to move toward and maintain its target capital structure mix of debt and equity. 
E)  All of the above statements are correct. 
A)  The weights represent a variable financing mix. 
B)  These target weights represent a mix of debt and equity that the firm will try to achieve or maintain over the planning horizon. 
C)  As much as possible, the target weights should reflect the combination of debt and equity that management believes will minimize the firm's weighted average cost of capital. 
D)  The firm should make an effort over time to move toward and maintain its target capital structure mix of debt and equity. 
E)  All of the above statements are correct.

Question 2

Issuance costs are costs of issuing stock; includes accounting, legal, and printing costs of offering shares to the public, as well as the commission or fees earned by the investment bankers.

Accepted Answer

A) True 
 B)False

Question 3

All classes of common equity may have the same voting rights.

Accepted Answer

A) True 
 B)False

Question 4

EBIT/EPS analysis shows the ranges of EBIT where a firm may prefer one capital structure over another.

Accepted Answer

A) True 
 B)False

Question 5

Minimum cash flow ∕ Investment = Maximum rate of return.

Accepted Answer

A) True 
 B)False

Question 6

A decrease in the debt ratio will normally have no effect on:

Accepted Answer

A)  financial risk 
B)  business risk 
C)  total risk 
D)  systematic risk 
A)  financial risk 
B)  business risk 
C)  total risk 
D)  systematic risk

Question 7

All of the following components are needed to calculate the sustainable growth rate except:

Accepted Answer

A)  return on assets 
B)  retention rate 
C)  return on equity 
D)  earnings on assets 
A)  return on assets 
B)  retention rate 
C)  return on equity 
D)  earnings on assets

Question 8

If a firm has current earnings before interest and taxes of $100,000 and interest expense of $10,000, its degree of financial leverage would be:

Accepted Answer

A)  10 
B)  1.11 
C)  .10 
D)  1.10 
A)  10 
B)  1.11 
C)  .10 
D)  1.10

Question 9

Other factors being constant, higher fixed operating costs mean:

Accepted Answer

A)  higher financial leverage 
B)  higher operating leverage 
C)  lower combined leverage 
D)  the degree of financial leverage is equal to 1.0 
A)  higher financial leverage 
B)  higher operating leverage 
C)  lower combined leverage 
D)  the degree of financial leverage is equal to 1.0

Question 10

Surveys of U.S. firms find that most firms use before-tax WACC as their required rate of return for projects.

Accepted Answer

A) True 
 B)False

Question 11

Which of the following is not potentially used in the weighted average cost of capital equation?

Accepted Answer

A)  cost of retained earnings 
B)  weight of debt 
C)  average corporate income tax rate 
D)  marginal tax rate 
A)  cost of retained earnings 
B)  weight of debt 
C)  average corporate income tax rate 
D)  marginal tax rate

Question 12

A theory that firms time the market by issuing stock when their stock prices are high and repurchasing shares when their stock values are low.

Accepted Answer

A)  Rational decision maker hypothesis 
B)  Static trade-off hypothesis 
C)  Pecking order hypothesis 
D)  Market timing hypothesis 
A)  Rational decision maker hypothesis 
B)  Static trade-off hypothesis 
C)  Pecking order hypothesis 
D)  Market timing hypothesis

Question 13

A firm's business risk is affected by all of the following, except:

Accepted Answer

A)  business cycle 
B)  the firm's operating leverage 
C)  competitive pressures 
D)  the interest rate on previously issued bonds 
A)  business cycle 
B)  the firm's operating leverage 
C)  competitive pressures 
D)  the interest rate on previously issued bonds

Question 14

Retained earnings are not directly related to net income.

Accepted Answer

A) True 
 B)False

Question 15

If a firm has current earnings per share of $2 and a degree of combined leverage of 4, a 10% increase in sales would result in earnings per share of:

Accepted Answer

A)  $2.80 
B)  $8.00 
C)  $2.20 
D)  $6.00 
A)  $2.80 
B)  $8.00 
C)  $2.20 
D)  $6.00

Question 16

All of the following affects a firm's choice of capital structures, except:

Accepted Answer

A)  flexibility 
B)  timing 
C)  corporate control 
D)  management compensation 
A)  flexibility 
B)  timing 
C)  corporate control 
D)  management compensation

Question 17

This is the proportion of each dollar of earnings that is paid to shareholders as a dividend; equals one minus the retention rate.

Accepted Answer

A)  Internal rate of return 
B)  Internal growth rate 
C)  Retention rate 
D)  Dividend payout ratio 
A)  Internal rate of return 
B)  Internal growth rate 
C)  Retention rate 
D)  Dividend payout ratio

Question 18

All of the following statements are correct except:

Accepted Answer

A)  Relevant cash flows are incremental before-tax cash flows, which must be discounted using an incremental after-tax cost of capital. 
B)  The firm's relevant cost of capital is computed from after-tax financing costs. 
C)  A project's incremental cash flows must be discounted at a cost of capital that represents the incremental or marginal cost to the firm of financing the project, that is, the cost of raising one additional dollar of capital. 
D)  In estimating the cost of capital, the firm's analysts need to evaluate investors' expected returns under likely market conditions and then use these expected returns to compute the firm's marginal future cost of raising funds. 
A)  Relevant cash flows are incremental before-tax cash flows, which must be discounted using an incremental after-tax cost of capital. 
B)  The firm's relevant cost of capital is computed from after-tax financing costs. 
C)  A project's incremental cash flows must be discounted at a cost of capital that represents the incremental or marginal cost to the firm of financing the project, that is, the cost of raising one additional dollar of capital. 
D)  In estimating the cost of capital, the firm's analysts need to evaluate investors' expected returns under likely market conditions and then use these expected returns to compute the firm's marginal future cost of raising funds.

Question 19

It is equal to the ratio of the expected increase in retained earnings over the next year to the current asset base.

Accepted Answer

A)  Internal rate of return 
B)  Internal growth rate 
C)  Retention rate 
D)  Dividend payout ratio 
A)  Internal rate of return 
B)  Internal growth rate 
C)  Retention rate 
D)  Dividend payout ratio

Question 20

The degree of financial leverage may be measured by taking the firm's earnings before interest and taxes and dividing by earnings before taxes.

Accepted Answer

A) True 
 B)False

All of the following statements regarding capital structure weights in the WACC equation are correct except:

Issuance costs are costs of issuing stock; includes accounting, legal, and printing costs of offering shares to the public, as well as the commission or fees earned by the investment bankers.

All classes of common equity may have the same voting rights.

EBIT/EPS analysis shows the ranges of EBIT where a firm may prefer one capital structure over another.

Minimum cash flow ∕ Investment = Maximum rate of return.

A decrease in the debt ratio will normally have no effect on:

All of the following components are needed to calculate the sustainable growth rate except:

If a firm has current earnings before interest and taxes of $100,000 and interest expense of $10,000, its degree of financial leverage would be:

Other factors being constant, higher fixed operating costs mean:

Surveys of U.S. firms find that most firms use before-tax WACC as their required rate of return for projects.

Which of the following is not potentially used in the weighted average cost of capital equation?

A theory that firms time the market by issuing stock when their stock prices are high and repurchasing shares when their stock values are low.

A firm's business risk is affected by all of the following, except:

Retained earnings are not directly related to net income.

If a firm has current earnings per share of $2 and a degree of combined leverage of 4, a 10% increase in sales would result in earnings per share of:

All of the following affects a firm's choice of capital structures, except:

This is the proportion of each dollar of earnings that is paid to shareholders as a dividend; equals one minus the retention rate.

All of the following statements are correct except:

It is equal to the ratio of the expected increase in retained earnings over the next year to the current asset base.

The degree of financial leverage may be measured by taking the firm's earnings before interest and taxes and dividing by earnings before taxes.

The Financial Environment

Money and the Monetary System

Banks and Other Financial Institutions

Federal Reserve System

Policy Makers and the Money Supply

International Finance and Trade

Savings and Investment Process

Interest Rates

Time Value of Money

Bonds and Stocks: Characteristics and Valuations

Securities and Markets

Financial Return and Risk Concepts

Business Organization and Financial Data

Financial Analysis and Long-Term Financial Planning

Managing Working Capital

Short-Term Business Financing

Capital Budgeting Analysis

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Exam 18: Capital Structure and the Cost of Capital

All of the following statements regarding capital structure weights in the WACC equation are correct except:

Issuance costs are costs of issuing stock; includes accounting, legal, and printing costs of offering shares to the public, as well as the commission or fees earned by the investment bankers.

All classes of common equity may have the same voting rights.

EBIT/EPS analysis shows the ranges of EBIT where a firm may prefer one capital structure over another.

Minimum cash flow ∕ Investment = Maximum rate of return.

A decrease in the debt ratio will normally have no effect on:

All of the following components are needed to calculate the sustainable growth rate except:

If a firm has current earnings before interest and taxes of $100,000 and interest expense of $10,000, its degree of financial leverage would be:

Other factors being constant, higher fixed operating costs mean:

Surveys of U.S. firms find that most firms use before-tax WACC as their required rate of return for projects.

Which of the following is not potentially used in the weighted average cost of capital equation?

A theory that firms time the market by issuing stock when their stock prices are high and repurchasing shares when their stock values are low.

A firm's business risk is affected by all of the following, except:

Retained earnings are not directly related to net income.

If a firm has current earnings per share of $2 and a degree of combined leverage of 4, a 10% increase in sales would result in earnings per share of:

All of the following affects a firm's choice of capital structures, except:

This is the proportion of each dollar of earnings that is paid to shareholders as a dividend; equals one minus the retention rate.

All of the following statements are correct except:

It is equal to the ratio of the expected increase in retained earnings over the next year to the current asset base.

The degree of financial leverage may be measured by taking the firm's earnings before interest and taxes and dividing by earnings before taxes.

The Financial Environment

Money and the Monetary System

Banks and Other Financial Institutions

Federal Reserve System

Policy Makers and the Money Supply

International Finance and Trade

Savings and Investment Process

Interest Rates

Time Value of Money

Bonds and Stocks: Characteristics and Valuations

Securities and Markets

Financial Return and Risk Concepts

Business Organization and Financial Data

Financial Analysis and Long-Term Financial Planning

Managing Working Capital

Short-Term Business Financing

Capital Budgeting Analysis

Filters