Question 1

A survey of Fortune 500 firms indicate 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 B

Question 2

With an optimal capital structure

Accepted Answer

A) overall capital costs are minimized 
B) the net present value of new projects is minimized 
C) financial leverage is minimized 
D) the weighted cost of capital is maximized 
A) overall capital costs are minimized 
B) the net present value of new projects is minimized 
C) financial leverage is minimized 
D) the weighted cost of capital is maximized A

Question 3

When a corporation must get external financing, the first place to look for funds is with debt.There are various reasons for this preference.List the reasons why debt is generally issued first.

Accepted Answer

1.Flotation costs for debt are generally lower than the costs for equities.
2.The stock market tends to react negatively to announcements of new common stock offerings.
3.Debt is considered the "safest" of the external securities that could be issued.
4.Debt may offer more financial flexibility.

Question 4

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

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 5

represents the permanent sources of the firm's financing.

Accepted Answer

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

Question 6

Calculate the market value of a firm with total assets of $60 million and a net worth of $35 million.The firm's cost of equity is 15% and the cost of perpetual debt is 8%.The firm has a perpetual net operating income (EBIT) of $4.5 million and a marginal tax rate of 35%.

Accepted Answer

A) $41.67 million 
B) $30.00 million 
C) $35.83 million 
D) $30.83 million 
A) $41.67 million 
B) $30.00 million 
C) $35.83 million 
D) $30.83 million

Question 7

Triad Labs has total assets of $120 million and $40 million of debt in its capital structure.Its current cost of equity is 13% and its cost of debt is 8.5%.Triad is considering increasing its debt to $70 million and purchasing its own stock with proceeds from the sale of $30 million in debt with a cost of 9.5%, reducing equity to $50 million.The cost of equity will increase to 14.5%.Net operating income (EBIT) will remain at $12 million.If Triad has a marginal tax rate of 40%, should the firm increase its debt? Assume that both debt and EBIT are perpetual.

Accepted Answer

A) No, the value of the firm decreases $15.9 million 
B) No, the value of the firm decreases $30.0 million 
C) Yes, the value of the firm increases $14.1 million 
D) Yes, the value of the firm increases $30.0 million 
A) No, the value of the firm decreases $15.9 million 
B) No, the value of the firm decreases $30.0 million 
C) Yes, the value of the firm increases $14.1 million 
D) Yes, the value of the firm increases $30.0 million

Question 8

The tax deductibility of interest payments provides the firm with a:

Accepted Answer

A) market advantage 
B) learning curve 
C) tax shield 
D) safeguard against auditing 
A) market advantage 
B) learning curve 
C) tax shield 
D) safeguard against auditing

Question 9

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) beyond some point, becomes greater than the cost of equity 
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) beyond some point, becomes greater than the cost of equity 
D) initially rises slowly, then increases rapidly beyond some point

Question 10

Two prominent finance researchers (Modigliani and Miller) showed that

Accepted Answer

A) the firm's optimal capital structure consists of approximately equal proportions of debt and equity 
B) the value of the firm is independent of its capital structure in perfect capital markets with no income taxes 
C) the firm's cost of capital is minimized when its capital structure consists of approximately equal proportions of debt and equity 
D) the firm's cost of capital is maximized when its capital structure consists of approximately equal proportions of debt and equity 
A) the firm's optimal capital structure consists of approximately equal proportions of debt and equity 
B) the value of the firm is independent of its capital structure in perfect capital markets with no income taxes 
C) the firm's cost of capital is minimized when its capital structure consists of approximately equal proportions of debt and equity 
D) the firm's cost of capital is maximized when its capital structure consists of approximately equal proportions of debt and equity

Question 11

The Modigliani-Miller theory that the value of the firm is independent of its capital structure is based on a(n) ?process.

Accepted Answer

A) reinvestment 
B) capital asset pricing model 
C) arbitraging 
D) compound interest 
A) reinvestment 
B) capital asset pricing model 
C) arbitraging 
D) compound interest

Question 12

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

Question 13

RoTek has a capital structure of $300,000 in equity and $300,000 in perpetual debt.The firm's cost of equity is 14 percent and its cost of debt is 9 percent.If the firm has an expected, perpetual net operating income of $120,000 and a marginal tax rate of 40 percent, what is the market value of RoTek? Assume all net income is paid out as dividends.

Accepted Answer

A) $698,571 
B) $814,286 
C) $818,571 
D) $55,800 
A) $698,571 
B) $814,286 
C) $818,571 
D) $55,800

Question 14

The increased variability in earnings per share due to the firm's use of debt is a definition of .

Accepted Answer

A) combined leverage 
B) agency risk 
C) financial risk 
D) operating risk 
A) combined leverage 
B) agency risk 
C) financial risk 
D) operating risk

Question 15

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 16

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

Accepted Answer

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

Question 17

Operating leverage involves the use of

Accepted Answer

A) equity and debt in equal proportions 
B) market power 
C) debt 
D) assets having fixed costs 
A) equity and debt in equal proportions 
B) market power 
C) debt 
D) assets having fixed costs

Question 18

Biotec has estimated the costs of debt and equity capital for various proportions of debt in its capital structure:
 
Based on these estimates, determine Biotec's optimal capital structure.

Accepted Answer

A) 35% debt 
B) 40% debt 
C) 45% debt 
D) 50% debt 
A) 35% debt 
B) 40% debt 
C) 45% debt 
D) 50% debt

Question 19

Calculate the market value of Lotle Group, a firm with total assets of $80 million and $30 million of perpetual debt in its capital structure.The firm's cost of equity is 14% and the cost of debt is 9%.Lotle expects annual, perpetual net operating income (EBIT) of $9 million and a marginal tax rate of 40%.

Accepted Answer

A) $30 million 
B) $61.3 million 
C) $57 million 
D) $64.3 million 
A) $30 million 
B) $61.3 million 
C) $57 million 
D) $64.3 million

Question 20

Investors' required returns and the cost of equity capital as the relative amount of debt used to finance the firm .

Accepted Answer

A) increase, increases 
B) increase, decreases 
C) remain constant, increases 
D) remain constant, decreases 
A) increase, increases 
B) increase, decreases 
C) remain constant, increases 
D) remain constant, decreases

Exam 13: Capital Structure Concepts

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

With an optimal capital structure

When a corporation must get external financing, the first place to look for funds is with debt.There are various reasons for this preference.List the reasons why debt is generally issued first.

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

represents the permanent sources of the firm's financing.

Calculate the market value of a firm with total assets of $60 million and a net worth of $35 million.The firm's cost of equity is 15% and the cost of perpetual debt is 8%.The firm has a perpetual net operating income (EBIT) of $4.5 million and a marginal tax rate of 35%.

The tax deductibility of interest payments provides the firm with a:

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

Two prominent finance researchers (Modigliani and Miller) showed that

The Modigliani-Miller theory that the value of the firm is independent of its capital structure is based on a(n) ?process.

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

The increased variability in earnings per share due to the firm's use of debt is a definition of .

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%?

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

Operating leverage involves the use of

Biotec has estimated the costs of debt and equity capital for various proportions of debt in its capital structure: Based on these estimates, determine Biotec's optimal capital structure.

Investors' required returns and the cost of equity capital as the relative amount of debt used to finance the firm .

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

A: The Time Value of Money

Fixed-Income Securities: Characteristics and Valuation

Common Stock: Characteristics, Valuation, and Issuance

Analysis of Risk and Return

Capital Budgeting and Cash Flow Analysis

Capital Budgeting: Decision Criteria and Real Option Considerations

A: Capital Budgeting: Decision Criteria and Real Option Considerations

Capital Budgeting and Risk

The Cost of Capital, Capital Structure, and Dividend Policy

Capital Structure Management in Practice

A: Capital Structure Management in Practice

Dividend Policy

Working Capital Management

The Management of Cash and Marketable Securities

The Management of Accounts Receivable and Inventories

Lease and Intermediate-Term Financing

Financing with Derivatives

A: Financing with Derivatives

Risk Management

International Financial Management

Corporate Restructuring

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