Question 1

Which of the following statements concerning a firm's degree of financial leverage (DFL) is correct? Assume everything else is equal.

Accepted Answer

A) If the firm issues additional common stock, its DFL should increase. 
B) Compared to a lower DFL, a higher DFL implies a greater financial risk. 
C) Compared to a higher DFL, a lower DFL implies a greater financial risk. 
D) If the firm issues additional long-term debt, its DFL should decrease. 
E) The firm's DFL cannot be negative. 
A) If the firm issues additional common stock, its DFL should increase. 
B) Compared to a lower DFL, a higher DFL implies a greater financial risk. 
C) Compared to a higher DFL, a lower DFL implies a greater financial risk. 
D) If the firm issues additional long-term debt, its DFL should decrease. 
E) The firm's DFL cannot be negative. B

Question 2

Top-Shelf Construction discovered that for every 1 percent decrease in its sales, its earnings before interest and taxes (EBIT) decrease by 3.2 percent. Based on this information, we know that Top-Shelf Construction has a:

Accepted Answer

A) debt/assets ratio equal to 3.2 times its debt/equity ratio. 
B) degree of operating leverage (DOL) equal to 3.2. 
C) current ratio (= Current assets/Current liabilities) equal to 3.2. 
D) degree of total leverage equal to 3.2. 
E) degree of financial leverage (DFL) equal to 3.2. 
A) debt/assets ratio equal to 3.2 times its debt/equity ratio. 
B) degree of operating leverage (DOL) equal to 3.2. 
C) current ratio (= Current assets/Current liabilities) equal to 3.2. 
D) degree of total leverage equal to 3.2. 
E) degree of financial leverage (DFL) equal to 3.2. B

Question 3

The presence of fixed operating costs is known as _____.

Accepted Answer

A) financial leverage 
B) operating leverage 
C) beta risk 
D) market risk 
E) firm-specific risk 
A) financial leverage 
B) operating leverage 
C) beta risk 
D) market risk 
E) firm-specific risk B

Question 4

According to the following information, what is the firm's optimal capital structure?    $\begin{array}{ccc}
\text { Proportion } & \text { Earnings Per } & \text { Weighted Average Cost } \
\text { of Debt } & \text { Share (EPS) } & \text { of Capital (WACC) } \
\hline 30 \% & \$ 2.50 & 13.2 \% \
40 & 3.80 & 12.7 \
50 & 4.75 & 12.4 \
60 & 5.25 & 12.8
\end{array}$

Accepted Answer

A) 30% 
B) 40% 
C) 50% 
D) 60% 
E) To determine the optimal capital structure, the market value of the stock must be known. 
A) 30% 
B) 40% 
C) 50% 
D) 60% 
E) To determine the optimal capital structure, the market value of the stock must be known.

Question 5

According to the basic capital structure theory proposed by Modigliani and Miller (MM), when will a firm's value be maximum?

Accepted Answer

A) When it is financed entirely with equity. 
B) When its capital structure contains 50 percent debt and 50 percent equity. 
C) When it is financed entirely with retained earnings. 
D) When it is financed with almost 100 percent through debt. 
E) When its assets are financed with 50 percent equity and 50 percent retained earnings. 
A) When it is financed entirely with equity. 
B) When its capital structure contains 50 percent debt and 50 percent equity. 
C) When it is financed entirely with retained earnings. 
D) When it is financed with almost 100 percent through debt. 
E) When its assets are financed with 50 percent equity and 50 percent retained earnings.

Question 6

Which of the following statements concerning a firm's times-interest earned (TIE) ratio is correct?

Accepted Answer

A) Generally the lower its TIE ratio, the higher the probability that the firm will default on its debt. 
B) The TIE ratio is calculated by dividing net income by interest charges. 
C) The TIE ratio increases if the debt/assets ratio increases, and vice versa. 
D) The TIE ratio is always greater than 1. 
E) The TIE ratio shows the effects of both operating leverage and financial leverage. 
A) Generally the lower its TIE ratio, the higher the probability that the firm will default on its debt. 
B) The TIE ratio is calculated by dividing net income by interest charges. 
C) The TIE ratio increases if the debt/assets ratio increases, and vice versa. 
D) The TIE ratio is always greater than 1. 
E) The TIE ratio shows the effects of both operating leverage and financial leverage.

Question 7

If a firm's times-interest-earned (TIE) ratio decreases, the probability that it will default on its outstanding debt also decreases.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following is considered a component of financial risk?

Accepted Answer

A) Fixed operating costs 
B) Variable operating costs 
C) The variability of a product's selling price 
D) Interest payments on bonds 
E) Fixed labor costs 
A) Fixed operating costs 
B) Variable operating costs 
C) The variability of a product's selling price 
D) Interest payments on bonds 
E) Fixed labor costs

Question 9

Trueware Corporation is a start-up firm with a capital structure that includes 25 percent debt. Trueware has no preferred stock. The firm has two possible scenarios for its operations: Ruby or Emerald. The Ruby scenario has a 70 percent probability of occurring and the forecast earnings before interest and taxes (EBIT) in this scenario is $80,000. The Emerald scenario has a 30 percent chance of occurring and the EBIT is expected to be $32,000. Further, the firm's cost of debt is 10 percent. The firm has $500,000 in total assets and its marginal tax rate is 30 percent. The company has 22,000 shares of common stock outstanding. Calculate the difference in earnings per share (EPS) for the capital structure

Accepted Answer

A) $1.53 
B) $1.20 
C) $1.48 
D) $2.24 
E) $3.15 
A) $1.53 
B) $1.20 
C) $1.48 
D) $2.24 
E) $3.15

Question 10

According to the trade-off theory that has been suggested as a possible explanation for the differences in firms' capital structures that we observe in the real world, which of the following securities is the least expensive form of financing for a particular firm?

Accepted Answer

A) Common stock 
B) Preferred stock 
C) Corporate debt 
D) Retained earnings 
E) Classified stock 
A) Common stock 
B) Preferred stock 
C) Corporate debt 
D) Retained earnings 
E) Classified stock

Question 11

Everything else equal, and for one particular firm, in which of the following capital structures would the common stockholders have to bear the greatest amount of of business risk?

Accepted Answer

A) 100 percent equity 
B) 25 percent equity and 75 percent debt 
C) 50 percent equity and 50 percent debt 
D) 1 percent equity and 99 percent debt 
E) 75 percent equity and 25 percent debt 
A) 100 percent equity 
B) 25 percent equity and 75 percent debt 
C) 50 percent equity and 50 percent debt 
D) 1 percent equity and 99 percent debt 
E) 75 percent equity and 25 percent debt

Question 12

Following are the results of the capital structure analysis SoCal Irrigation just completed:    
$$\begin{array} { c c c } 
\begin{array} { c } 
\text { Proportion } \
\text { of Debt }
\end{array} & \begin{array} { c } 
\text { Stock Price } \
\text { (per share) }
\end{array} & \begin{array} { c } 
\text { Earnings per } \
\text { Share (EPS) }
\end{array} \
\hline 20 \% & \$ 44.50 & \$ 1.20 \
40 & 45.15 & 1.26 \
60 & 45.20 & 1.22 \
80 & 44.95 & 1.18
\end{array}$$
According to this information, what is SoCal's optimal capital structure?

Accepted Answer

A) 20% 
B) 40% 
C) 60% 
D) 80% 
E) To determine the optimal capital structure, the market value of the stock must be known. 
A) 20% 
B) 40% 
C) 60% 
D) 80% 
E) To determine the optimal capital structure, the market value of the stock must be known.

Question 13

Olson Corporation has a beta coefficient of 1.5 at a debt/assets ratio equal to 40 percent. The risk-free rate of return, rRF, is 5 percent and the market return, rM, is 9 percent. Based on the capital asset pricing model (CAPM), what is Olson's required rate of return on its common equity?

Accepted Answer

A) 18.5% 
B) 13.5% 
C) 11.0% 
D) 15.0% 
E) 6.0% 
A) 18.5% 
B) 13.5% 
C) 11.0% 
D) 15.0% 
E) 6.0%

Question 14

Everything else equal, in which of the following situations will a firm's degree of operating leverage (DOL) increase? Assume the firm currently generates a positive net operating income.

Accepted Answer

A) Sales increase substantially. 
B) The firm issues preferred stock. 
C) Fixed costs are decreased. 
D) The firm takes advantage of quantity discounts for the first time. 
E) The firm's sales move closer to its operating breakeven point. 
A) Sales increase substantially. 
B) The firm issues preferred stock. 
C) Fixed costs are decreased. 
D) The firm takes advantage of quantity discounts for the first time. 
E) The firm's sales move closer to its operating breakeven point.

Question 15

At its optimal capital structure, the firm's debt/assets ratio will always be lower than the one that maximizes its _____.

Accepted Answer

A) expected earnings per share (EPS) 
B) weighted average cost of capital 
C) beta coefficient 
D) degree of financial leverage 
E) net operating income 
A) expected earnings per share (EPS) 
B) weighted average cost of capital 
C) beta coefficient 
D) degree of financial leverage 
E) net operating income

Question 16

The optimal capital structure is the capital structure that strikes a balance between risk and return such that the firm's stock price is maximized.

Accepted Answer

A) True 
 B)False

Question 17

According to the signaling theory, a firm with unfavorable future prospects might issue common stock in an effort to:

Accepted Answer

A) share any losses with new stockholders (owners). 
B) increase bankruptcy costs associated with the firm. 
C) skip the regular dividend payments on common stock. 
D) maintain a reserve borrowing capacity. 
E) increase the tax benefit it derives from dividend payments to stockholders. 
A) share any losses with new stockholders (owners). 
B) increase bankruptcy costs associated with the firm. 
C) skip the regular dividend payments on common stock. 
D) maintain a reserve borrowing capacity. 
E) increase the tax benefit it derives from dividend payments to stockholders.

Question 18

Copybold Corporation is a start-up company that has a capital structure with a debt/assets ratio equal to 0.75. Copybold has no preferred stock. There are two possible scenarios with respect to the firm's operations: Feast or Famine. The Feast scenario has a 60 percent probability of occurring, and the forecast earnings before interest and taxes (EBIT) in this scenario is $60,000. The Famine scenario has a 40 percent chance of occurring, and the EBIT is expected to be $20,000. Further, the firm's cost of debt is 12 percent. The firm has $400,000 in total assets, and its marginal tax rate is 40 percent. The company has 10,000 shares of stock outstanding. What is the difference between the earnings per share (EPS) forecasts for the Feast scenario and the Famine scenario?

Accepted Answer

A) $1.44 per share 
B) $2.40 per share 
C) $1.48 per share 
D) $0.48 per share 
E) $0.96 per share 
A) $1.44 per share 
B) $2.40 per share 
C) $1.48 per share 
D) $0.48 per share 
E) $0.96 per share

Question 19

Operating leverage refers to the presence of _____.

Accepted Answer

A) fixed-income securities 
B) beta risks 
C) firm-specific risks 
D) variable operating costs 
E) fixed operating costs 
A) fixed-income securities 
B) beta risks 
C) firm-specific risks 
D) variable operating costs 
E) fixed operating costs

Question 20

Equity monitoring costs are lower in the United States than in other countries because:

Accepted Answer

A) debt that corporations use in the United States consists primarily of bank loans. 
B) capital gains are not taxed in the United States unless they exceed some minimum amount. 
C) U.S. companies must comply with fairly stringent financial audit requirements. 
D) dividends in the United States are exempt from personal taxes; i.e., investors are not required to pay taxes on the dividends they receive. 
E) banks in the United States hold a significant proportion of long-term bonds (debt) issued by companies, which means they can better monitor companies' debt than can banks in other countries. 
A) debt that corporations use in the United States consists primarily of bank loans. 
B) capital gains are not taxed in the United States unless they exceed some minimum amount. 
C) U.S. companies must comply with fairly stringent financial audit requirements. 
D) dividends in the United States are exempt from personal taxes; i.e., investors are not required to pay taxes on the dividends they receive. 
E) banks in the United States hold a significant proportion of long-term bonds (debt) issued by companies, which means they can better monitor companies' debt than can banks in other countries.

Which of the following statements concerning a firm's degree of financial leverage (DFL) is correct? Assume everything else is equal.

Top-Shelf Construction discovered that for every 1 percent decrease in its sales, its earnings before interest and taxes (EBIT) decrease by 3.2 percent. Based on this information, we know that Top-Shelf Construction has a:

The presence of fixed operating costs is known as _____.

According to the following information, what is the firm's optimal capital structure? Proportion Earnings Per Weighted Average Cost of Debt Share (EPS) of Capital (WACC) 30\% \ 2.50 13.2\% 40 3.80 12.7 50 4.75 12.4 60 5.25 12.8

According to the basic capital structure theory proposed by Modigliani and Miller (MM), when will a firm's value be maximum?

Which of the following statements concerning a firm's times-interest earned (TIE) ratio is correct?

If a firm's times-interest-earned (TIE) ratio decreases, the probability that it will default on its outstanding debt also decreases.

Which of the following is considered a component of financial risk?

According to the trade-off theory that has been suggested as a possible explanation for the differences in firms' capital structures that we observe in the real world, which of the following securities is the least expensive form of financing for a particular firm?

Everything else equal, and for one particular firm, in which of the following capital structures would the common stockholders have to bear the greatest amount of of business risk?

Following are the results of the capital structure analysis SoCal Irrigation just completed: Proportion of Debt Stock Price (per share) Earnings per Share (EPS) 20\% \ 44.50 \ 1.20 40 45.15 1.26 60 45.20 1.22 80 44.95 1.18 According to this information, what is SoCal's optimal capital structure?

Olson Corporation has a beta coefficient of 1.5 at a debt/assets ratio equal to 40 percent. The risk-free rate of return, rRF, is 5 percent and the market return, rM, is 9 percent. Based on the capital asset pricing model (CAPM), what is Olson's required rate of return on its common equity?

Everything else equal, in which of the following situations will a firm's degree of operating leverage (DOL) increase? Assume the firm currently generates a positive net operating income.

At its optimal capital structure, the firm's debt/assets ratio will always be lower than the one that maximizes its _____.

The optimal capital structure is the capital structure that strikes a balance between risk and return such that the firm's stock price is maximized.

According to the signaling theory, a firm with unfavorable future prospects might issue common stock in an effort to:

Operating leverage refers to the presence of _____.

Equity monitoring costs are lower in the United States than in other countries because:

An Overview of Managerial Finance

Analysis of Financial Statements

The Financial Environment: Markets, Institutions, and Investment Banking

Time Value of Money

The Cost of Money Interest Rates

Bonds Debt Characteristics and Valuation

Stocks Equity Characteristics and Valuation

Risk and Rates of Return

Capital Budgeting Techniques

Project Cash Flows and Risk

The Cost of Capital

Distribution of Retained Earnings: Dividends and Stock Repurchases

Managing Short-Term Financing Liabilities

Managing Short-Term Assets

Financial Planning and Control

Filters

Exam 12: Capital Structure

Which of the following statements concerning a firm's degree of financial leverage (DFL) is correct? Assume everything else is equal.

Top-Shelf Construction discovered that for every 1 percent decrease in its sales, its earnings before interest and taxes (EBIT) decrease by 3.2 percent. Based on this information, we know that Top-Shelf Construction has a:

The presence of fixed operating costs is known as _____.

According to the following information, what is the firm's optimal capital structure? Proportion Earnings Per Weighted Average Cost of Debt Share (EPS) of Capital (WACC) 30\% \ 2.50 13.2\% 40 3.80 12.7 50 4.75 12.4 60 5.25 12.8

According to the basic capital structure theory proposed by Modigliani and Miller (MM), when will a firm's value be maximum?

Which of the following statements concerning a firm's times-interest earned (TIE) ratio is correct?

If a firm's times-interest-earned (TIE) ratio decreases, the probability that it will default on its outstanding debt also decreases.

Which of the following is considered a component of financial risk?

According to the trade-off theory that has been suggested as a possible explanation for the differences in firms' capital structures that we observe in the real world, which of the following securities is the least expensive form of financing for a particular firm?

Everything else equal, and for one particular firm, in which of the following capital structures would the common stockholders have to bear the greatest amount of of business risk?

Following are the results of the capital structure analysis SoCal Irrigation just completed: Proportion of Debt Stock Price (per share) Earnings per Share (EPS) 20\% \ 44.50 \ 1.20 40 45.15 1.26 60 45.20 1.22 80 44.95 1.18 According to this information, what is SoCal's optimal capital structure?

Olson Corporation has a beta coefficient of 1.5 at a debt/assets ratio equal to 40 percent. The risk-free rate of return, rRF, is 5 percent and the market return, rM, is 9 percent. Based on the capital asset pricing model (CAPM), what is Olson's required rate of return on its common equity?

Everything else equal, in which of the following situations will a firm's degree of operating leverage (DOL) increase? Assume the firm currently generates a positive net operating income.

At its optimal capital structure, the firm's debt/assets ratio will always be lower than the one that maximizes its _____.

The optimal capital structure is the capital structure that strikes a balance between risk and return such that the firm's stock price is maximized.

According to the signaling theory, a firm with unfavorable future prospects might issue common stock in an effort to:

Operating leverage refers to the presence of _____.

Equity monitoring costs are lower in the United States than in other countries because:

An Overview of Managerial Finance

Analysis of Financial Statements

The Financial Environment: Markets, Institutions, and Investment Banking

Time Value of Money

The Cost of Money Interest Rates

Bonds Debt Characteristics and Valuation

Stocks Equity Characteristics and Valuation

Risk and Rates of Return

Capital Budgeting Techniques

Project Cash Flows and Risk

The Cost of Capital

Distribution of Retained Earnings: Dividends and Stock Repurchases

Managing Short-Term Financing Liabilities

Managing Short-Term Assets

Financial Planning and Control

Filters