Question 1

Which of the following statements is not true regarding Miller's analysis?

Accepted Answer

A) There is an optimal debt/equity ratio for the corporate sector. 
B) There is no optimal debt/equity ratio for individual companies. 
C) Shareholders benefit from the tax saving of interest on debt. 
D) Securities issued by different companies will appeal to different clientele. 
A) There is an optimal debt/equity ratio for the corporate sector. 
B) There is no optimal debt/equity ratio for individual companies. 
C) Shareholders benefit from the tax saving of interest on debt. 
D) Securities issued by different companies will appeal to different clientele. C

Question 2

Which theory proposes that companies have an optimal capital structure based on a trade-off between the benefits and costs of using debt?

Accepted Answer

A) Trade-off theory. 
B) Reverse pecking order theory. 
C) Information asymmetry theory. 
D) Pecking order theory. 
A) Trade-off theory. 
B) Reverse pecking order theory. 
C) Information asymmetry theory. 
D) Pecking order theory. A

Question 3

The proportion of debt and equity financing used by a company is known as its ____________________.

Accepted Answer

capital structure

Question 4

Which of the following statements is true concerning debt that has no risk of default?

Accepted Answer

A) A company's cost of capital increases as more debt is used in its capital structure. 
B) The cost of debt increases as more debt is used in the company's capital structure. 
C) The cost of debt increases as more debt is used in the company's capital structure because total risk increases. 
D) The cost of equity capital increases with increasing proportions of debt because,although the total amount of risk does not change,risk is concentrated on a proportionately smaller amount of equity capital. 
A) A company's cost of capital increases as more debt is used in its capital structure. 
B) The cost of debt increases as more debt is used in the company's capital structure. 
C) The cost of debt increases as more debt is used in the company's capital structure because total risk increases. 
D) The cost of equity capital increases with increasing proportions of debt because,although the total amount of risk does not change,risk is concentrated on a proportionately smaller amount of equity capital.

Question 5

From the following data,calculate the company's cost of capital: annual earnings = $0.2 million,total market value of company = $0.5 million,total value of debt = 0,interest on debt = 12% p.a.

Accepted Answer

A) 28% 
B) 4.8% 
C) 12% 
D) 40% 
A) 28% 
B) 4.8% 
C) 12% 
D) 40%

Question 6

An example of adverse incentive effects of debt is:

Accepted Answer

A) an increase in the dividend payout ratio. 
B) an appointment of a liquidator. 
C) disgruntled employees taking sick leave. 
D) none of the given options. 
A) an increase in the dividend payout ratio. 
B) an appointment of a liquidator. 
C) disgruntled employees taking sick leave. 
D) none of the given options.

Question 7

Which of the following statements is true?

Accepted Answer

A) Bankruptcy costs do not concern shareholders because they are borne entirely by other parties. 
B) Debtholders rarely realise the potential for bankruptcy and do not demand a higher rate of interest on their loans in compensation. 
C) Debtholders will not demand higher interest rates on loans because in so doing they may increase the likelihood of bankruptcy. 
D) For any given level of business risk,the higher the financial risk,the greater the probability of bankruptcy. 
A) Bankruptcy costs do not concern shareholders because they are borne entirely by other parties. 
B) Debtholders rarely realise the potential for bankruptcy and do not demand a higher rate of interest on their loans in compensation. 
C) Debtholders will not demand higher interest rates on loans because in so doing they may increase the likelihood of bankruptcy. 
D) For any given level of business risk,the higher the financial risk,the greater the probability of bankruptcy.

Question 8

A company with low financial leverage,large reserve borrowing capacity and few profitable investment opportunities is likely to:

Accepted Answer

A) have a high cost of capital. 
B) generate larger free cash flows. 
C) generate smaller free cash flows. 
D) have a high cost of debt. 
A) have a high cost of capital. 
B) generate larger free cash flows. 
C) generate smaller free cash flows. 
D) have a high cost of debt.

Question 9

Financial risk comes about when:

Accepted Answer

A) new competitors emerge. 
B) new government regulations are introduced. 
C) the dividend payout ratio is increased. 
D) a company uses fixed-charge finance. 
A) new competitors emerge. 
B) new government regulations are introduced. 
C) the dividend payout ratio is increased. 
D) a company uses fixed-charge finance.

Question 10

The 'traditional view' of capital structure argues that:

Accepted Answer

A) a company's overall cost of capital can be reduced by financial leverage provided that the degree of leverage is not too great. 
B) the cost of capital is unaltered by using 'cheaper debt'. 
C) a company's cost of capital increases as more debt is used in its capital structure. 
D) a firm's value is independent of its capital structure. 
A) a company's overall cost of capital can be reduced by financial leverage provided that the degree of leverage is not too great. 
B) the cost of capital is unaltered by using 'cheaper debt'. 
C) a company's cost of capital increases as more debt is used in its capital structure. 
D) a firm's value is independent of its capital structure.

Question 11

Given the following data,a suitable arbitrage opportunity for an investor with a 2% share in Company L would be to:

Accepted Answer

A) sell 1% shares in L,borrow on personal account and invest in shares of L. 
B) borrow on personal account and buy more shares in L. 
C) sell shares in L and buy 2% shares in U. 
D) sell shares in L and buy 1% shares in U. 
A) sell 1% shares in L,borrow on personal account and invest in shares of L. 
B) borrow on personal account and buy more shares in L. 
C) sell shares in L and buy 2% shares in U. 
D) sell shares in L and buy 1% shares in U.

Question 12

Which of the following is true of debt?

Accepted Answer

A) Variation in expected EPS increases as the level of debt increases. 
B) Variation in expected EPS increases as the level of debt decreases. 
C) Variation in expected EPS is not affected as the level of debt increases. 
D) Variation in expected EPS decreases as the level of debt increases. 
A) Variation in expected EPS increases as the level of debt increases. 
B) Variation in expected EPS increases as the level of debt decreases. 
C) Variation in expected EPS is not affected as the level of debt increases. 
D) Variation in expected EPS decreases as the level of debt increases.

Question 13

The chance that a borrower will fail to meet obligations to pay interest and principal as promised is known as:

Accepted Answer

A) natural conservation of risk. 
B) credit risk. 
C) default risk. 
D) business risk. 
A) natural conservation of risk. 
B) credit risk. 
C) default risk. 
D) business risk.

Question 14

The ___________ theory establishes a hierarchy of financing sources which are preferred by the managers of a company.

Accepted Answer

The answer of The ___________ theory establishes a hierarchy of...

Question 15

Financial leverage exposes shareholders to financial risk because:

Accepted Answer

A) competition forces companies to adopt an optimal capital structure. 
B) a company uses debt to increase the expected rate of return to shareholders. 
C) interest on debt needs to be paid even when operating performance declines. 
D) none of the given options. 
A) competition forces companies to adopt an optimal capital structure. 
B) a company uses debt to increase the expected rate of return to shareholders. 
C) interest on debt needs to be paid even when operating performance declines. 
D) none of the given options.

Question 16

The effect of debt on the rate of return earned by shareholders of the company is known as _____________________.

Accepted Answer

The answer of The effect of debt on the rate...

Question 17

If a company is financed entirely by equity then variations in the return to shareholders are attributable only to:

Accepted Answer

A) financial risk. 
B) business risk. 
C) technology risk. 
D) diversifiable risk. 
A) financial risk. 
B) business risk. 
C) technology risk. 
D) diversifiable risk.

Question 18

When considering personal taxes (but ignoring imputation):

Accepted Answer

A) effectively,the marginal tax rate on share income is greater than on debt income. 
B) the tax deductibility of interest could never be fully offset by the tax differential on income to debtholders and shareholders. 
C) the benefit of the tax deductibility of interest may be offset by the fact that investors need to be compensated for the higher personal tax on income to debtholders than shareholders. 
D) tax paid on company income is zero. 
A) effectively,the marginal tax rate on share income is greater than on debt income. 
B) the tax deductibility of interest could never be fully offset by the tax differential on income to debtholders and shareholders. 
C) the benefit of the tax deductibility of interest may be offset by the fact that investors need to be compensated for the higher personal tax on income to debtholders than shareholders. 
D) tax paid on company income is zero.

Question 19

Calculate the cost of debt from the following information: company cost of capital = 15%,cost of equity capital = 16 per cent,D = $0.2 million,and V = $0.5 million.

Accepted Answer

A) 12.5% 
B) 13.5% 
C) 10.5% 
D) 15.5% 
A) 12.5% 
B) 13.5% 
C) 10.5% 
D) 15.5%

Question 20

With the introduction of risky debt,MM argues that the:

Accepted Answer

A) cost of equity increases at a decreasing rate as the debt/equity ratio increases beyond a certain level. 
B) cost of equity continues to increase as the debt/equity ratio increases. 
C) cost of debt increases at a decreasing rate as the debt/equity ratio increases beyond a certain level. 
D) company cost of capital increases as the debt/equity ratio increases beyond a certain level. 
A) cost of equity increases at a decreasing rate as the debt/equity ratio increases beyond a certain level. 
B) cost of equity continues to increase as the debt/equity ratio increases. 
C) cost of debt increases at a decreasing rate as the debt/equity ratio increases beyond a certain level. 
D) company cost of capital increases as the debt/equity ratio increases beyond a certain level.

Exam 12: Principles of Capital Structure

Which of the following statements is not true regarding Miller's analysis?

Which theory proposes that companies have an optimal capital structure based on a trade-off between the benefits and costs of using debt?

The proportion of debt and equity financing used by a company is known as its ____________________.

Which of the following statements is true concerning debt that has no risk of default?

From the following data,calculate the company's cost of capital: annual earnings = $0.2 million,total market value of company = $0.5 million,total value of debt = 0,interest on debt = 12% p.a.

An example of adverse incentive effects of debt is:

Which of the following statements is true?

A company with low financial leverage,large reserve borrowing capacity and few profitable investment opportunities is likely to:

Financial risk comes about when:

The 'traditional view' of capital structure argues that:

Given the following data,a suitable arbitrage opportunity for an investor with a 2% share in Company L would be to:

Which of the following is true of debt?

The chance that a borrower will fail to meet obligations to pay interest and principal as promised is known as:

The ___________ theory establishes a hierarchy of financing sources which are preferred by the managers of a company.

Financial leverage exposes shareholders to financial risk because:

The effect of debt on the rate of return earned by shareholders of the company is known as _____________________.

If a company is financed entirely by equity then variations in the return to shareholders are attributable only to:

When considering personal taxes (but ignoring imputation):

Calculate the cost of debt from the following information: company cost of capital = 15%,cost of equity capital = 16 per cent,D = $0.2 million,and V = $0.5 million.

With the introduction of risky debt,MM argues that the:

Introduction

Consumption, Investment and the Capital Market

The Time Value of Money: An Introduction to Financial Mathematics

Applying the Time Value of Money to Security Valuation

Project Evaluation: Principles and Methods

The Application of Project Evaluation Methods

Risk and Return

The Capital Market

Sources of Finance: Equity

Sources of Finance: Debt

Payout Policy

Capital Structure Decisions

The Cost of Capital and Taxation Issues in Project Evaluation

Leasing and Other Equipment Finance

Capital Market Efficiency

Futures Contracts

Options and Contingent Claims

Analysis of Takeovers

International Financial Management

Management of Short-Term Assets: Inventory

Management of Short-Term Assets: Liquid Assets and Accounts Receivable

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