Question 1

Leverage magnifies both gains and losses.

Accepted Answer

A) True 
 B)False  True

Question 2

You have a project that costs $800,000. It has a 1/3 chance of paying off $3,000,000 and a 2/3 chance of paying off $0. What is the expected profit from the new project?

Accepted Answer

A)  $300,000 
B)  $200,000 
C)  $100,000 
D)  zero 
A)  $300,000 
B)  $200,000 
C)  $100,000 
D)  zero B

Question 3

Investors Bill and Maggie lend $60,000 to each new idea. Bill picks low-risk projects that are successful 60% of the time. Maggie takes on high-risk projects that that are successful 20% of the time. What rate of return must each successful project pay Bill and Maggie for them to break even?

Accepted Answer

The answer of Investors Bill and Maggie lend $60,000 to...

Question 4

Above the break-even EBIT, there is no benefit in debt financing.

Accepted Answer

A) True 
 B)False

Question 5

The contribution of M&M comes from the fact that there is a constant trade-off ratio. Which of the statements below describe this constant trade-off ratio?

Accepted Answer

A)  When a firm adds more low cost debt, it automatically increases the cost of equity so that the overall cost of capital remains constant. 
B)  When a firm adds more low cost debt, it automatically increases the cost of equity so that the overall cost of capital increases. 
C)  When a firm adds more low cost debt, it automatically increases the cost of equity so that the overall cost of capital decreases. 
D)  None of these 
A)  When a firm adds more low cost debt, it automatically increases the cost of equity so that the overall cost of capital remains constant. 
B)  When a firm adds more low cost debt, it automatically increases the cost of equity so that the overall cost of capital increases. 
C)  When a firm adds more low cost debt, it automatically increases the cost of equity so that the overall cost of capital decreases. 
D)  None of these

Question 6

You have a project that costs $800,000. It has a 1/3 chance of paying off $3,000,000 and a 2/3 chance of paying off $0. What is the expected payoff from the new project?

Accepted Answer

A)  $500,000 
B)  $800,000 
C)  $1,000,000 
D)  $1,200,000 
A)  $500,000 
B)  $800,000 
C)  $1,000,000 
D)  $1,200,000

Question 7

________ means that managers or owners of a company know more about the future performance of the company than potential outside lenders.

Accepted Answer

A)  Symmetric information 
B)  External financing 
C)  Asymmetric information 
D)  Two-sided information 
A)  Symmetric information 
B)  External financing 
C)  Asymmetric information 
D)  Two-sided information

Question 8

If company earnings reflect a rate of return less than the cost of debt, then more debt ________.

Accepted Answer

A)  will increase the percentage of earnings available for distribution to the equity owners 
B)  will lower the percentage of earnings available for distribution to the debt owners 
C)  will increase the percentage of dividends available for distribution to the equity owners 
D)  will lower the percentage of earnings available for distribution to the equity owners 
A)  will increase the percentage of earnings available for distribution to the equity owners 
B)  will lower the percentage of earnings available for distribution to the debt owners 
C)  will increase the percentage of dividends available for distribution to the equity owners 
D)  will lower the percentage of earnings available for distribution to the equity owners

Question 9

Consider the Modigliani and Miller world of corporate taxes. An unlevered (all-equity) firm value is $500 million. By adding debt, the annual interest expense is $100 million, the corporate tax rate is 30%, and the discount rate on the tax shield is 8%. What is the gain to leverage or the value added from issuing debt?

Accepted Answer

A)  $500 million 
B)  $875 million 
C)  $938 million 
D)  $1,000 million 
A)  $500 million 
B)  $875 million 
C)  $938 million 
D)  $1,000 million

Question 10

Which of the statements below is FALSE?

Accepted Answer

A)  When a company performs well, it can handle more debt and benefit the owners. 
B)  Borrowing from debt lenders at one rate and investing the money in the business and making a higher rate is bad for the owners. 
C)  Assume that the more debt the company has sold, the better off the shareholders are. This is the case where the earnings reflect a return greater than the cost of debt. 
D)  Financial leverage is the degree to which a firm or individual utilizes borrowed money to make money. 
A)  When a company performs well, it can handle more debt and benefit the owners. 
B)  Borrowing from debt lenders at one rate and investing the money in the business and making a higher rate is bad for the owners. 
C)  Assume that the more debt the company has sold, the better off the shareholders are. This is the case where the earnings reflect a return greater than the cost of debt. 
D)  Financial leverage is the degree to which a firm or individual utilizes borrowed money to make money.

Question 11

Consider the M&M world of corporate taxes. The interest expense is $10 million, the corporate tax rate is 20%, and the discount rate on the tax shield is 10%. What is the gain to leverage or the value added from issuing debt?

Accepted Answer

A)  $19 million 
B)  $20 million 
C)  $29 million 
D)  $30 million 
A)  $19 million 
B)  $20 million 
C)  $29 million 
D)  $30 million

Question 12

The Pecking Order Hypothesis suggests that profitable companies will borrow less (because they have more internal funds available) and may have higher debt-equity ratios because they have more debt capacity.

Accepted Answer

A) True 
 B)False

Question 13

Refer to the scenario above. If Southern Cornbread's EBIT is $1,800, compare EPS before and after the new debt.

Accepted Answer

A)  All-equity EPS = $3.00, leveraged-equity EPS = $4.50 
B)  All-equity EPS = $4.50, leveraged-equity EPS = $3.00 
C)  All-equity EPS = $3.00, leveraged-equity EPS = $3.00 
D)  All-equity EPS = $4.50, leveraged-equity EPS = $4.50 
A)  All-equity EPS = $3.00, leveraged-equity EPS = $4.50 
B)  All-equity EPS = $4.50, leveraged-equity EPS = $3.00 
C)  All-equity EPS = $3.00, leveraged-equity EPS = $3.00 
D)  All-equity EPS = $4.50, leveraged-equity EPS = $4.50

Question 14

The return to the investor is the cost to the seller.

Accepted Answer

A) True 
 B)False

Question 15

Which of the statements below is TRUE?

Accepted Answer

A)  Debt capacity refers to the ability to add equity financing to the current borrowing of the firm and still be able to make interest and principal repayments on time. 
B)  The asymmetric information foundation for the Pecking Order Hypothesis (POH) is that managers know less about their companies than the outside world. 
C)  There are three implications of the POH. One of these is that profitable companies will borrow less (because they have more internal funds available) and may have lower debt-equity ratios because they have more debt capacity. 
D)  There are three implications of the POH. One of these is that more profitable companies will need more external funding and will first seek debt financing in an asymmetric world, avoiding the equity market. 
A)  Debt capacity refers to the ability to add equity financing to the current borrowing of the firm and still be able to make interest and principal repayments on time. 
B)  The asymmetric information foundation for the Pecking Order Hypothesis (POH) is that managers know less about their companies than the outside world. 
C)  There are three implications of the POH. One of these is that profitable companies will borrow less (because they have more internal funds available) and may have lower debt-equity ratios because they have more debt capacity. 
D)  There are three implications of the POH. One of these is that more profitable companies will need more external funding and will first seek debt financing in an asymmetric world, avoiding the equity market.

Question 16

The more ________ used, the greater the leverage a company employs on behalf of its owners.

Accepted Answer

A)  debt 
B)  equity 
C)  debt and equity 
D)  All of these 
A)  debt 
B)  equity 
C)  debt and equity 
D)  All of these

Question 17

One way of measuring the advantage of financial leverage to the owners of the company is ________.

Accepted Answer

A)  to examine the earnings per share (EPS) of a company before borrowing from debt lenders 
B)  to examine the earnings per share (EPS) of a company after borrowing from debt lenders 
C)  to examine the dividends per share (DPS) of a company before and after borrowing from debt lenders 
D)  to examine the earnings per share (EPS) of a company before and after borrowing from debt lenders 
A)  to examine the earnings per share (EPS) of a company before borrowing from debt lenders 
B)  to examine the earnings per share (EPS) of a company after borrowing from debt lenders 
C)  to examine the dividends per share (DPS) of a company before and after borrowing from debt lenders 
D)  to examine the earnings per share (EPS) of a company before and after borrowing from debt lenders

Question 18

________ is the degree to which a firm or individual utilizes borrowed money to make money.

Accepted Answer

A)  Variable leverage 
B)  Fixed leverage 
C)  Operating leverage 
D)  Financial leverage 
A)  Variable leverage 
B)  Fixed leverage 
C)  Operating leverage 
D)  Financial leverage

Question 19

The municipal bond market is open only to ________.

Accepted Answer

A)  state government agencies 
B)  local government agencies 
C)  the federal government 
D)  Both A & B 
A)  state government agencies 
B)  local government agencies 
C)  the federal government 
D)  Both A & B

Question 20

Fuji Inc. is registered as a business in the film-making industry and has a required return on its assets of 12%. It can borrow in the debt market at 6%. If there are no taxes and M&M's proposition II holds, what is the cost of equity if there is 100% equity financing?

Accepted Answer

A)  12% 
B)  13% 
C)  14% 
D)  15% 
A)  12% 
B)  13% 
C)  14% 
D)  15%

Leverage magnifies both gains and losses.

You have a project that costs $800,000. It has a 1/3 chance of paying off $3,000,000 and a 2/3 chance of paying off $0. What is the expected profit from the new project?

Investors Bill and Maggie lend $60,000 to each new idea. Bill picks low-risk projects that are successful 60% of the time. Maggie takes on high-risk projects that that are successful 20% of the time. What rate of return must each successful project pay Bill and Maggie for them to break even?

Above the break-even EBIT, there is no benefit in debt financing.

The contribution of M&M comes from the fact that there is a constant trade-off ratio. Which of the statements below describe this constant trade-off ratio?

You have a project that costs $800,000. It has a 1/3 chance of paying off $3,000,000 and a 2/3 chance of paying off $0. What is the expected payoff from the new project?

________ means that managers or owners of a company know more about the future performance of the company than potential outside lenders.

If company earnings reflect a rate of return less than the cost of debt, then more debt ________.

Which of the statements below is FALSE?

Consider the M&M world of corporate taxes. The interest expense is $10 million, the corporate tax rate is 20%, and the discount rate on the tax shield is 10%. What is the gain to leverage or the value added from issuing debt?

The Pecking Order Hypothesis suggests that profitable companies will borrow less (because they have more internal funds available) and may have higher debt-equity ratios because they have more debt capacity.

Refer to the scenario above. If Southern Cornbread's EBIT is $1,800, compare EPS before and after the new debt.

The return to the investor is the cost to the seller.

Which of the statements below is TRUE?

The more ________ used, the greater the leverage a company employs on behalf of its owners.

One way of measuring the advantage of financial leverage to the owners of the company is ________.

________ is the degree to which a firm or individual utilizes borrowed money to make money.

The municipal bond market is open only to ________.

Fuji Inc. is registered as a business in the film-making industry and has a required return on its assets of 12%. It can borrow in the debt market at 6%. If there are no taxes and M&M's proposition II holds, what is the cost of equity if there is 100% equity financing?

Financial Management

Financial Statements

The Time Value of Money Part 1

The Time Value of Money Part 2

Interest Rates

Bonds and Bond Valuation

Stocks and Stock Valuation

Risk and Return

Capital Budgeting Decision Models

Cash Flow Estimation

The Cost of Capital

Forecasting and Short-Term Financial Planning

Working Capital Management

Financial Ratios and Firm Performance

Raising Capital

Dividends, Dividend Policy, and Stock Splits

International Financial Management

Filters

Exam 16: Capital Structure

Leverage magnifies both gains and losses.

You have a project that costs $800,000. It has a 1/3 chance of paying off $3,000,000 and a 2/3 chance of paying off $0. What is the expected profit from the new project?

Investors Bill and Maggie lend $60,000 to each new idea. Bill picks low-risk projects that are successful 60% of the time. Maggie takes on high-risk projects that that are successful 20% of the time. What rate of return must each successful project pay Bill and Maggie for them to break even?

Above the break-even EBIT, there is no benefit in debt financing.

The contribution of M&M comes from the fact that there is a constant trade-off ratio. Which of the statements below describe this constant trade-off ratio?

You have a project that costs $800,000. It has a 1/3 chance of paying off $3,000,000 and a 2/3 chance of paying off $0. What is the expected payoff from the new project?

________ means that managers or owners of a company know more about the future performance of the company than potential outside lenders.

If company earnings reflect a rate of return less than the cost of debt, then more debt ________.

Which of the statements below is FALSE?

Consider the M&M world of corporate taxes. The interest expense is $10 million, the corporate tax rate is 20%, and the discount rate on the tax shield is 10%. What is the gain to leverage or the value added from issuing debt?

The Pecking Order Hypothesis suggests that profitable companies will borrow less (because they have more internal funds available) and may have higher debt-equity ratios because they have more debt capacity.

Refer to the scenario above. If Southern Cornbread's EBIT is $1,800, compare EPS before and after the new debt.

The return to the investor is the cost to the seller.

Which of the statements below is TRUE?

The more ________ used, the greater the leverage a company employs on behalf of its owners.

One way of measuring the advantage of financial leverage to the owners of the company is ________.

________ is the degree to which a firm or individual utilizes borrowed money to make money.

The municipal bond market is open only to ________.

Fuji Inc. is registered as a business in the film-making industry and has a required return on its assets of 12%. It can borrow in the debt market at 6%. If there are no taxes and M&M's proposition II holds, what is the cost of equity if there is 100% equity financing?

Financial Management

Financial Statements

The Time Value of Money Part 1

The Time Value of Money Part 2

Interest Rates

Bonds and Bond Valuation

Stocks and Stock Valuation

Risk and Return

Capital Budgeting Decision Models

Cash Flow Estimation

The Cost of Capital

Forecasting and Short-Term Financial Planning

Working Capital Management

Financial Ratios and Firm Performance

Raising Capital

Dividends, Dividend Policy, and Stock Splits

International Financial Management

Filters