Question 1

The optimal capital structure:

Accepted Answer

A) of a firm will vary over time as taxes and market conditions change. 
B) is unaffected by changes in the financial markets. 
C) will be the same for all firms in the same industry. 
D) places more emphasis on the operations of a firm rather than the financing of a firm. 
E) will remain constant over time unless the firm makes an acquisition. 
A) of a firm will vary over time as taxes and market conditions change. 
B) is unaffected by changes in the financial markets. 
C) will be the same for all firms in the same industry. 
D) places more emphasis on the operations of a firm rather than the financing of a firm. 
E) will remain constant over time unless the firm makes an acquisition. A

Question 2

Issuing debt instead of new equity in a closely held firm more likely:

Accepted Answer

A) causes the owner-manager to work less hard and shirk their duties as they have less capital at risk. 
B) causes the owner-manager to consume more perquisites because the cost is passed to the debtholders. 
C) causes both more shirking and perquisite consumption since the government provides a tax shield on debt. 
D) causes agency costs to fall as owner-managers do not need to worry about other shareholders. 
E) causes the owner-manager to reduce shirking and perquisite consumption as the excess cash flow must be used to meet debt payments. 
A) causes the owner-manager to work less hard and shirk their duties as they have less capital at risk. 
B) causes the owner-manager to consume more perquisites because the cost is passed to the debtholders. 
C) causes both more shirking and perquisite consumption since the government provides a tax shield on debt. 
D) causes agency costs to fall as owner-managers do not need to worry about other shareholders. 
E) causes the owner-manager to reduce shirking and perquisite consumption as the excess cash flow must be used to meet debt payments. E

Question 3

Assume that all earnings are paid out as dividends.Now consider the fact that Louis must pay personal tax on the firm's cash flow.Louis pays taxes on interest at a rate of 33%,but pays taxes on dividends at a rate of 28%.Calculate the total cash flow to Louis after he pays personal taxes.(Challenge problem; covered in text problems 9 and 10)

Accepted Answer

The answer of Assume that all earnings are paid out...

Question 4

Which one of the following statements concerning bankruptcy is correct?

Accepted Answer

A) An indirect cost of bankruptcy is the loss of key employees. 
B) Bondholders have a greater incentive than stockholders to keep a firm from filing for bankruptcy. 
C) Bankruptcy is sometimes used as a means to increase payroll costs. 
D) The assets of a firm tend to increase in value when a firm is in financial distress. 
E) The administrative costs incurred in a bankruptcy are considered indirect bankruptcy costs. 
A) An indirect cost of bankruptcy is the loss of key employees. 
B) Bondholders have a greater incentive than stockholders to keep a firm from filing for bankruptcy. 
C) Bankruptcy is sometimes used as a means to increase payroll costs. 
D) The assets of a firm tend to increase in value when a firm is in financial distress. 
E) The administrative costs incurred in a bankruptcy are considered indirect bankruptcy costs.

Question 5

An exchange offer may:

Accepted Answer

A) allow customers a 30 day money-back guarantee on the firm's product. 
B) allow customers a 90 day warranty on the firm's product from defects. 
C) allow bondholders to exchange some debt for stock. 
D) allow stockholders to exchange some of their stock for debt. 
E) Both C and D. 
A) allow customers a 30 day money-back guarantee on the firm's product. 
B) allow customers a 90 day warranty on the firm's product from defects. 
C) allow bondholders to exchange some debt for stock. 
D) allow stockholders to exchange some of their stock for debt. 
E) Both C and D.

Question 6

If a firm issues debt but writes protective and restrictive covenants into the loan contract,then the firm's debt may be issued at a _____ interest rate compared with otherwise similar debt.

Accepted Answer

A) significantly higher 
B) slightly higher 
C) equal 
D) lower 
E) Either A or B. 
A) significantly higher 
B) slightly higher 
C) equal 
D) lower 
E) Either A or B.

Question 7

When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends,these will result in:

Accepted Answer

A) undertaking scale enhancing projects. 
B) investments of the same risk class that the firm is in. 
C) positive agency costs, as bondholders impose various restrictions and covenants, which will diminish firm value. 
D) no action by debtholders since these are equity holder concerns. 
E) lower agency costs, as shareholders have more control over the firm's assets. 
A) undertaking scale enhancing projects. 
B) investments of the same risk class that the firm is in. 
C) positive agency costs, as bondholders impose various restrictions and covenants, which will diminish firm value. 
D) no action by debtholders since these are equity holder concerns. 
E) lower agency costs, as shareholders have more control over the firm's assets.

Question 8

What are the advantages of a prepackaged bankruptcy for a firm?
 What are the disadvantages?

Accepted Answer

A prepack allows a firm to minimize its

Question 9

The explicit and implicit costs associated with corporate default are referred to as the _____ costs of a firm.

Accepted Answer

A) flotation 
B) default beta 
C) direct bankruptcy 
D) indirect bankruptcy 
E) financial distress 
A) flotation 
B) default beta 
C) direct bankruptcy 
D) indirect bankruptcy 
E) financial distress

Question 10

An investment is available that pays a tax-free 5%.Ignoring risk,what is the pre-tax return on taxable bonds? The corporate tax rate is 30%.

Accepted Answer

A) 4.20% 
B) 6.00% 
C) 7.14% 
D) 8.57% 
E) None of the above. 
A) 4.20% 
B) 6.00% 
C) 7.14% 
D) 8.57% 
E) None of the above.

Question 11

The TrunkLine Company's debtholders are promised payments of $30 if the firm does well,but will receive only $20 if the firm does poorly.Bondholders are willing to pay $25.The promised return to the bondholders is approximately

Accepted Answer

A) 2.9% 
B) 20.0% 
C) 27.3% 
D) 40.0% 
E) 100% 
A) 2.9% 
B) 20.0% 
C) 27.3% 
D) 40.0% 
E) 100%

Question 12

Loveland Enterprises will earn $70 in one year if it does well.The debtholders are promised payments of $40 in one year if the firm does well.If the firm does poorly,expected earnings in one year will be $35 and the repayment will be $25 because of the dead weight cost of bankruptcy.The probability of the firm performing poorly or well is 50%.If bondholders are fully aware of these costs what will they pay for the debt? The interest rate on the bonds is 9%.

Accepted Answer

A) $23.50 
B) $25.00 
C) $27.50 
D) $29.82 
E) $35.00 
A) $23.50 
B) $25.00 
C) $27.50 
D) $29.82 
E) $35.00

Question 13

Explain the difference between direct and indirect bankruptcy costs.Give an example of each.

Accepted Answer

Direct bankruptcy costs are the costs in

Question 14

The pecking order states how financing should be raised.In order to avoid asymmetric information problems and misinterpretation of whether management is sending a signal on security overvaluation the firm's first rule is to:

Accepted Answer

A) issue new equity first. 
B) always issue debt then the market won't know when management thinks the security is overvalued. 
C) finance with internally generated funds. 
D) issue debt first. 
E) None of the above. 
A) issue new equity first. 
B) always issue debt then the market won't know when management thinks the security is overvalued. 
C) finance with internally generated funds. 
D) issue debt first. 
E) None of the above.

Question 15

The optimal capital structure will tend to include more debt for firms with:

Accepted Answer

A) less taxable income. 
B) lower probability of financial distress. 
C) substantial tax shields from other sources. 
D) the lowest marginal tax rate. 
E) the highest depreciation deductions. 
A) less taxable income. 
B) lower probability of financial distress. 
C) substantial tax shields from other sources. 
D) the lowest marginal tax rate. 
E) the highest depreciation deductions.

Question 16

Which of the following is true?

Accepted Answer

A) A firm with low anticipated profit will likely take on a high level of debt. 
B) Investors will generally view an increase in debt as a positive sign for the firm's value. 
C) Rational investors are likely to infer a higher firm value from a zero debt level. 
D) Rational firms raise debt levels when profits are expected to decline. 
E) A successful firm will probably take on zero debt. 
A) A firm with low anticipated profit will likely take on a high level of debt. 
B) Investors will generally view an increase in debt as a positive sign for the firm's value. 
C) Rational investors are likely to infer a higher firm value from a zero debt level. 
D) Rational firms raise debt levels when profits are expected to decline. 
E) A successful firm will probably take on zero debt.

Question 17

Which of the following industries would tend to have the highest leverage?

Accepted Answer

A) Paper 
B) Electronics 
C) Drugs 
D) Computer 
E) Biological products 
A) Paper 
B) Electronics 
C) Drugs 
D) Computer 
E) Biological products

Question 18

Your firm has a debt-equity ratio of .40.Your cost of equity is 12% and your after-tax cost of debt is 6%.What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

Accepted Answer

A) 11.45% 
B) 12.00% 
C) 13.50% 
D) 13.67% 
E) 14.56% 
A) 11.45% 
B) 12.00% 
C) 13.50% 
D) 13.67% 
E) 14.56%

Question 19

An investment is available that pays a tax-free 6%.Ignoring risk,what is the pre-tax return on taxable bonds? The corporate tax rate is 35%.

Accepted Answer

A) 3.50% 
B) 6.00% 
C) 7.14% 
D) 9.23% 
E) None of the above. 
A) 3.50% 
B) 6.00% 
C) 7.14% 
D) 9.23% 
E) None of the above.

Question 20

Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

Accepted Answer

A) 9.50% 
B) 10.50% 
C) 11.00% 
D) 11.25% 
E) 12.00% 
A) 9.50% 
B) 10.50% 
C) 11.00% 
D) 11.25% 
E) 12.00%

The optimal capital structure:

Issuing debt instead of new equity in a closely held firm more likely:

Which one of the following statements concerning bankruptcy is correct?

An exchange offer may:

If a firm issues debt but writes protective and restrictive covenants into the loan contract,then the firm's debt may be issued at a _____ interest rate compared with otherwise similar debt.

When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends,these will result in:

What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?

The explicit and implicit costs associated with corporate default are referred to as the _____ costs of a firm.

An investment is available that pays a tax-free 5%.Ignoring risk,what is the pre-tax return on taxable bonds? The corporate tax rate is 30%.

The TrunkLine Company's debtholders are promised payments of $30 if the firm does well,but will receive only $20 if the firm does poorly.Bondholders are willing to pay $25.The promised return to the bondholders is approximately

Explain the difference between direct and indirect bankruptcy costs.Give an example of each.

The pecking order states how financing should be raised.In order to avoid asymmetric information problems and misinterpretation of whether management is sending a signal on security overvaluation the firm's first rule is to:

The optimal capital structure will tend to include more debt for firms with:

Which of the following is true?

Which of the following industries would tend to have the highest leverage?

Your firm has a debt-equity ratio of .40.Your cost of equity is 12% and your after-tax cost of debt is 6%.What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

An investment is available that pays a tax-free 6%.Ignoring risk,what is the pre-tax return on taxable bonds? The corporate tax rate is 35%.

Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

Introduction to Corporate Finance

Financial Statements Cash Flow

Financial Statements Analysis and Long-Term Planning

Discounted Cash Flow Valuation

Interest Rate and Bond Valuation

Stock Valuation

Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, Real Options, and Capital Budgeting

Risk and Return Lessons From Market History

Return and Risk: The Capital Asset Pricing Model Capm

Risk, Cost of Capital, and Capital Budgeting

Efficient Capital Markets and Behavioral Challenges

Capital Structure: Basic Concepts

Dividend and Other Payouts

Options and Corporate Finance

Short-Term Finance and Planning

Raising Capital

International Corporate Finance

Filters

Exam 15: Capital Structure: Limits to the Use of Debt

The optimal capital structure:

Issuing debt instead of new equity in a closely held firm more likely:

Which one of the following statements concerning bankruptcy is correct?

An exchange offer may:

If a firm issues debt but writes protective and restrictive covenants into the loan contract,then the firm's debt may be issued at a _____ interest rate compared with otherwise similar debt.

When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends,these will result in:

What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?

The explicit and implicit costs associated with corporate default are referred to as the _____ costs of a firm.

An investment is available that pays a tax-free 5%.Ignoring risk,what is the pre-tax return on taxable bonds? The corporate tax rate is 30%.

The TrunkLine Company's debtholders are promised payments of $30 if the firm does well,but will receive only $20 if the firm does poorly.Bondholders are willing to pay $25.The promised return to the bondholders is approximately

Explain the difference between direct and indirect bankruptcy costs.Give an example of each.

The pecking order states how financing should be raised.In order to avoid asymmetric information problems and misinterpretation of whether management is sending a signal on security overvaluation the firm's first rule is to:

The optimal capital structure will tend to include more debt for firms with:

Which of the following is true?

Which of the following industries would tend to have the highest leverage?

Your firm has a debt-equity ratio of .40.Your cost of equity is 12% and your after-tax cost of debt is 6%.What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

An investment is available that pays a tax-free 6%.Ignoring risk,what is the pre-tax return on taxable bonds? The corporate tax rate is 35%.

Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

Introduction to Corporate Finance

Financial Statements Cash Flow

Financial Statements Analysis and Long-Term Planning

Discounted Cash Flow Valuation

Interest Rate and Bond Valuation

Stock Valuation

Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, Real Options, and Capital Budgeting

Risk and Return Lessons From Market History

Return and Risk: The Capital Asset Pricing Model Capm

Risk, Cost of Capital, and Capital Budgeting

Efficient Capital Markets and Behavioral Challenges

Capital Structure: Basic Concepts

Dividend and Other Payouts

Options and Corporate Finance

Short-Term Finance and Planning

Raising Capital

International Corporate Finance

Filters