Deck 29: Capital Structure, Dividends, and Share Repurchases

Question 1

Describe how leverage can cause business erosion.

Answer 1

Business erosion is a type of cost associated with highly leveraged companies.Since they need to have cash available to repay their debts on time,highly leveraged companies are more likely to forgo investment opportunities or to reduce budgets for research and development (R&D )and other costs or investments for which the payoffs are further in the future.By cutting back on such investment,these companies may miss significant opportunities to create value.Also,such companies may lose customers,employees,and suppliers because of their higher risk of financial distress.

Question 2

Leverage and coverage measure the same thing but over different time horizons.

Answer 2

True

Question 3

Which of the following is the correct order of financing choices according to the pecking-order theory,starting with the most preferred choice?

A)Internal funds,debt,equity.
B)Debt,equity,internal funds.
C)Internal funds,equity,debt.
D)Equity,internal funds,debt.

Answer 3

A

Question 4

For a given firm,which of the following is most likely to be the result of lower leverage?

A)Corporate overinvestment.
B)Increased investor conflicts.
C)Tax savings for the firm.
D)Shareholders preferring higher-risk projects.

Question 5

For a manager attempting to determine the optimal capital structure of a firm,which of the following is most accurate?

A)It is a fruitless endeavor and should be discouraged based on the conservation of value principle.
B)The best place to start is by examining the capital structures of the industry peer group of the company.
C)Well-defined algorithms exist that high-priced consulting firms use,and their cost is generally justified in terms of the potential value creation.
D)The best place to start is with a Monte Carlo simulation of possible market movements and their effects on the capitalization weights and the value of the firm.

Question 6

Which of the following is most likely to have a negative effect on share price?

A)Issuing debt.
B)Issuing equity.
C)Dividend increase.
D)Extraordinary dividend.

Question 7

Although academic researchers have investigated the issue for decades,there is still no clear model for deciding a company's optimal leverage ratio (i.e. ,the leverage that would create most value for shareholders).

Question 8

Based on the observed distribution of credit ratings,which of the following ranges of debt ratings is an effective rating level,meaning it cannot clearly be improved upon in terms of creating value for shareholders?

A)From BB+ to BBB.
B)From BBB- to A+.
C)From A to AA-.
D)From AA- to AAA.

Question 9

Business erosion is a result of too little leverage and the resulting stagnation and loss of customers.

Question 10

Which of the following is the most important factor in determining a company's credit rating?

A)Size.
B)Coverage.
C)Tax bracket.
D)Use of a complex capital structure.

Question 11

Option valuation models that determine default estimates of companies have longer time horizons and therefore produce "through the cycle" estimates.