Deck 14: Capital Structure and Dividend Policy Decisions

Question 1

Which of the following factors does not affect a firm's business risk?

A) Demand variability.
B) Input price variability.
C) Interest cost variability.
D) Operating leverage.
E) Sales price variability.

Answer 1

Interest cost variability.

Question 2

The most commonly held view of capital structure, according to the text, is that the weighted average cost of capital

A) First falls with moderate levels of leverage and then increases.
B) Does not change with leverage.
C) Increases proportionately with increases in leverage.
D) Increases with moderate amounts of leverage and then falls.
E) None of the above.

Answer 2

First falls with moderate levels of leverage and then increases.

Question 3

Which of the following statements is correct?

A) A firm's business risk is solely determined by the financial characteristics of its industry.
B) The factors which affect a firm's business risk are determined partly by industry characteristics and partly by economic conditions.Unfortunately, these and other factors which affect a firm's business risk are not subject to any degree of managerial control.
C) One of the benefits to a firm of being at or near its target capital structure is that financial flexibility becomes much less important.
D) The firm's financial risk may have both market risk and diversifiable risk components.
E) The above statements are all false.

Answer 3

The firm's financial risk may have both market risk and diversifiable risk components.

Question 4

Which of the following statements is most correct?

A) The optimal capital structure minimizes the WACC.
B) If the after-tax cost of equity financing exceeds the after-tax cost of debt financing, firms are always able to reduce their WACC by increasing the amount of debt in their capital structure.
C) Increasing the amount of debt in a firm's capital structure is likely to increase the cost of both debt and equity financing.
D) Answers a and c are both correct.
E) Answers b and c are both correct.

Question 5

If debt financing is used, which of the following is correct?

A) The percentage change in net operating income is greater than a given percentage change in net income.
B) The percentage change in net operating income is equal to a given percentage change in net income.
C) The percentage change in net operating income depends on the interest rate charged on debt.
D) The percentage change in net operating income is less than the percentage change in net income.
E) The degree of operating leverage is greater than 1.

Question 6

Which of the following types of dividends is (are) never paid out in the form of cash?

A) Regular dividend.
B) Stock dividend.
C) Extra dividend.
D) Liquidating dividend.
E) All of the above are paid in the form of cash.

Question 7

Which of the following statements is correct?

A) When financial leverage is used, the graphical probability distribution of net income would tend to be more peaked than a distribution where no leverage is present, other things held constant.
B) From an operational standpoint the goal of maintaining financial flexibility translates into maintaining adequate reserve borrowing capacity.
C) While business risk varies from one industry to another and can change over time, it affects all firms equally within a particular industry.
D) The optimal capital structure is the one that maximizes EBIT, and this always calls for a debt-to-assets ratio which is lower than the one that maximizes expected EPS.
E) The above statements are all false.

Question 8

Which of the following statements is correct?

A) Suppose Company A's EPS is expected to experience a larger percentage change in response to a given percentage change in sales than Company B's EPS.Other things held constant, Company A would appear to have more business risk than Company B.
B) Statement a would be correct if the term "EBIT" were substituted for "EPS."
C) Statement a would be correct if the term "EBIT" were substituted for "sales."
D) Statement a would be correct if the words "financial risk" were substituted for "business risk."
E) The above statements are all false.

Question 9

The "Pure Modigliani and Miller Result" establishes, under restrictive assumptions, that the firm's stock price will be maximized if it uses virtually 100 percent debt.Which of the following real world conditions does the most to limit real world corporate debt-to-assets ratios to far less than 100 percent?

A) There are brokerage costs.
B) At high levels of debt revenues decline.
C) Investors can't really borrow at the same rate as corporations.
D) Interest rates increase as the debt-to-assets ratio rises.
E) Dividends are relevant in the real world.

Question 10

Business risk is concerned with the operations of the firm.Which of the following is not associated with (or not a part of) business risk?

A) Demand variability.
B) Sales price variability.
C) The extent to which operating costs are fixed.
D) Changes in required returns due to financing decisions.
E) The ability to change prices as costs change.

Question 11

The firm's target capital structure is consistent with which of the following?

A) Maximum earnings per share.
B) Minimum cost of debt (r_d).
C) Minimum risk.
D) Minimum cost of equity (r_s).
E) Minimum weighted average cost of capital.

Question 12

If you know that your firm is facing relatively poor prospects but needs new capital, and you know that investors do not have this information, signaling theory would predict that you would

A) Issue debt to maintain the returns of equity holders.
B) Issue equity to share the burden of decreased equity returns between old and new shareholders.
C) Be indifferent between issuing debt and equity.
D) Postpone going into capital markets until your firm's prospects improve.
E) Convey your inside information to investors using the media to eliminate the information asymmetry.

Question 13

A decrease in the debt-to-assets ratio will generally have no effect on ____ risk.

A) Financial
B) Total
C) Business
D) Systematic, or market
E) None of the above (it will affect each type of risk above).

Question 14

From the information below, select the optimal capital structure for Minnow Entertainment Company.

A) Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.
B) Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90.
C) Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20.
D) Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40.
E) Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.

Question 15

As a general rule, the capital structure that

A) Maximizes expected EPS also maximizes the price per share of common stock.
B) Minimizes the interest rate on debt also maximizes the expected EPS.
C) Minimizes the required rate on equity also maximizes the stock price.
D) Maximizes the price per share of common stock also minimizes the weighted average cost of capital.
E) None of the above.

Question 16

Empirical testing has confirmed the validity of which of the following attitudes concerning dividends?

A) Dividend irrelevance, or Modigliani-Miller, theory.
B) Investors prefer dividends to capital gains because dividends are more certain.
C) Investors prefer capital gains to dividends because capital gains are taxed at more favorable rates.
D) Empirical testing has produced some evidence in support of each of the theories above.
E) Empirical testing has not produced any definitive results.

Question 17

Which of the following statements is correct?

A) As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.
B) The optimal capital structure simultaneously maximizes EPS and minimizes the WACC.
C) The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price.
D) The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC.
E) Each of the above statements is false.

Question 18

A decrease in a firm's willingness to pay dividends might result from an increase in its

A) Earnings stability.
B) Access to capital markets.
C) Profitable investment opportunities.
D) Collection of accounts receivable.
E) Stock price.

Question 19

In the real world, we find that dividends

A) Usually exhibit greater stability than earnings.
B) Fluctuate more widely than earnings.
C) Tend to be a lower percentage of earnings for mature firms.
D) Are usually changed every year to reflect earnings changes.
E) Are usually set as a fixed percentage of earnings.

Question 20

Which of the following would not have an influence on the optimal dividend policy?

A) The possibility of accelerating or delaying investment projects.
B) A strong shareholders' preference for current income versus capital gains.
C) Bond indenture constraints.
D) The costs associated with selling new common stock.
E) All of the above can have an effect on dividend policy.

Question 21

Which of the following is correct?

A) Generally, debt to total assets ratios do not vary much among different industries although they do vary for firms within a particular industry.
B) Utilities generally have very high common equity ratios due to their need for vast amounts of equity supported capital.
C) The drug industry has a high debt to common equity ratio because their earnings are very stable and thus, can support the large interest costs associated with higher debt levels.
D) Wide variations in capital structures exist between industries and also between individual firms within industries and are influenced by unique firm factors including managerial attitudes.
E) Since most stocks sell at or around their book values, using accounting values provides an accurate picture of a firm's capital structure.

Question 22

If a firm adheres strictly to the residual dividend model, then if its optimal capital budget requires the use of all earnings for that year (along with new debt according to the optimal debt/total assets ratio), the firm should pay

A) No dividends except out of past retained earnings.
B) No dividends to common stockholders.
C) Dividends, in effect, out of a new issue of common stock.
D) Dividends by borrowing the money (debt).
E) Either c or d above could be used.

Question 23

Which of the following statements is correct?

A) A key advantage of the residual dividend policy is that it usually results in a stable dividend policy which is attractive to investors.
B) Investors should prefer that a corporation repurchase its common stock when the stock is overpriced.
C) A reduction in the capital gains rate should work to discourage corporations from repurchasing their shares.
D) The theory that investors prefer dividends rather than capital gains suggests that firms that increase their dividend payout should expect to realize a higher share price and a lower cost of equity capital.
E) Answers c and d are both correct.

Question 24

Which of the following statements is correct?

A) There have been no significant observed differences in the capital structures of U.S.corporations in comparison to their German and Japanese counterparts.
B) Different countries use essentially the same international accounting conventions with respect to reporting assets on a historical versus replacement cost basis.
C) An analysis of both bankruptcy and equity reporting costs leads to the conclusion that U.S.firms should have more equity and less debt than firms in Japan and Germany.
D) Equity monitoring costs are higher in the United States than in Japan and Germany.
E) Debt monitoring costs are probably lower in the United States than in Japan and Germany.

Question 25

Strategic Systems Inc.expects to have net income of $800,000 during the next year.Its target, and current, capital structure is 40 percent debt and 60 percent common equity.The Director of Capital Budgeting has determined that the optimal capital budget for next year is $1.2 million.If Strategic uses the residual dividend model to determine next year's dividend payout, what is the expected payout ratio?

A) 0%
B) 10%
C) 28%
D) 42%
E) 56%

Question 26

If the debt-to-assets ratio is 50 percent, the interest rate on all debt is 8 percent, the tax rate is 50 percent, and the return on equity is 10 percent, then the ratio of earnings before interest and taxes (EBIT) to total assets, or the basic earning power ratio, must be

A) 10%.
B) 14%.
C) 12%.
D) 8%.
E) 16%.

Question 27

If you were to argue that the firm's cost of equity, r_s, increases as the dividend payout decreases, you would be making an argument ____ with MM's dividend irrelevance theory, and ____ with the theory that investors prefer dividends received in the current period rather than capital gains received in the future.

A) consistent; consistent
B) inconsistent; consistent
C) consistent; inconsistent
D) inconsistent; inconsistent
E) The argument above does not make sense; neither theory involves the cost of equity capital.

Question 28

Your company has decided that its capital budget during the coming year will be $20 million.Its optimal capital structure is 60 percent equity and 40 percent debt.Its earnings before interest and taxes (EBIT) are projected to be $34.667 million for the year.The company has $200 million of assets; its average interest rate on outstanding debt is 10 percent; and its tax rate is 40 percent.If the company follows the residual dividend policy and maintains the same capital structure, what will its dividend payout ratio be?

A) 15%
B) 20%
C) 25%
D) 30%
E) 35%

Question 29

The following facts apply to your company: Based on the residual dividend policy, the payout ratio is 60 percent.How large (in millions of dollars) will the capital budget be?

A) $43.2
B) $50.0
C) $64.8
D) $86.4
E) $108.0

Question 30

Howell Enterprises is forecasting EPS of $4.00 per share for next year.The firm has 10,000 shares outstanding, it pays 12 percent interest on its debt, and it faces a 40 percent marginal tax rate.Its estimated fixed costs are $80,000 while its variable costs are estimated at 40 percent of revenue.The firm's target capital structure is 40 percent equity and 60 percent debt and it has total assets of $400,000.On what level of sales is Howell basing its EPS forecast?

A) $1,000,000
B) $480,400
C) $316,722
D) $292,445
E) $105,280

Question 31

Which of the following statements is correct?

A) If the dividend irrelevance theory (which is associated with the names Modigliani and Miller) were exactly correct, and if this theory could be tested with "clean" data, then we would find, in a regression of dividend yield and capital gains, a line with a slope of −1.0.
B) The tax preference and bird-in-the-hand theories lead to identical conclusions as to the optimal dividend policy.
C) If a company raises its dividend by an unexpectedly large amount, the announcement of this new and higher dividend is generally accompanied by an increase in the stock price.This is consistent with the bird-in-the-hand theory, and Modigliani and Miller used these findings to support their position on dividend theory.
D) If it could be demonstrated that a clientele effect exists, this would suggest that firms could alter their dividend payment policies from year to year to take advantage of investment opportunities without having to worry about the effects of changing dividends on capital costs.
E) Each of the above statements is false.

Question 32

The Altman Company has a debt-to-assets ratio of 33.33 percent, and it needs to raise $100,000 to expand.Management feels that an optimal debt-to-assets ratio would be 16.67 percent.Sales are currently $750,000, and the total assets turnover is 7.5.How should the expansion be financed so as to produce the desired debt-to-assets ratio?

A) Finance it all with equity.
B) Finance it all with debt.
C) Finance 20% debt, 80% equity.
D) Finance 40% debt, 60% equity.
E) Finance 50% debt, 50% equity.

Question 33

Stargell Industries follows a strict residual dividend policy.The company has a capital budget of $3,000,000.It has a target capital structure which consists of 30 percent debt and 70 percent equity.The company forecasts that its net income will be $3,500,000.What will be the company's payout ratio this year?

A) 25%
B) 30%
C) 35%
D) 40%
E) 45%

Question 34

Which of the following statement completions is correct? If investors prefer dividends to capital gains, then

A) The equilibrium return, r_s, will not be affected by a change in dividend policy because tax effects will offset these preferences.
B) r_s will decrease as dividends are reduced.
C) r_s will increase as dividends are reduced.
D) r_s will decrease as the retention rate increases.
E) Dividend policy as determined by the residual dividend model is the only dividend policy which will maximize the price per share of common stock.

Question 35

If the Modigliani and Miller hypothesis about dividends is correct, and if one found a group of companies which differed only with respect to dividend policy, which of the following statements would be most correct?

A) The residual dividend model should not be used, because it is inconsistent with the MM dividend hypothesis.
B) The total expected return, which in equilibrium is also equal to the required return, would be higher for those companies with lower payout ratios because of the greater risk associated with capital gains versus dividends.
C) If the expected total return of each of the sample companies were divided into a dividend yield and a growth rate, and then a scatter diagram (or regression) analysis were undertaken, then the slope of the regression line (or b in the equation D₁/P₀ = a + b(g)) would be equal to +1.0.
D) None of the above statements is true.
E) All of the above statements are true.

Question 36

If a firm adheres strictly to the residual dividend model, a sale of new common stock by the company would suggest that

A) The dividend payout ratio has remained constant.
B) The dividend payout ratio is increasing.
C) No dividends were paid for the year.
D) The dividend payout ratio is decreasing.
E) The dollar amount of investments has decreased.

Question 37

Which of the following statements is correct?

A) "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage.
B) If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tradeoff theory of capital structure were correct, then corporations should tend to increase their use of debt.
C) If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tradeoff theory of capital structure were correct, then corporations should tend to decrease their use of debt.
D) The optimal capital structure is the one which (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS.
E) Statements b and d are both correct.

Question 38

Modigliani and Miller (MM) argued that dividend policy is irrelevant.On the other hand, others, such as Gordon and Lintner (GL), argued that dividend policy does matter.GL's argument rests on the contention that

A) r_s = /P₀ + g is constant for any dividend policy.
B) Because of perceived differences in risk, investors value a dollar of dividends more highly than a dollar of expected capital gains.
C) Investors, because of tax differentials, value a dollar of expected capital gains more highly than a dollar of dividends.
D) Most investors will reinvest rather than spend dividends, so it would save investors' money (taxes) if corporations simply reinvested earnings rather than paid them out as dividends.
E) None of the above.

Question 39

Flavortech Inc.expects EBIT of $2,000,000 for the coming year.The firm's capital structure consists of 40 percent debt and 60 percent equity, and its marginal tax rate is 40 percent.The cost of equity is 14 percent, and the company pays a 10 percent rate on its $5,000,000 of long-term debt.One million shares of common stock are outstanding.In its next capital budgeting cycle, the firm expects to fund one large positive NPV project costing $1,200,000, and it will fund this project in accordance with its target capital structure.If the firm follows a residual dividend policy and has no other projects, what is its expected dividend payout ratio?

A) 100%
B) 60%
C) 40%
D) 20%
E) 0%

Question 40

The Congress Company has identified two methods for producing playing cards.One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards.The other method would use a less expensive machine (fixed cost = $5,000), but it would require greater variable costs ($1.50 per deck of cards).If the selling price per deck of cards will be the same under each method, at what level of output will the two methods produce the same net operating income?

A) 5,000 decks
B) 10,000 decks
C) 15,000 decks
D) 20,000 decks
E) 25,000 decks

Question 41

Which of the following is not a factor that influences capital structure decisions for firms?

A) financial flexibility
B) rational investors
C) business risk
D) tax position

Question 42

According to the signaling theory of capital structure, a firm with favorable prospects should raise new capital by issuing ____ and a firm with unfavorable prospects raise new capital by issuing ____.

A) debt; equity
B) equity; debt
C) debt; debt
D) equity; equity

Question 43

Once a target capital structure for a firm is determined the firm ____.

A) does not allow the target to change.
B) uses it as guide for raising capital.
C) issues debt to lower leverage.
D) none of the above.

Question 44

Growth Rate
Copybold Corporation
Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive.The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75.Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine.The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000.Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent.The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share.
Refer to Copybold Corporation.What is the coefficient of variation of expected EPS under the conservative capital structure plan?

A) 0.58
B) 0.39
C) 0.15
D) 0.23
E) 1.00

Question 45

It has been shown that a firm's beta ____ an increase in its degree of financial leverage.

A) increases with
B) decreases with
C) remains constant with
D) is not related to

Question 46

Which of the following is not one of the four primary factors that influence capital structure?

A) Geographic location of the firm.
B) Managerial attitude of the firm.
C) Financial flexibility of the firm.
D) Tax position of the firm.
E) Business risk of the firm.

Question 47

Calculate the current price per share (P₀) for Olson Corporation, given the following information.The data all pertain to the year just ended.

A) $39.20
B) $57.84
C) $29.43
D) $61.90
E) None of the above.

Question 48

When a firm conducts a seasoned equity offering and uses the proceeds to purchase a portion of the firm's outstanding debt, then the firm's

A) financial risk increases.
B) financial risk decreases.
C) business risk increases.
D) business risk decreases.

Question 49

Business risk depends on all of the following factors except ____.

A) sales variability
B) interest rates
C) input price variability
D) change in output prices

Question 50

Driver Corporation faces an IOS schedule calling for a capital budget of $60 million.Its optimal capital structure is 60 percent equity and 40 percent debt.Its earnings before interest and taxes (EBIT) were $98 million for the year.The firm has $200 million in assets, pays an average of 10 percent on all its debt, and faces a marginal tax rate of 34 percent.If the firm maintains a residual dividend policy and will keep its optimal capital structure intact, what will be the amount of the dividends it pays out after financing its capital budget?

A) $23.4 million
B) $59.4 million
C) $20.76 million
D) $30.0 million
E) $0

Question 51

____ information is the situation in which managers have better information about the firm's prospects.

A) Asymmetric
B) Symmetric
C) Perfect
D) Public

Question 52

What is the single most important determinant of capital structure for a company?

A) Business risk
B) Financial risk
C) Exchange rate risk
D) Interest rate risk

Question 53

Growth Rate
Copybold Corporation
Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive.The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75.Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine.The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000.Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent.The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share.
Refer to Copybold Corporation.What is the coefficient of variation of expected EPS under the aggressive capital structure plan?

A) 1.00
B) 1.18
C) 2.45
D) 2.88
E) 3.76

Question 54

Which of the following factors do not have an impact on the business risk of a firm?

A) Sales variability
B) Input price variability
C) Price elasticity
D) Operating leverage
E) All of the above impact a firm's business risk

Question 55

If you own 100 shares in a company that announces a 2-for-1 stock split (with no other announcement), you should

A) be happy because your investment has doubled.
B) be happy because you will be receiving cash from your investment as a result of the split.
C) be sad because the value of your investment will decline because of the split.
D) be indifferent because the overall value of your investment has not changed.

Question 56

Van Slyke Inc.has $5,000,000 in assets, and currently has no debt⎯it is financed entirely with 200,000 shares of common stock, each of which trades at $25 per share.The firm's EBIT is expected to be $1,250,000 at year end .The corporate tax rate is 40 percent.Van Slyke expects to pay out a dividend at year end which is 50 percent of its net income.The company estimates that its earnings and dividends grow at a constant rate of 3 percent a year.The company is considering a recapitalization where they would issue $1,000,000 of debt at a before-tax cost of 10 percent.The proceeds from the debt issued would be used to repurchase shares of the company's stock at $25 per share.The company's investment bankers estimate that the cost of equity capital would be 16 percent after the recapitalization.What would you expect the company's stock price to be immediately following the recapitalization? Assume that the dividend has not yet been paid.

A) $12.15
B) $16.59
C) $20.98
D) $27.25
E) $33.17

Question 57

Using more debt in the firm's capital structure

A) decreases the probability of filing for bankruptcy.
B) raises the riskiness of the firm's earnings stream.
C) generally leads to a lower expected rate of return.
D) none of the above.

Question 58

Growth Rate
Copybold Corporation
Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive.The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75.Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine.The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000.Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent.The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share.
Refer to Copybold Corporation.What is the difference between the EPS forecasts for Feast and Famine under the aggressive capital structure?

A) $0
B) $1.48
C) $0.62
D) $0.98
E) $2.40

Question 59

Growth Rate
Copybold Corporation
Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive.The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75.Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine.The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000.Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent.The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share.
Refer to Copybold Corporation.What is the difference between the EPS forecasts for Feast and Famine under the conservative capital structure?

A) $1.00
B) $0.80
C) $2.20
D) $0.44
E) $0

Question 60

Given the information below, calculate the expected growth rate (g) of dividends, using the constant growth model Beta = 1.75; r_RF = 7 percent; r_M = 11 percent; dividend payout ratio = 30 percent; r_d = 10 percent (paid) on all long-term debt; P/E ratio = 10; sales = 5,000 units; sales price per unit = $5; variable cost per unit = $2; fixed cost = $1,000; common stock shares outstanding = 5,000; long-term debt outstanding = $10,000; tax rate = 40 percent.Assume equilibrium exists in the market.

A) 11.34%
B) 6.54%
C) 11.0%
D) 10.68%
E) 10.19%

Question 61

If a firm utilizes debt financing, a decrease in earnings before interest and taxes (EBIT) will result in a more than proportionate decrease in earnings per share.

Question 62

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

Question 63

You are the president of a small, publicly-traded corporation.Since you believe that your firm's stock price is temporarily depressed, all additional capital funds required during the current year will be raised using debt.Thus, the appropriate marginal cost of capital for the current year is the after-tax cost of debt.

Question 64

The ability of a firm to raise sufficient capital on competitive terms under adverse conditions in order to sustain steady operations is referred to as financial flexibility.

Question 65

The central result from the work of Miller and Modigliani (MM) and subsequent researchers, is that it is now possible to precisely identify a firm's optimal capital structure.

Question 66

Financial risk refers to the extra risk stockholders bear as a result of the use of debt as compared with the risk they would bear if no debt were used.

Question 67

The optimal capital structure is that which results in the highest earnings per share because that will ensure maximum stock price.

Question 68

Asymmetric information involves a situation where the firm's managers have different (better) information about their firm's prospects than do investors.

Question 69

If a firm uses no debt, the uncertainty inherent in projections of future returns on equity can be described as business risk.

Question 70

As long as a firm is near its target capital structure it will not have to concern itself with financial flexibility.

Question 71

Financial leverage affects both EPS and EBIT, while operating leverage only affects EBIT.

Question 72

The mix of debt, preferred stock, and common equity with which the firm plans to support its asset structure is known as the target capital structure.

Question 73

Business risk, which is the risk inherent in a firm's assets if it uses less than its optimal amount of debt, is one important influence in the capital structure decision.

Question 74

Because creditors can foresee, to at least some extent, the costs of bankruptcy, they charge an interest rate that has a premium built into it to compensate for the present value of bankruptcy costs.

Question 75

According to MM, in a world without taxes, the optimal capital structure for a firm should approach 100 percent debt financing.

Question 76

Business risk will not affect a firm's beta, because beta is determined by the market and thus is outside the control of the firm.

Question 77

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Question 78

In a world with no taxes, MM show that the capital structure of a firm does not affect the value of the firm.However, when taxes are considered, MM show a positive relationship between debt and firm value.

Question 79

The degree of financial risk is the single most important determinant of a firm's capital structure.

Question 80

The level of sales at which expected EPS will be the same regardless of whether the firm uses debt or common stock financing is called the EPS indifference point.