Question 1

The basic lesson of MM theory is that the value of a firm is dependent upon the:

Accepted Answer

A) capital structure of the firm. 
B) total cash flows of the firm. 
C) percentage of a firm to which the bondholders have a claim. 
D) tax claim placed on the firm by the government. 
E) size of the stockholders claims on the firm.

Question 2

The Aggie Company has EBIT of $50,000 and market value debt of $100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Accepted Answer

A) $120,000 
B) $162,948 
C) $258,537 
D) $263,080 
E) $332,143

Question 3

Given the following information,leverage will add how much value to the unlevered firm per dollar of debt?
Corporate tax rate:
34%
Personal tax rate on income from bonds:
30%
Personal tax rate on income from stocks:
30%

Accepted Answer

A) $-0.050 
B) $0.006 
C) $0.246 
D) $0.340 
E) $0.660

Question 4

Under a Chapter 7 bankruptcy,which one of the following is generally considered to be the highest priority claim?

Accepted Answer

A) Consumer claim 
B) Payment of employee wages 
C) Payment to an unsecured creditor 
D) Company contribution to the employees' retirement account 
E) Dividend payment to preferred shareholder

Question 5

A firm that has a negative net worth is said to be:

Accepted Answer

A) experiencing a business failure. 
B) in legal bankruptcy. 
C) experiencing technical insolvency. 
D) experiencing accounting insolvency. 
E) in Chapter 11 bankruptcy reorganization.

Question 6

What three factors are important to consider in determining a target debt to equity ratio?

Accepted Answer

A) Taxes, asset types, and pecking order and financial slack 
B) Asset types, uncertainty of operating income, and pecking order and financial slack 
C) Taxes, financial slack and pecking order, and uncertainty of operating income 
D) Taxes, asset types, and uncertainty of operating income 
E) None of the above.

Question 7

Given the following information,leverage will add how much value to the unlevered firm per dollar of debt?
Corporate tax rate:
34%
Personal tax rate on income from bonds:
10%
Personal tax rate on income from stocks:
40%

Accepted Answer

A) $-0.050 
B) $-0.188 
C) $0.367 
D) $0.560 
E) None of the above.

Question 8

One of the indirect costs of bankruptcy is the incentive for managers to take large risks.When following this strategy:

Accepted Answer

A) the firm will rank all projects and take the project which results in the highest expected value of the firm. 
B) stockholders expropriate value from bondholders by selecting high risk projects. 
C) stockholders expropriate value from stockholders by selecting high risk projects. 
D) the firm will always take the low risk project. 
E) Both A and B.

Question 9

Indirect bankruptcy costs:

Accepted Answer

A) effectively limit the amount of equity a firm issues. 
B) serve as an incentive to increase the financial leverage of a firm. 
C) include the costs incurred by a firm as it tries to avoid seeking bankruptcy protection. 
D) tend to increase as the debt-equity ratio decreases. 
E) include direct costs such as legal and accounting fees.

Question 10

Given the following information,leverage will add how much value to the unlevered firm per dollar of debt?
Corporate tax rate:
34%
Personal tax rate on income from bonds:
20%
Personal tax rate on income from stocks:
0%

Accepted Answer

A) $0.175 
B) $0.472 
C) $0.528 
D) $0.825 
E) None of the above.

Question 11

Corporations in the U.S.tend to:

Accepted Answer

A) have extremely high debt-equity ratios. 
B) rely less on equity financing than they should. 
C) underutilize debt. 
D) maximize taxes. 
E) rely more heavily on bonds than stocks as the major source of financing.

Question 12

Which of the following is not empirically true when formulating capital structure policy?

Accepted Answer

A) Most corporations have low debt-asset ratios. 
B) Some firms use no debt. 
C) Debt levels across industries vary widely. 
D) There are no differences in capital structure across different industries. 
E) Debt ratios in all countries are considerably less than 100%.

Question 13

Studies have found that firms with high proportions of intangible assets are likely to use ___________ debt compared with firms with low proportions of intangible assets.

Accepted Answer

A) more 
B) the same amount of 
C) less 
D) either more or the same amount of

Question 14

A firm is technically insolvent when:

Accepted Answer

A) the value of its stock declines by more than 50%. 
B) the value of the firm's assets is less than the value of the firm's liabilities. 
C) it files the legal forms petitioning for bankruptcy protection. 
D) it is unable to meet its financial obligations. 
E) it has a negative net worth on its balance sheet.

Question 15

The value of a firm in financial distress is diminished only if the firm:

Accepted Answer

A) is declared bankrupt and proceeds to be liquidated. 
B) is declared insolvent and undergoes financial reorganization. 
C) hires lawyers and accountants to receive and make all payments. 
D) Both A and C. 
E) Both A and B.

Question 16

The optimal capital structure has been achieved when the:

Accepted Answer

A) weight of equity is equal to the weight of debt. 
B) debt-equity ratio is equal to 1. 
C) debt-equity ratio selected results in the lowest possible weighted average cost of capital. 
D) debt-equity ratio is such that the cost of debt exceeds the cost of equity. 
E) cost of equity is maximized given a pre-tax cost of debt.

Question 17

The complete termination of a firm as a going business concern is called a:

Accepted Answer

A) liquidation. 
B) repurchase program. 
C) merger. 
D) divestiture. 
E) reorganization.

Question 18

The costs of avoiding a bankruptcy filing by a financially distressed firm are classified as _____ costs.

Accepted Answer

A) capital structure 
B) direct bankruptcy 
C) financial solvency 
D) indirect bankruptcy 
E) flotation

Question 19

Windsor Company's debtholders are promised payments of $45 if the firm does well,but will receive only $20 if the firm does poorly.Bondholders are willing to pay $35.The promised return to the bondholders is approximately

Accepted Answer

A) 2.9% 
B) 14.3% 
C) 15.0% 
D) 22.1% 
E) 28.6%

Question 20

The explicit costs,such as the legal expenses,associated with corporate default are classified as _____ costs.

Accepted Answer

A) unlevered 
B) direct bankruptcy 
C) beta conversion 
D) indirect bankruptcy 
E) flotation

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