Question 1

The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant.

Accepted Answer

A) True 
 B)False

Question 2

The CFO of Google believes that its greatest strategic goal is to maintain flexibility. To achieve this goal, which of the following financial structures is in place at Google?

Accepted Answer

A)   Google has issued significantly more long-term debt than equity (common shares)  because debt has a significantly lower after-tax cost.
B)   Google has issued significantly more equity (common shares)  to avoid the restrictions that debt would imposed through restrictive covenants.
C)   Google holds large amounts of cash and short-term investments in spite of the opportunity loss resulting from low investment earnings.
D)   Google maintains a dividend payout ratio in line with other firms in the industry to ensure that its common shares are attractive to investors.E) None of the above
F) B) and C)

Question 3

Ang Enterprises has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40%. What would Ang's beta be if it used no debt, i.e., what is its unlevered beta?

Accepted Answer

A)   0.67
B)   0.71
C)   0.75
D)   0.79E) A) and B)
F) A) and C)

Question 4

The bankruptcy risk produces an ambiguous effect on agency costs.

Accepted Answer

A) True 
 B)False

Question 5

If a firm utilizes debt financing, an X% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than X.

Accepted Answer

A) True 
 B)False

Question 6

Whenever a firm borrows money, it is using financial leverage.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following statements is correct?

Accepted Answer

A)   A firm can use retained earnings without paying a flotation cost. Therefore, while the cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of debt.
B)   The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price.
C)   The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes its earnings per share.
D)   If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio must reduce its WACC.E) B) and D)
F) None of the above

Question 8

Which statement concerning capital structure theory is NOT true?

Accepted Answer

A)   The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt.
B)   Under MM with zero taxes, financial leverage has no effect on a firm's value.
C)   Under MM with corporate taxes, the value of a levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt.
D)   Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing.E) A) and B)
F) A) and D)

Question 9

What is likely to happen in the MM model with a high risk of bankruptcy?

Accepted Answer

A)   almost 100% debt financing
B)   valuable projects are foregone to preserve cash
C)   wasteful expenditures are often found
D)   management buys back shares from the open marketE) None of the above
F) A) and B)

Question 10

In a perfect world of no taxes, what happens if the weighted average cost of capital (WACC)  is unaffected by the capital structure?

Accepted Answer

A)   MM proposition I holds.
B)   MM proposition II holds.
C)   SML is positively sloped.
D)   SML is negatively sloped.E) B) and C)
F) A) and D)

Question 11

MM shows that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

Accepted Answer

A) True 
 B)False

Question 12

The MM model employs the concept of arbitrage to develop its theory.

Accepted Answer

A) True 
 B)False

Question 13

If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal.

Accepted Answer

A) True 
 B)False

Question 14

During a recession, companies with a significant portion of their capital structure in the form of debt (i.e., high leverage) often struggle to meet their legally binding interest obligations.

Accepted Answer

A) True 
 B)False

Question 15

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

Accepted Answer

A) True 
 B)False

Question 16

Business risk is affected by a firm's operations. Which of the following is NOT associated with (or does not contribute to)  business risk?

Accepted Answer

A)   demand variability
B)   input price variability
C)   the extent to which operating costs are fixed
D)   the extent to which interest rates on the firm's debt fluctuateE) B) and C)
F) A) and B)

Question 17

Vafeas Inc.'s capital structure consists of 80% debt and 20% common equity, it has a beta of 1.60, and its tax rate is 35%. However, the CFO thinks the company has too much debt, and he is considering moving to a capital structure with 40% debt and 60% equity. The risk-free rate is 5.0% and the market risk premium is 6.0%. By how much would the firm's cost of equity change as a result of altering its capital structure?

Accepted Answer

A)   -5.20%
B)   -5.78%
C)   -6.36%
D)   -6.99%E) A) and B)
F) B) and D)

Question 18

Which of the following statements is correct?

Accepted Answer

A)   If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted trade-off theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.
B)   A change in the personal tax rate should not affect firms' capital structure decisions.
C)   "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.
D)   The optimal capital structure is the one that simultaneously (1)  maximizes the price of the firm's stock, (2)  minimizes its WACC, and (3)  maximizes its EPS.E) B) and C)
F) B) and D)

Question 19

Based on the information below, what is Ezzel Enterprises' optimal capital structure?

Accepted Answer

A)   Debt = 40%; Equity = 60%; EPS = $2.95; Common share price = $26.50
B)   Debt = 50%; Equity = 50%; EPS = $3.05; Common share price = $28.90
C)   Debt = 60%; Equity = 40%; EPS = $3.18; Common share price = $31.20
D)   Debt = 80%; Equity = 20%; EPS = $3.42; Common share price = $30.40E) B) and D)
F) A) and D)

Question 20

Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.

Accepted Answer

A) True 
 B)False

Exam 12: Capital Structure Decisions

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

Correct Answer
verified

The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant.

Correct Answer
verified

Ang Enterprises has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40%. What would Ang's beta be if it used no debt, i.e., what is its unlevered beta?

Correct Answer
verified

The MM model employs the concept of arbitrage to develop its theory.

Correct Answer
verified

Correct Answer
verified

Based on the information below, what is Ezzel Enterprises' optimal capital structure?

Correct Answer
verified

Which of the following statements is correct?

Correct Answer
verified

What is likely to happen in the MM model with a high risk of bankruptcy?

Correct Answer
verified

Business risk is affected by a firm's operations. Which of the following is NOT associated with (or does not contribute to) business risk?

Correct Answer
verified

If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal.

Correct Answer
verified

Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.

Correct Answer
verified

The CFO of Google believes that its greatest strategic goal is to maintain flexibility. To achieve this goal, which of the following financial structures is in place at Google?

Correct Answer
verified

During a recession, companies with a significant portion of their capital structure in the form of debt (i.e., high leverage) often struggle to meet their legally binding interest obligations.

Correct Answer
verified

Which statement concerning capital structure theory is NOT true?

Correct Answer
verified

In a perfect world of no taxes, what happens if the weighted average cost of capital (WACC) is unaffected by the capital structure?

Correct Answer
verified

MM shows that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

Correct Answer
verified

Which of the following statements is correct?

Correct Answer
verified

The bankruptcy risk produces an ambiguous effect on agency costs.

Correct Answer
verified

If a firm utilizes debt financing, an X% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than X.

Correct Answer
verified

Whenever a firm borrows money, it is using financial leverage.

Correct Answer
verified

Exam 12: Capital Structure Decisions

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

Correct AnswerverifiedShow Answer

The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant.

Correct AnswerverifiedShow Answer

Ang Enterprises has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40%. What would Ang's beta be if it used no debt, i.e., what is its unlevered beta?

Correct AnswerverifiedShow Answer

The MM model employs the concept of arbitrage to develop its theory.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Based on the information below, what is Ezzel Enterprises' optimal capital structure?

Correct AnswerverifiedShow Answer

Which of the following statements is correct?

Correct AnswerverifiedShow Answer

What is likely to happen in the MM model with a high risk of bankruptcy?

Correct AnswerverifiedShow Answer

Business risk is affected by a firm's operations. Which of the following is NOT associated with (or does not contribute to) business risk?

Correct AnswerverifiedShow Answer

If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal.

Correct AnswerverifiedShow Answer

Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.

Correct AnswerverifiedShow Answer

The CFO of Google believes that its greatest strategic goal is to maintain flexibility. To achieve this goal, which of the following financial structures is in place at Google?

Correct AnswerverifiedShow Answer

During a recession, companies with a significant portion of their capital structure in the form of debt (i.e., high leverage) often struggle to meet their legally binding interest obligations.

Correct AnswerverifiedShow Answer

Which statement concerning capital structure theory is NOT true?

Correct AnswerverifiedShow Answer

In a perfect world of no taxes, what happens if the weighted average cost of capital (WACC) is unaffected by the capital structure?

Correct AnswerverifiedShow Answer

MM shows that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

Correct AnswerverifiedShow Answer

Which of the following statements is correct?

Correct AnswerverifiedShow Answer

The bankruptcy risk produces an ambiguous effect on agency costs.

Correct AnswerverifiedShow Answer

If a firm utilizes debt financing, an X% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than X.

Correct AnswerverifiedShow Answer

Whenever a firm borrows money, it is using financial leverage.

Correct AnswerverifiedShow Answer

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