Question 1

Which event is likely to encourage a company to raise its target debt ratio, other things held constant?

Accepted Answer

A)   an increase in the corporate tax rate
B)   an increase in the personal tax rate
C)   an increase in the company's operating leverage
D)   the company's stock price hitting a new highE) None of the above
F) All of the above

Question 2

What is the major contribution of the Miller model?

Accepted Answer

A)   It demonstrates that personal taxes decrease the value of using corporate debt.
B)   It demonstrates that financial distress and agency costs reduce the value of using corporate debt.
C)   It demonstrates that equity costs increase with financial leverage.
D)   It demonstrates that debt costs increase with financial leverage.E) B) and C)
F) A) and B)

Question 3

Elephant Books sells paperback books for $7 each. The variable cost per book is $5. At current annual sales of 200,000 books, the publisher is just breaking even. It is estimated that if the authors' royalties are reduced, the variable cost per book will drop by $1. Assume authors' royalties are reduced and sales remain constant; how much more money can the publisher put into advertising (a fixed cost)  and still break even?

Accepted Answer

A)   $600,000
B)   $466,667
C)   $333,333
D)   $200,000E) A) and C)
F) All of the above

Question 4

Vu Enterprises expects to have the following data during the coming year. What is Vu's expected ROE? Assets
$200,000
Interest rate
8%
D/A
65%
Tax rate
40%
EBIT
$25,000

Accepted Answer

A)   12.51%
B)   13.14%
C)   13.80%
D)   14.49%E) None of the above
F) A) and D)

Question 5

Financial distress, agency costs, and direct and indirect bankruptcy costs affect a firm's target capital structure.

Accepted Answer

A) True 
 B)False

Question 6

A firm's financial risk has identifiable market risk and diversifiable risk components.

Accepted Answer

A) True 
 B)False

Question 7

The MM model is the same as the Miller model, but with zero corporate taxes.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following statements best describes WACC?

Accepted Answer

A)   Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.
B)   Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC.
C)   Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing. However, this action still may raise the company's WACC.
D)   Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing. However, this action still may lower the company's WACC.E) B) and D)
F) All of the above

Question 9

Which of the following statements best describes capital structure?

Accepted Answer

A)   The capital structure that maximizes expected EPS also maximizes the price per share of common shares.
B)   The capital structure that minimizes the interest rate on debt also maximizes the expected EPS.
C)   The capital structure that minimizes the required return on equity also maximizes the share price.
D)   The capital structure that minimizes the WACC also maximizes the price per share of common shares.E) B) and C)
F) A) and B)

Question 10

Suppose a firm has a debt-to-equity ratio (D/E)  of 0.5, return on assets of 18%, and return on debt of 12%. What will its return on equity be?

Accepted Answer

A)   15.00%
B)   16.67%
C)   20.00%
D)   21.17%E) A) and B)
F) A) and C)

Question 11

Although they operate in different industries, two firms have the same expected earnings per share and the same standard deviation of expected EPS. Thus, the two firms must have the same business risk.

Accepted Answer

A) True 
 B)False

Question 12

As a firm approaches bankruptcy, the indirect costs of bankruptcy (e.g., financial distress) will tend to increase.

Accepted Answer

A) True 
 B)False

Question 13

Which statement concerning the MM extension with growth is incorrect?

Accepted Answer

A)   The value of a growing tax shield is greater than the value of a constant tax shield.
B)   For a given D/E, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax)  assumptions.
C)   For a given D/E, the WACC is less than the WACC under MM's original (with tax)  assumptions.
D)   The total value of the firm increases with the amount of debt.E) A) and B)
F) A) and D)

Question 14

What is the firm's cost of equity?

Accepted Answer

A)   23.3%
B)   25.9%
C)   28.8%
D)   32.0%E) A) and B)
F) None of the above

Question 15

If the value of a levered firm is $5 million, what is the value of the same firm with all-equity financing?

Accepted Answer

A)   $7 million
B)   $6 million
C)   $5 million
D)   $4 millionE) B) and C)
F) C) and D)

Question 16

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Accepted Answer

A) True 
 B)False

Question 17

Which of the following statements regarding risk, or the avoidance of risk, is correct?

Accepted Answer

A)   A firm's business risk is determined solely by the financial characteristics of its industry.
B)   Risk due to industry characteristics is beyond the control of the firm's management.
C)   One of the benefits to a firm of being at or near its target capital structure is that this eliminates any risk of bankruptcy.
D)   A firm's financial risk can be minimized by diversification.E) A) and C)
F) A) and B)

Question 18

Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant?

Accepted Answer

A)   an increase in costs incurred when filing for bankruptcy
B)   an increase in the corporate tax rate
C)   an increase in the personal tax rate
D)   the company's stock price hitting a new lowE) A) and B)
F) B) and D)

Question 19

DeLong Inc. has fixed operating costs of $470,000, variable costs of $2.80 per unit produced, and its products sell for $4.00 per unit. What is the company's break-even point, i.e., at what unit sales volume would income equal costs?

Accepted Answer

A)   391,667
B)   411,250
C)   431,813
D)   453,403E) C) and D)
F) None of the above

Question 20

What is the value of the firm according to MM with corporate taxes?

Accepted Answer

A)   $475,875
B)   $528,750
C)   $587,500
D)   $646,250E) B) and D)
F) A) and B)

Exam 12: Capital Structure Decisions

What is the value of the firm according to MM with corporate taxes?

Correct Answer
verified

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Correct Answer
verified

Correct Answer
verified

The MM model is the same as the Miller model, but with zero corporate taxes.

Correct Answer
verified

Which of the following statements best describes WACC?

Correct Answer
verified

Which of the following statements best describes capital structure?

Correct Answer
verified

DeLong Inc. has fixed operating costs of $470,000, variable costs of $2.80 per unit produced, and its products sell for $4.00 per unit. What is the company's break-even point, i.e., at what unit sales volume would income equal costs?

Correct Answer
verified

Suppose a firm has a debt-to-equity ratio (D/E) of 0.5, return on assets of 18%, and return on debt of 12%. What will its return on equity be?

Correct Answer
verified

Which event is likely to encourage a company to raise its target debt ratio, other things held constant?

Correct Answer
verified

A firm's financial risk has identifiable market risk and diversifiable risk components.

Correct Answer
verified

As a firm approaches bankruptcy, the indirect costs of bankruptcy (e.g., financial distress) will tend to increase.

Correct Answer
verified

Although they operate in different industries, two firms have the same expected earnings per share and the same standard deviation of expected EPS. Thus, the two firms must have the same business risk.

Correct Answer
verified

Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant?

Correct Answer
verified

What is the firm's cost of equity?

Correct Answer
verified

Vu Enterprises expects to have the following data during the coming year. What is Vu's expected ROE? Assets $200,000 Interest rate 8% D/A 65% Tax rate 40% EBIT $25,000

Correct Answer
verified

If the value of a levered firm is $5 million, what is the value of the same firm with all-equity financing?

Correct Answer
verified

Which statement concerning the MM extension with growth is incorrect?

Correct Answer
verified

Which of the following statements regarding risk, or the avoidance of risk, is correct?

Correct Answer
verified

Financial distress, agency costs, and direct and indirect bankruptcy costs affect a firm's target capital structure.

Correct Answer
verified

What is the major contribution of the Miller model?

Correct Answer
verified

Exam 12: Capital Structure Decisions

What is the value of the firm according to MM with corporate taxes?

Correct AnswerverifiedShow Answer

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The MM model is the same as the Miller model, but with zero corporate taxes.

Correct AnswerverifiedShow Answer

Which of the following statements best describes WACC?

Correct AnswerverifiedShow Answer

Which of the following statements best describes capital structure?

Correct AnswerverifiedShow Answer

DeLong Inc. has fixed operating costs of $470,000, variable costs of $2.80 per unit produced, and its products sell for $4.00 per unit. What is the company's break-even point, i.e., at what unit sales volume would income equal costs?

Correct AnswerverifiedShow Answer

Suppose a firm has a debt-to-equity ratio (D/E) of 0.5, return on assets of 18%, and return on debt of 12%. What will its return on equity be?

Correct AnswerverifiedShow Answer

Which event is likely to encourage a company to raise its target debt ratio, other things held constant?

Correct AnswerverifiedShow Answer

A firm's financial risk has identifiable market risk and diversifiable risk components.

Correct AnswerverifiedShow Answer

As a firm approaches bankruptcy, the indirect costs of bankruptcy (e.g., financial distress) will tend to increase.

Correct AnswerverifiedShow Answer

Although they operate in different industries, two firms have the same expected earnings per share and the same standard deviation of expected EPS. Thus, the two firms must have the same business risk.

Correct AnswerverifiedShow Answer

Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant?

Correct AnswerverifiedShow Answer

What is the firm's cost of equity?

Correct AnswerverifiedShow Answer

Vu Enterprises expects to have the following data during the coming year. What is Vu's expected ROE? Assets $200,000 Interest rate 8% D/A 65% Tax rate 40% EBIT $25,000

Correct AnswerverifiedShow Answer

If the value of a levered firm is $5 million, what is the value of the same firm with all-equity financing?

Correct AnswerverifiedShow Answer

Which statement concerning the MM extension with growth is incorrect?

Correct AnswerverifiedShow Answer

Which of the following statements regarding risk, or the avoidance of risk, is correct?

Correct AnswerverifiedShow Answer

Financial distress, agency costs, and direct and indirect bankruptcy costs affect a firm's target capital structure.

Correct AnswerverifiedShow Answer

What is the major contribution of the Miller model?

Correct AnswerverifiedShow Answer

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