Question 1

Which of the following statements is CORRECT, holding other things constant?

Accepted Answer

A)   Firms whose assets are relatively liquid tend to have relatively low bankruptcy costs, hence they tend to use relatively little debt.
B)   An increase in the personal tax rate is likely to increase the debt ratio of the average corporation.
C)   If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely lead to lower debt ratios for corporations.
D)   An increase in the company's degree of operating leverage would tend to encourage the firm to use more debt in its capital structure so as to keep its total risk unchanged.
E)   An increase in the corporate tax rate would in theory encourage companies to use more debt in their capital structures.F) All of the above
G) None of the above

Question 2

Other things held constant, firms that use assets that can be sold easily (like trucks) tend to use more debt than firms whose assets are harder to sell (like those engaged in research and development).

Accepted Answer

A) True 
 B)False

Question 3

Your uncle is considering investing in a new company that will produce high quality stereo speakers. The sales price would be set at 1.5 times the variable cost per unit; the variable cost per unit is estimated to be $75.00; and fixed costs are estimated at $1,200,000. What sales volume would be required to break even, i.e., to have EBIT = zero?

Accepted Answer

A)   28,880
B)   30,400
C)   32,000
D)   33,600
E)   35,280F) A) and B)
G) A) and D)

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)   If Congress lowered corporate tax rates while other things were held constant, and if the Modigliani-Miller tax-adjusted 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)   If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation's debt ratio.F) B) and E)
G) A) and C)

Question 5

An increase in the debt ratio will generally have no effect on which of these items?

Accepted Answer

A)   Business risk.
B)   Total risk.
C)   Financial risk.
D)   Market risk.
E)   The firm's beta.F) B) and D)
G) B) and C)

Question 6

Which of the following statements is CORRECT?

Accepted Answer

A)   Increasing its use of financial leverage is one way to increase a firm's return on investors' capital (ROI
C)  .
B)   If a firm lowered its fixed costs but increased its variable costs by just enough to hold total costs at the present level of sales constant, this would increase its operating leverage.
C)   The debt ratio that maximizes expected EPS generally exceeds the debt ratio that maximizes share price.
D)   If a company were to issue debt and use the money to repurchase common stock, this would reduce its return on investors' capital (ROI
C)  . (Assume that the repurchase has no impact on the company's operating income.) 
E)   If a change in the bankruptcy code made bankruptcy less costly to corporations, this would tend to reduce corporations' debt ratios.F) A) and B)
G) B) and D)

Question 7

Companies HD and LD have identical tax rates, total assets, total investor-supplied capital, and returns on investors' capital However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT?

Accepted Answer

A)   Company HD has a higher net income than Company LD.
B)   Company HD has a lower ROA than Company LD.
C)   Company HD has a lower ROE than Company LD.
D)   The two companies have the same ROA.
E)   The two companies have the same ROE.F) A) and C)
G) A) and B)

Question 8

According to Modigliani and Miller (MM), in a world without corporate income taxes the use of debt has no effect on the firm's value.

Accepted Answer

A) True 
 B)False

Question 9

You plan to invest in one of two home delivery pizza companies, High and Low, that were recently founded and are about to commence operations. They are identical except for their use of debt (wd)  and the interest rates on their debt--High uses more debt and thus must pay a higher interest rate. Based on the data given below, how much higher or lower will High's expected EPS be versus that of Low, i.e., what is EPSHigh - EPSLow?

Accepted Answer

A)   $0.49
B)   $0.54
C)   $0.60
D)   $0.66
E)   $0.73F) All of the above
G) A) and E)

Question 10

A firm's treasurer likes to be in a position to raise funds to support operations whenever such funds are needed, even in "bad times". This is called "financial flexibility," and the lower the firm's debt ratio, the greater its financial flexibility, other things held constant.

Accepted Answer

A) True 
 B)False

Question 11

A group of venture investors is considering putting money into Lemma Books, which wants to produce a new reader for electronic books. The variable cost per unit is estimated at $250, the sales price would be set at twice the VC/unit, or $500, and fixed costs are estimated at $750,000. The investors will put up the funds if the project is likely to have an operating income of $500,000 or more. What sales volume would be required in order to meet the minimum profit goal? (Hint: Use the break-even formula, but include the required profit in the numerator.)

Accepted Answer

A)   4,513
B)   4,750
C)   5,000
D)   5,250
E)   5,513F) C) and D)
G) B) and C)

Question 12

Your girlfriend plans to start a new company to make a new type of cat litter. Her father will finance the operation, but she will have to pay him back. You are helping her, and the issue now is how to finance the company, with equity only or with a mix of debt and equity. The price per unit will be $10.00 regardless of how the firm is financed. The expected fixed and variable operating costs, along with other information, are shown below. How much higher or lower will the firm's expected EPS be if it uses some debt rather than only equity, i.e., what is EPSL - EPSU?

Accepted Answer

A)   $0.54
B)   $0.60
C)   $0.67
D)   $0.75
E)   $0.83F) A) and E)
G) All of the above

Question 13

Longstreet Inc. has fixed operating costs of $470,000, variable costs of $2.80 per unit produced, and its product sells 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)   453,403
E)   476,073F) B) and E)
G) A) and E)

Question 14

If a firm utilizes debt financing, a 10% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than 10%, and the higher the debt ratio, the larger this difference will be.

Accepted Answer

A) True 
 B)False

Question 15

Your company plans to produce a new product, a wireless computer mouse. Two machines can be used to make the mouse, Machines A and B. The price per mouse will be $25.00 regardless of which machine is used. The fixed and variable costs associated with the two machines are shown below. At the expected sales level of 75,000 units, how much higher or lower will the firm's expected EBIT be if it uses Machine B with high fixed costs rather than Machine A with low fixed costs, i.e., what is EBITB - EBITA?

Accepted Answer

A)   $123,019
B)   $136,688
C)   $151,875
D)   $168,750
E)   $185,625F) A) and E)
G) C) and E)

Question 16

According to Modigliani and Miller (MM), in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Accepted Answer

A) True 
 B)False

Question 17

Your firm is currently 100% equity financed. The CFO is considering a recapitalization plan under which the firm would issue long-term debt with an after-tax yield of 9% and use the proceeds to repurchase some of its common stock. The recapitalization would not change the company's total investor-supplied capital, the size of the firm (i.e., total assets) , and it would not affect the firm's return on investors' capital (ROIC) , which is 15%. The CFO believes that this recapitalization would reduce the firm's WACC and increase its stock price. Which of the following would be likely to occur if the company goes ahead with the recapitalization plan?

Accepted Answer

A)   The company's net income would increase.
B)   The company's earnings per share would decline.
C)   The company's cost of equity would increase.
D)   The company's ROA would increase.
E)   The company's ROE would decline.F) None of the above
G) All of the above

Question 18

Modigliani and Miller's first article led to the conclusion that capital structure is "irrelevant" because it has no effect on a firm's value. However, that article was criticized because it assumed that no taxes existed. MM then revised their original article to include corporate taxes, and this model led to the conclusion that a firm's value would be maximized if it used (almost) 100% debt.

Accepted Answer

A) True 
 B)False

Question 19

Gator Fabrics Inc. currently has zero debt . It is a zero growth company, and additional firm data are shown below. Now the company is considering using some debt, moving to the new capital structure indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACCOld - WACCNew?

Accepted Answer

A)   2.74%
B)   3.01%
C)   3.32%
D)   3.65%
E)   4.01%F) B) and E)
G) A) and E)

Question 20

Companies HD and LD have identical amounts of assets, investor-supplied capital, operating income Which of the following statements is CORRECT?

Accepted Answer

A)   Company HD has a higher return on assets (RO
A)   than Company LD.
B)   Company HD has a higher times interest earned (TI
E)   ratio than Company LD.
C)   Company HD has a higher return on equity (RO
E)   than Company LD, and its risk as measured by the standard deviation of ROE is also higher than LD's.
D)   The two companies have the same ROE.
E)   Company HD's ROE would be higher if it had no debt.F) A) and B)
G) B) and D)

Exam 13: Capital Structure

According to Modigliani and Miller (MM), in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Correct Answer
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Correct Answer
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Companies HD and LD have identical amounts of assets, investor-supplied capital, operating income Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Correct Answer
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Which of the following statements is CORRECT, holding other things constant?

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Other things held constant, firms that use assets that can be sold easily (like trucks) tend to use more debt than firms whose assets are harder to sell (like those engaged in research and development).

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Companies HD and LD have identical tax rates, total assets, total investor-supplied capital, and returns on investors' capital However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT?

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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An increase in the debt ratio will generally have no effect on which of these items?

Correct Answer
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Correct Answer
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According to Modigliani and Miller (MM), in a world without corporate income taxes the use of debt has no effect on the firm's value.

Correct Answer
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Longstreet Inc. has fixed operating costs of $470,000, variable costs of $2.80 per unit produced, and its product sells 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
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A firm's treasurer likes to be in a position to raise funds to support operations whenever such funds are needed, even in "bad times". This is called "financial flexibility," and the lower the firm's debt ratio, the greater its financial flexibility, other things held constant.

Correct Answer
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If a firm utilizes debt financing, a 10% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than 10%, and the higher the debt ratio, the larger this difference will be.

Correct Answer
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Exam 13: Capital Structure

According to Modigliani and Miller (MM), in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Companies HD and LD have identical amounts of assets, investor-supplied capital, operating income Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT, holding other things constant?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Other things held constant, firms that use assets that can be sold easily (like trucks) tend to use more debt than firms whose assets are harder to sell (like those engaged in research and development).

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Companies HD and LD have identical tax rates, total assets, total investor-supplied capital, and returns on investors' capital However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

An increase in the debt ratio will generally have no effect on which of these items?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

According to Modigliani and Miller (MM), in a world without corporate income taxes the use of debt has no effect on the firm's value.

Correct AnswerverifiedShow Answer

Longstreet Inc. has fixed operating costs of $470,000, variable costs of $2.80 per unit produced, and its product sells 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

A firm's treasurer likes to be in a position to raise funds to support operations whenever such funds are needed, even in "bad times". This is called "financial flexibility," and the lower the firm's debt ratio, the greater its financial flexibility, other things held constant.

Correct AnswerverifiedShow Answer

If a firm utilizes debt financing, a 10% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than 10%, and the higher the debt ratio, the larger this difference will be.

Correct AnswerverifiedShow Answer

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