Answer: a. True
Question: Other things held constant, the lower a firm’s tax rate, the more logical it is for the firm to use debt. a. True b. False
Answer: b. False
Question: A 100% stock dividend and a 2:1 stock split should, at least conceptually, have the same effect on the firm’s stock price.
Answer Options:
a. True
b. False
Answer: True
Question: Which of the following actions will best enable a company to raise additional equity capital, other things held constant? a. Refund long-term debt with lower cost short-term debt. b. Declare a stock split. c. Begin an open-market purchase dividend reinvestment plan. d. Initiate a stock repurchase program. e. Begin a new-stock dividend reinvestment plan.
Answer: e
Question: One advantage of dividend reinvestment plans is that they allow shareholders to delay paying taxes on the dividends that they choose to reinvest.
Answer Options:
a. True
b. False
Answer: False
Question: Financial risk refers to the extra risk borne by stockholders as a result of a firm’s use of debt as compared with their risk if the firm had used no debt. a. True b. False
Answer: a. True
Question: You recently sold 100 shares of Microsoft stock to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following best describes this transaction? a. This is an example of a direct transfer of capital. b. This is an example of a primary market transaction. c. This is an example of an exchange of physical assets. d. This is an example of a money market transaction. e. This is an example of a derivative market transaction.
Answer: a
Question: Firms U and L each have the same amount of assets, investor-supplied capital, and both have a return on investors’ capital (ROIC) of 12%. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm L’s debt has an after-tax cost of 8%. Both firms have positive net income and a 35% tax rate. Which of the following statements is CORRECT?
Answer Options:
a. The two companies have the same times interest earned (TIE) ratio.
b. Firm L has a lower ROA than Firm U.
c. Firm L has a lower ROE than Firm U.
d. Firm L has the higher times interest earned (TIE) ratio.
e. Firm L has a higher EBIT than Firm U.
Answer: b
Question: Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument.
Answer Options:
a. True
b. False
Answer: False
Question: Other things held constant, an increase in financial leverage will increase a firm’s market (or systematic) risk as measured by its beta coefficient. a. True b. False
Answer: a. True
Question: Which of the following statements is CORRECT? a. One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive. b. If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not adhere strictly to the residual dividend model. c. If a firm adheres strictly to the residual dividend model, then, holding all else constant, its dividend payout ratio will tend to rise whenever its investment opportunities improve. d. If Congress eliminates taxes on capital gains but leaves the personal tax rate on dividends unchanged, this would motivate companies to increase their dividend payout ratios. e. Despite its drawbacks, following the residual dividend model will tend to stabilize actual cash dividends, and this will make it easier for firms to attract a clientele that prefers high dividends, such as retirees.
Answer: e (Incorrect, the correct answer is b)
Question: 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?
Answer Options:
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.
Answer: c
Question: Which of the following statements is CORRECT?
Answer Options:
a. When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase.
b. The capital structure that maximizes the stock price is generally the capital structure that also maximizes the return on equity.
Answer: a
Question: Miller and Modigliani’s dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on either its cost of capital or its stock price.
Answer Options:
a. True
b. False
Answer: True
Question: In a “Dutch auction” for new stock, individual investors place bids for shares directly. Each potential bidder indicates the price he or she is willing to pay and how many shares he or she will purchase at that price. The highest price that permits the company to sell all the shares it wants to sell is determined, and this is the “market clearing price.” All bidders who specified this price or higher are allowed to purchase their shares at the market clearing price. a. True b. False
Answer: True
Question: A firm’s CFO is considering increasing the target debt ratio, which would also increase the company’s interest
Answer Options:
a. Since the proposed plan increases the firm’s financial risk, the stock price might fall even if EPS increases.
b. If the plan reduces the WACC, the stock price is likely to decline.
c. Since the plan is expected to increase EPS, this implies that net income is also expected to increase.
d. If the plan does increase the EPS, the stock price will automatically increase at the same rate.
e. Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds.
Answer: a
Question: Which of the following statements is CORRECT? As a firm increases the operating leverage used to produce a given quantity of output, this
Answer Options:
a. normally leads to an increase in its fixed assets turnover ratio.
b. normally leads to a decrease in its business risk.
c. normally leads to a decrease in the standard deviation of its expected EBIT.
d. normally leads to a decrease in the variability of its expected EPS.
e. normally leads to a reduction in its fixed assets turnover ratio.
Answer: e
Question: If a firm declares a 20:1 stock split, and the pre-split price was $500, then we might expect the post-split price to be $25. However, it often turns out that the post-split price will be higher than $25. This higher price could be due to signaling effects investors believe that management split the stock because they think the firm is going to do better in the future. The higher price could also be because investors like lower-priced shares.
Answer Options:
a. True
b. False
Answer: True
Question: Which of the following statements is CORRECT? a. One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their investment in the company. b. One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account. c. Stock repurchases can be used by a firm that wants to increase its debt ratio. d. Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities. e. One advantage of an open market dividend reinvestment plan is that it provides both equity capital and increases the shares outstanding.
Answer: c
Question: 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. a. True b. False
Answer: a. True
Question: A firm’s capital structure does not affect its free cash flows as discussed in the text, because FCF reflects only operating cash flows, which are available to service debt, to pay dividends to stockholders, and for other purposes. a. True b. False
Answer: b. False
Question: Which of the following would be most likely to lead to a decrease in a firm’s dividend payout ratio? a. Its earnings become more stable. b. Its access to the capital markets increases. c. Its research and development efforts pay off, and it now has more high-return investment opportunities. d. Its accounts receivable decrease due to a change in its credit policy. e. Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages.
Answer: c