Answer Options:
a. True
b. False
Correct Answer: a
Answer:
Question: According to the signaling theory of capital structure, firms first use common equity for their capital, then use debt if and only if they can raise no more equity on “reasonable” terms. This occurs because the use of debt financing signals to investors that the firm’s managers think that the future does not look good.
Answer Options:
a. True
b. False
Answer: b. False
Question: Modigliani and Miller’s second article, which assumed the existence of corporate income taxes, led to the conclusion that a firm’s value would be maximized, and its cost of capital minimized, if it used (almost) 100% debt. However, this model did not take account of bankruptcy costs. The existence of bankruptcy costs leads to the assumption of an optimal capital structure where the debt ratio is less than 100%.
Answer Options:
a. True
b. False
Answer: a. True
Question: Operating leases often have terms that include
Answer Options:
a. maintenance of the equipment by the lessor.
b. full amortization over the life of the lease.
c. very high penalties if the lease is cancelled.
d. restrictions on how much the leased property can be used.
e. much longer lease periods than for most financial leases.
Correct Answer: a
Answer:
Question: Which one of the following will NOT increase the value of a real option? a. Lengthening the time during which a real option must be exercised. b. An increase in the volatility of the underlying source of risk. c. An increase in the risk-free rate. d. An increase in the cost of obtaining the real option. e. A decrease in the probability that a competitor will enter the market of the project in question.
Answer: d. An increase in the cost of obtaining the real option.
Question: FAS 13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the
Answer Options:
a. residual value as a fixed asset.
b. residual value as a liability.
c. present value of future lease payments as an asset and also showing this same amount as an offsetting liability.
d. undiscounted sum of future lease payments as an asset and as an offsetting liability.
e. undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability.
Correct Answer: c
Answer:
Question: Which of the following would tend to increase a firm’s target debt ratio, other things held constant?
Answer Options:
a. The costs associated with filing for bankruptcy increase.
b. The corporate tax rate is increased.
c. The personal tax rate is increased.
d. The Federal Reserve tightens interest rates in an effort to fight inflation.
e. The company’s stock price hits a new low.
Correct Answer: b
Answer:
Question: Is it possible for Firms A and B to have identical financial and operating leverage, yet for Firm A to have more risk as measured by the variability of EPS. This would occur if Firm A has more business risk than Firm B.
Answer Options:
a. True
b. False
Answer: a. True
Question: Some people–including the former chairman of the Federal Reserve Board of Governors (Ben Bernanke)–have argued that one advantage of corporate debt from the stockholders’ standpoint is that the existence of debt forces managers to focus on cash flow and to refrain from spending too much of the firm’s money on private plane and other “perks.” This is one of the factors that led to the rise of LBOs and private equity firms.
Answer Options:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT? a. Since debt financing raises the firm’s financial risk, increasing the target debt ratio will always increase the 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 costs 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 costs of both debt and equity financing. However, this action still may lower the company’s WACC. e. Since a firm’s beta coefficient is not affected by its use of financial leverage, leverage does not affect the cost of equity.
Answer: d. Increasing a company’s debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company’s WACC.
Question: Assume that a piece of leased equipment has a relatively high expected residual value. From the lessee’s viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.
Answer Options:
a. True
b. False
Correct Answer: b
Answer:
Question: Other things held constant, which of the following events would be most likely to encourage a firm to increase the amount of debt in its capital structure?
Answer Options:
a. Its sales are projected to become less stable in the future.
b. The bankruptcy laws are changed in a way that would make bankruptcy more costly to the firm and its stockholders.
c. Management believes that the firm’s stock is currently overvalued.
d. The firm decides to automate its factory with specialized equipment and thus increase its use of operating leverage.
e. The corporate tax rate is increased.
Correct Answer: e
Answer:
Question: Which of the following statements is CORRECT?
Answer Options:
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.
Correct Answer: a
Answer:
Question: The cost of capital may be different for a foreign project than for an equivalent domestic project because foreign projects may be more or less risky.
Answer Options:
a. True
b. False
Answer: a. True