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.
Correct Answer: e
Answer:
Question: Firms generally do not call their convertibles unless the conversion value is greater than the call price.
Answer Options:
a. True
b. False
Correct Answer: a
Answer:
Question: 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).
Answer Options:
a. True
b. False
Answer: a. True
Question: A firm’s CFO is considering increasing the target debt ratio, which would also increase the company’s interest expense. New bonds would be issued and the proceeds would be used to buy back shares of common stock. Neither total assets nor operating income would change, but expected earnings per share (EPS) would increase. Assuming the CFO’s estimates are correct, which of the following statements is CORRECT?
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.
Correct Answer: a
Answer:
Question: A convertible debenture can never sell for more than its conversion value or less than its bond value.
Answer Options:
a. True
b. False
Correct Answer: b
Answer:
Question: 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.
Answer Options:
a. True
b. False
Answer: a. True
Question: The text gives a number of valid, acceptable reasons for companies to merge. Which of the following is NOT acceptable?
Answer Options:
a. Synergistic benefits arising from mergers.
b. Reduction in competition resulting from mergers.
c. Acquisition of assets at below replacement value.
d. Attempts to minimize taxes by acquiring a firm with large accumulated losses that can be used immediately.
e. Using surplus cash to acquire another firm and prevent unfavorable tax consequences for shareholders.
Correct Answer: e
Answer:
Question: A call option whose underlying stock value is less than the corresponding exercise price is an example of a(n)
Answer Options:
a. Straddle option.
b. Put option.
c. Out-of-the-money option.
d. Naked option.
e. Covered option.
Answer: c. Out-of-the-money option
Question: The rate used to discount projected merger cash flows should be the overall cost of capital of the new consolidated firm because it incorporates the actual capital structure of the new firm.
Answer Options:
a. True
b. False
Correct Answer: b
Answer:
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. 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.
Answer Options:
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.
Answer Options:
a. True
b. False
Answer: a. True
Question: Modigliani and Miller (MM) won Nobel Prizes for their work on capital structure theory.
Answer Options:
a. True
b. False
Answer: a. True
Question: Which of the following statements is most CORRECT?
Answer Options:
a. Leveraged buyouts (LBOs) occur when a firm issues equity and uses the proceeds to take a firm public.
b. In a typical LBO, bondholders do well but shareholders see their value decline.
c. Firms are forbidden by law to sell any assets during the first five years following a leveraged buyout.
d. Not all target firms are acquired by publicly traded corporations. In recent years, an increasing number of firms have been acquired by private equity firms. Private equity firms raise capital from wealthy individuals and look for opportunities to make profitable investments.
e. In an LBO sometimes the acquiring group plans to run the acquired company for a number of years, boost its sales and profits, and then take it public again as a stronger company. In other instances, the LBO firm plans to sell off divisions to other firms that can gain synergies. In either case, the acquiring group expects to make a substantial profit from the LBO, but the inherent risks are small due to the heavy use of venture capital and very little debt.
Correct Answer: d
Answer:
Question: Which of the following are reasons why companies move into international operations? a. To take advantage of lower production costs in regions where labor costs are relatively low. b. To develop new markets for the firm’s products. c. To better serve their primary customers. d. Because important raw materials are located abroad. e. All of the above.
Answer: e. All of the above
Question: The firm’s target capital structure should do which of the following?
Answer Options:
a. Maximize the earnings per share (EPS).
b. Minimize the cost of debt (rd).
c. Obtain the highest possible bond rating.
d. Minimize the cost of equity (rs).
e. Minimize the weighted average cost of capital (WACC).
Correct Answer: e
Answer: