Answer Options:
a. True
b. False
Answer: b. False
Question: If a firm uses the residual dividend model to set dividend policy, then dividends are determined as a residual after providing for the equity required to fund the capital budget. Under this model, the better the firm’s investment opportunities, the lower its payout ratio will be, other things held constant.
Answer Options:
a. True
b. False
Answer: a. True
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: a. True
Question: 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.
Answer Options:
a. True
b. False
Answer: a. True
Question: If a firm pays out all of its earnings as dividends and its stockholders then elect to have all of their dividends reinvested, the company should reconsider its dividend policy and possibly move to a lower dividend payout ratio.
Answer Options:
a. True
b. False
Answer: a. True
Question: Modigliani and Miller (MM), in their second article, took account of taxes, bankruptcy, and other factors that were assumed away in their original article. Once they took account of all these assumptions, they concluded that every firm has a unique optimal capital structure. Moreover, a manager can use the second MM model to determine his or her firm’s optimal debt ratio.
Answer Options:
a. True
b. False
Answer: b. False
Question: Other things held constant, the lower a firm’s tax rate, the more logical it is for the firm to use debt.
Answer Options:
a. True
b. False
Answer: b. False
Question: The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, an increase in the tax rate on dividends relative to that on capital gains would logically lead to an increase in dividend payout ratios.
Answer Options:
a. True
b. False
Answer: b. False
Question: Is it appropriate to use the fixed assets turnover ratio to appraise firms’ effectiveness in managing their fixed assets if and only if the firms being compared have the same proportion of fixed assets to total assets.
Answer Options:
a. True
b. False
Answer: b. False
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: The return on invested capital measures the total return that a company has provided for its investors.
a. True
b. False
Answer: a. True
Question: The alternative minimum tax (AMT) was created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions.
Answer Options:
a. True
b. False
Answer: a. True
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: The Modigliani and Miller (MM) articles implicitly assumed that bankruptcy did not exist. That led to the development of the “trade-off” model, where the firm’s value first rises with the use of debt due to the tax shelter of debt, but later falls as more debt is added because the potential costs of bankruptcy begin to more than offset the tax shelter benefits. Under the trade-off theory, an optimal capital structure exists.
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: Profitability ratios show the combined effects of liquidity, asset management, and debt management on a firm’s operating results.
a. True
b. False
Answer: a. True