Answer Options:
a. True
b. False
Answer:
False
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: 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.
Answer Options:
a. True
b. False
Answer:
True
Question: According to Modigliani and Miller (MM), in a world with corporate income taxes the optimal capital structure calls for approximately 100% debt financing.
Answer Options:
a. True
b. False
Answer:
True
Question: For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is obtained in accordance with its target capital structure, which for many firms means partly as debt, partly as preferred stock, and partly common equity. a. True b. False
Answer:
a. True
Question: Which of the following statements is CORRECT?
Answer Options:
a. When firms are deciding on the size of stock splits—say whether to declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split, because then the after-split price will be higher than if the 3-for-1 split had been used.
b. Back before the SEC was created in the 1930s, companies would declare reverse splits in order to boost their stock prices. However, this was determined to be a deceptive practice, and reverse splits are illegal today.
c. Stock splits create more administrative problems for investors than stock dividends, especially determining the tax basis of their shares when they decide to sell them, so today stock dividends are used far more often than stock splits.
d. When a company declares a stock split, the price of the stock typically declines—for example, by about 50% after a 2-for-1 split—and this necessarily reduces the total market value of the firm’s equity.
e. If a firm’s stock price is quite high relative to most stocks—say $500 per share—then it can declare a stock split of say 20-for-1 so as to bring the price down to something close to $25. Moreover, if the price is relatively low—say $2 per share—then it can declare a “reverse split” of say 1-for-10 so as to bring the price up to somewhere around $20 per share.
Answer:
e. If a firm’s stock price is quite high relative to most stocks—say $500 per share—then it can declare a stock split of say 20-for-1 so as to bring the price down to something close to $25. Moreover, if the price is relatively low—say $2 per share—then it can declare a “reverse split” of say 1-for-10 so as to bring the price up to somewhere around $20 per share.
Question: Modigliani and Miller (MM) won Nobel Prizes for their work on capital structure theory. 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:
False
Question: Other things held constant, firms with more stable and predictable sales tend to use more debt than firms with less stable sales.
Answer Options:
a. True
b. False
Answer:
True
Question: Which of the following statements is CORRECT? a. Increasing its use of financial leverage is one way to increase a firm’s return on investment (ROI). 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 (ROIC). (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.
Answer:
c
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:
False
Question: Which of the following statements is CORRECT, holding other things constant? 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 structure.
Answer:
e