Answer:
a. True
Question: If a firm borrows money, it is using financial leverage.
Answer Options:
a. True
b. False
Answer:
True
Question: Your firm adheres strictly to the residual dividend model. All else equal, which of the following factors would be most likely to lead to an increase in the firm’s dividend per share?
Answer Options:
a. The firm’s net income increases.
b. The company increases the percentage of equity in its target capital structure.
c. The number of profitable potential projects increases.
d. Congress lowers the tax rate on capital gains, leaving the rest of the tax code unchanged.
e. Earnings are unchanged, but the firm issues new shares of common stock.
Answer:
a. The firm’s net income increases.
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: A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.
Answer Options:
a. True
b. False
Answer:
a. True
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? 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.
Answer:
e
Question: Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to encourage the use of debt financing by corporations.
Answer Options:
a. True
b. False
Answer:
a. True
Question: A firm’s profit margin is 5%, its debt ratio is 56%, and its dividend payout ratio is 40%. If the firm is operating at less than full capacity, then sales could increase to some extent without the need for external funds, but if it is operating at full capacity with respect to all assets, including fixed assets, then any positive growth in sales will require some external financing. a. True b. False
Answer:
b. 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.
Answer Options:
a. True
b. False
Answer:
True
Question: As the text indicates, a firm’s financial risk can and should be divided into separate market and diversifiable risk components.
Answer Options:
a. True
b. False
Answer:
False
Question: Which of the following would tend to increase a firm’s target debt ratio, other things held constant?
Answer:
b. The corporate tax rate is increased
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:
True
Question: If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant.
Answer Options:
a. True
b. False
Answer:
a. True