Part 25 – Public Speaking & Communication / Communication Review with Finance & Capital Budgeting
Companies HD and LD have identical tax rates, total assets, total investor-supplied capital, and returns on investors’ capital (ROIC), and their ROICs exceed their after-tax costs of debt, rd(1 – T). However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT?
Answer Choices:
a. Company HD has a higher net income than Company LD.b. Company HD has a lower ROA than Company LD.c. Company HD has a lower ROE than Company LD.d. The two companies have the same ROA.e. The two companies have the same ROE.
Answer: b
Firms U and L each have the same amount of assets, investor-supplied capital, and both have a return on investors’ capital (ROIC) of 12%. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm L’s debt has an after-tax cost of 8%. Both firms have positive net income and a 35% tax rate. Which of the following statements is CORRECT?
Answer Choices:
a. The two companies have the same times interest earned (TIE) ratio.b. Firm L has a lower ROA than Firm U.c. Firm L has a lower ROE than Firm U.d. Firm L has the higher times interest earned (TIE) ratio.e. Firm L has a higher EBIT than Firm U.
Answer: b
Your firm is currently 100% equity financed. The CFO is considering a recapitalization plan under which the firm would issue long-term debt with an after-tax yield of 9% and use the proceeds to repurchase some of its common stock. The recapitalization would not change the company’s total investor-supplied capital, the size of the firm (i.e., total assets), and it would not affect the firm’s return on investors’ capital (ROIC), which is 15%. The CFO believes that this recapitalization would reduce the firm’s WACC and increase its stock price. Which of the following would be likely to occur if the company goes ahead with the recapitalization plan?
Answer Choices:
a. The company’s net income would increase.b. The company’s earnings per share would decline.c. The company’s cost of equity would increase.d. The company’s ROA would increase.e. The company’s ROE would decline.
Answer: c Questio 467 A major contribution of the Miller model is that it demonstrates, other things held constant, that Answer Options: a. personal taxes increase the value of using corporate debt. b. personal taxes lower the value of using corporate debt. c. personal taxes have no effect on the value of using corporate debt. d. financial distress and agency costs reduce the value of using corporate debt. e. debt costs increase with financial leverage. Correct Answer: b
Which of the following statements is CORRECT?
Answer Choices:
a. A firm’s business risk is determined solely by the financial characteristics of its industry.b. The factors that affect a firm’s business risk include industry characteristics and economic conditions, both of which are generally beyond the firm’s control.c. One of the benefits to a firm of being at or near its target capital structure is that this generally minimizes the risk of bankruptcy.d. A firm’s financial risk can be minimized by diversification.e. The amount of debt in its capital structure can under no circumstances affect a company’s EBIT and business risk.
Answer: b
Which of the following statements is CORRECT? As a firm increases the operating leverage used to produce a given quantity of output, this
Answer Choices:
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.
Answer: e
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 Choices:
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.
Answer: a
Which of the following statements is CORRECT?
Answer Choices:
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 saturation, 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
Which of the following statements is CORRECT, holding other things constant?
Answer Choices:
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
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 Choices:
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
Which of the following statements is CORRECT?
Answer Choices:
a. A firm can use retained earnings without paying a flotation cost. Therefore, while the cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of debt.b. The capital structure that minimizes a firm’s weighted average cost of capital is also the capital structure that maximizes its stock price.c. The capital structure that minimizes the firm’s weighted average cost of capital is also the capital structure that maximizes its earnings per share.d. If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio must reduce its WACC.e. Other things held constant, if corporate tax rates declined, then the Modigliani-Miller tax-adjusted theory would suggest that firms should increase their use of debt.
Answer: b
Which of the following statements is CORRECT?
Answer Choices:
a. The capital structure that maximizes the stock price is also the capital structure that minimizes the cost of equity from retained earnings (rs).b. The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share.c. The capital structure that maximizes the stock price is also the capital structure that maximizes the firm’s times interest earned (TIE) ratio.d. If a company increases its debt ratio, this will typically increase the marginal costs of both debt and equity, but it still may reduce the company’s WACC.e. If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios.
Answer: d
Which of the following statements is CORRECT?
Answer Choices:
a. In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.b. There is no reason to think that changes in the personal tax rate would affect firms’ capital structure decisions.c. A firm with a relatively high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.d. If a firm’s after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt.e. Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity.
Answer: a
Companies HD and LD have identical amounts of assets, investor-supplied capital, operating income (EBIT), tax rates, and business risk. Company HD, however, has a higher debt ratio than LD. Company HD’s return on investors’ capital (ROIC) exceeds its after-tax cost of debt, rd(1 – T). Which of the following statements is CORRECT?
Answer Choices:
a. Company HD has a higher return on assets (ROA) than Company LD.b. Company HD has a higher times interest earned (TIE) ratio than Company LD.c. Company HD has a higher return on equity (ROE) than Company LD, and its risk as measured by the standard deviation of ROE is also higher than LD’s.d. The two companies have the same ROE.e. Company HD’s ROE would be higher if it had no debt.
Answer: c
Which of the following statements is CORRECT?
Answer Choices:
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.
Answer: a
Which of the following statements is CORRECT?
Answer Choices:
a. When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase.b. The capital structure that maximizes the stock price is generally the capital structure that also maximizes the equity from retained earnings (rs).
Answer: a
Which of the following statements is CORRECT?
Answer Choices:
a. In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.b. There is no reason to think that changes in the personal tax rate would affect firms’ capital structure decisions.c. A firm with a relatively high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.d. Since debt financing raises the firm’s financial risk, increasing a company’s debt ratio will always increase its WACC.e. Since the cost of debt is generally fixed, increasing the debt ratio tends to stabilize net income.
Answer: c
Which of the following statements is CORRECT?
Answer Choices:
a. Generally, debt ratios do not vary much among different industries, although they do vary among firms within a given industry.b. Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries.c. Airline companies tend to have very volatile earnings, and as a result they generally have high target debt-to-equity ratios.d. Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes.e. Since most stocks sell at or very close to their book values, book value capital structures are typically adequate for use in estimating firms’ weighted average costs of capital.
Answer: d
Post-merger control and the negotiated price paid by the acquirer are two of the most important issues in the terms to merger agreements.
Answer Choices:
a. Trueb. False
Answer: a
Since the primary rationale for any operating merger is synergy, in planning such mergers the development of accurate pro forma cash flows is the single most important task.
Answer Choices:
a. Trueb. False
Answer: a