Answer: False
Question: The “over-the-counter” market received its name years ago because brokerage firms would hold inventories of stocks and then sell them by literally passing them over the counter to the buyer. a. True b. False
Answer: True
Question: Miller and Modigliani’s dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on its cost of capital, but it does affect its stock price.
Answer Options:
a. True
b. False
Answer: False
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. a. True b. False
Answer: a. True
Question: A publicly owned corporation is a company whose shares are held by the investing public, which may include other corporations as well as institutional investors. a. True b. False
Answer: True
Question: 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, r_d(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 Options:
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
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: True
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%. a. True b. False
Answer: a. True
Question: Modigliani and Miller (MM) won Nobel Prizes for their work on capital structure theory. a. True b. False
Answer: b. False
Question: As the text indicates, a firm’s financial risk can and should be divided into separate market and diversifiable risk components. a. True b. False
Answer: b. False
Question: If a retired individual lives on his or her investment income, then it would make sense for this person to prefer stocks with high payouts so he or she could receive cash without going to the trouble and expense of selling stocks. On the other hand, it would make sense for an individual who would just reinvest any dividends received to prefer a low-payout company because that would save him or her taxes and brokerage costs.
Answer Options:
a. True
b. False
Answer: True
Question: In the real world, dividends a. are usually more stable than earnings. b. fluctuate more widely than earnings. c. tend to be a lower percentage of earnings for mature firms. d. are usually changed every year to reflect earnings changes, and these changes are randomly higher to lower, without regard to the trend in earnings.
Answer: a
Question: An increase in the debt ratio will generally have no effect on which of these items? a. Business risk. b. Total risk. c. Financial risk. d. Market risk. e. The firm’s beta.
Answer: a. Business risk
Question: Which of the following statements is CORRECT?
Answer Options:
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
Question: Primary markets are large and important, while secondary markets are smaller and less important. a. True b. False
Answer: False
Question: If on January 3, 2015, a company declares a dividend of $1.50 per share, payable on January 31, 2015, then the price of the stock should drop by approximately $1.50 on January 31.
Answer Options:
a. True
b. False
Answer: False
Question: Which of the following statements is CORRECT?
Answer Options:
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
Question: Which of the following statements is CORRECT, holding other things constant?
Answer Options:
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
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). a. True b. False
Answer: a. True
Question: If a firm adheres strictly to the residual dividend model, the issuance of new common stock would suggest that a. the dividend payout ratio has remained constant. b. the dividend payout ratio is increasing. c. no dividends will be paid during the year. d. the dividend payout ratio is decreasing. e. the dollar amount of capital investments had decreased.
Answer: c
Question: One implication of the bird-in-the-hand theory of dividends is that a given reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm’s required return constant, other things held constant.
Answer Options:
a. True
b. False
Answer: True
Question: The annual rate of return on any given stock can be found as the stock’s dividend for the year plus the change in the stock’s price during the year, divided by its beginning-of-year price. a. True b. False
Answer: True
Question: Different borrowers have different risks of bankruptcy, and if a borrower goes bankrupt, its lenders will probably not get back the full amount of funds that they loaned. Therefore, lenders charge higher rates to borrowers judged to be more likely to go bankrupt. a. True b. False
Answer: a. True
Question: Your firm uses the residual dividend model to set dividend policy. Market interest rates suddenly rise, and stock prices decline. Your firm’s earnings, investment opportunities, and capital structure do not change. If the firm follows the residual dividend model, then its dividend payout ratio would increase.
Answer Options:
a. True
b. False
Answer: True
Question: Modigliani and Miller’s first article led to the conclusion that capital structure is extremely important, and that every firm has an optimal capital structure that maximizes its value and minimizes its cost of capital. a. True b. False
Answer: b. False