Answer Options:
a. True
b. False
Answer:
b. False
Question: In a world with no taxes, Modigliani and Miller (MM) show that a firm’s capital structure does not affect its value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., the firm’s value rises as it uses more and more debt, other things held constant.
Answer Options:
a. True
b. False
Answer:
True
Question: The Basic earning power ratio (BEP) reflects the earning power of a firm’s assets after giving consideration to financial leverage and tax effects. a. True b. False
Answer:
b. False
Question: If management wants to maximize its stock price, and if it believes that the dividend irrelevance theory is correct, then it must adhere to the residual dividend policy.
Answer Options:
a. True
b. False
Answer:
b. False
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:
a. True
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: Which of the following statements is CORRECT? a. The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the DSO or the inventory turnover ratio. b. If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE. c. An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio. d. An increase in the DSO, other things held constant, could be expected to increase the ROE. e. An increase in a firm’s total debt to total capital ratio, with no changes in its sales or operating costs, could be expected to lower its profit margin.
Answer:
e. An increase in a firm’s total debt to total capital ratio, with no changes in its sales or operating costs, could be expected to lower its profit margin.
Question: An increase in the debt ratio will generally have no effect on which of these items?
Answer:
c. Financial risk
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:
True
Question: Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their argument that the value of the firm is determined only by its basic earning power and its business risk.
Answer Options:
a. True
b. False
Answer:
a. True
Question: A firm’s capital structure does not affect its free cash flows as discussed in the text, because FCF reflects only operating cash flows, which are available to service debt, to pay dividends to stockholders, and for other purposes.
Answer Options:
a. True
b. False
Answer:
False
Question: Other things held constant, a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin.
Answer Options:
a. True
b. False
Answer:
b. False
Question: Which of the following statements is CORRECT? 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
Question: 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? 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
Question: The value of the target firm is calculated by discounting residual cash flows that belong to the acquiring firm’s shareholders at the target’s cost of equity reflecting any changes to its capital structure as a result of the merger.
Answer Options:
a. True
b. False
Answer:
a. True
Question: Longstreet Inc. has fixed operating costs of $470,000, variable costs of $2.80 per unit produced, and its product sells for $4.00 per unit. What is the company’s break-even point, i.e., at what unit sales volume would income equal costs? a. 391,667 b. 411,250 c. 431,813 d. 453,403
Answer:
a
Question: The Miller model begins with the Modigliani and Miller (MM) model with corporate taxes and then adds personal taxes.
Answer Options:
a. True
b. False
Answer:
True
Question: Which of the following is most CORRECT? a. Firms that use “off-balance-sheet” financing, such as leasing, would show lower debt ratios if the effects of their leases were reflected in their financial statements. b. Capitalizing a lease means that the firm issues equity capital in proportion to its current capital structure, in an amount sufficient to support the lease payment obligation. c. The fixed charges associated with a lease can be as high as, but never greater than, the fixed payments associated with a loan. d. Capital, or financial, leases generally provide for maintenance by the lessor.
Answer:
d. Capital, or financial, leases generally provide for maintenance by the lessor.
Question: Which of the following statements is CORRECT? 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 earnings per share. c. All else equal, an increase in the corporate tax rate would tend to encourage companies to increase their debt ratios. 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