Answer:
b
Question: A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. A bank that takes in demand deposits and then uses that money to make long-term mortgage loans is one example of a financial intermediary.
Answer Options:
a. True
b. False
Answer:
a. True
Question: Which of the following statements is CORRECT? A) Since companies can deduct dividends paid but not interest paid, our tax system favors the use of equity financing over debt financing, and this causes companies’ debt ratios to be lower than they would be if interest and dividends were both deductible. B) Interest paid to an individual is counted as income for federal tax purposes and taxed at the individual’s regular tax rate, which in 2014 could go up to 39.6%, but qualified dividends received were taxed at a maximum tax rate of 15% for individuals earning less than $400,000 and married taxpayers filing jointly earning less than $450,000. C) The maximum federal tax rate on corporate income in 2014 was 50%. D) Corporations obtain capital for use in their operations by borrowing and by raising equity capital, either by selling new common stock or by retaining earnings. The cost of debt capital is the interest paid on the debt, and the cost of the equity is the dividends paid on the stock. Both of these costs are deductible from income when calculating income for tax purposes. E) The maximum federal tax rate on personal income in 2014 was 50%.
Answer:
B
Question: Which of the following statements is CORRECT? 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
Question: Which of the following statements is CORRECT? a. Under normal conditions, a firm’s expected ROE would probably be higher if it financed with short-term rather than with long-term debt, but using short-term debt would probably increase the firm’s risk. b. Conservative firms generally use no short-term debt and thus have zero current liabilities. c. A short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt is normally higher than that of long-term debt. d. If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of 2/10, net 30, and if it must pay by Day 30 or else be cut off, then we would expect to see zero accounts payable on its balance sheet. e. If one of your firm’s customers is “stretching” its accounts payable, this may be a nuisance but it will not have an adverse financial impact on your firm if the customer periodically pays off its entire balance.
Answer Options:
a. Under normal conditions, a firm’s expected ROE would probably be higher if it financed with short-term rather than with long-term debt, but using short-term debt would probably increase the firm’s risk.
b. Conservative firms generally use no short-term debt and thus have zero current liabilities.
c. A short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt is normally higher than that of long-term debt.
d. If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of 2/10, net 30, and if it must pay by Day 30 or else be cut off, then we would expect to see zero accounts payable on its balance sheet.
e. If one of your firm’s customers is “stretching” its accounts payable, this may be a nuisance but it will not have an adverse financial impact on your firm if the customer periodically pays off its entire balance.
Answer:
a
Question: Which of the following statements is CORRECT? a. In general, if investors regard a company as being relatively risky and/or having relatively poor growth prospects, then it will have relatively high P/E and M/B ratios. b. The basic earning power ratio (BEP) reflects the earning power of a firm’s assets after giving consideration to financial leverage and tax effects. c. The “apparent,” but not necessarily the “true,” financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed. d. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value. In general, investors regard companies with higher M/B ratios as being more risky and/or less likely to enjoy higher future growth. e. Other things held constant, the higher a firm’s total debt to total capital ratio, the higher its TIE ratio will be.
Answer:
c. The “apparent,” but not necessarily the “true,” financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed.
Question: Is it possible for Firms A and B to have identical financial and operating leverage, yet for Firm A to have more risk as measured by the variability of EPS. This would occur if Firm A has more business risk than Firm B.
Answer Options:
a. True
b. False
Answer:
True
Question: According to Modigliani and Miller (MM), in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing. 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:
a. True
Question: Which of the following statements is CORRECT? 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: Your firm has $500 million of investor-supplied capital, its return on investors’ capital (ROIC) is 15%, and it currently has no debt in its capital structure (i.e., wd = 0). The CFO is contemplating a recapitalization where it would issue debt at an after-tax cost of 10% and use the proceeds to buy back some of its common stock, such that the percentage of common equity in the capital structure (we) is 1 – wd. If the company goes ahead with the recapitalization, its operating income, the size of the firm (i.e., total assets), total investor-supplied capital, and tax rate would remain unchanged. Which of the following is most likely to occur as a result of the recapitalization? a. The ROA would increase. b. The ROA would remain unchanged. c. The return on investors’ capital would decline. d. The return on investors’ capital would increase. e. The ROE would increase.
Answer:
e