Answer:
Options:
Question: According to the signaling theory of capital structure, firms first use common equity for their capital, then use debt if and only if they can raise no more equity on “reasonable” terms. This occurs because the use of debt financing signals to investors that the firm’s managers think that the future does not look good.
Answer:
Options:
Question: Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant? An increase in the corporate tax rate. An increase in the personal tax rate. An increase in the company’s operating leverage. The Federal Reserve tightens interest rates in an effort to fight inflation. The company’s stock price hits a new high.
Answer:
Options:
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? Company HD has a higher net income than Company LD. Company HD has a lower ROA than Company LD. Company HD has a lower ROE than Company LD. The two companies have the same ROA. The two companies have the same ROE.
Answer:
Options:
Question: Which of the following statements is CORRECT? A firm’s business risk is determined solely by the financial characteristics of its industry. 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. 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. A firm’s financial risk can be minimized by diversification. The amount of debt in its capital structure can under no circumstances affect a company’s EBIT and business risk.
Answer:
Options:
Question: Which of the following statements is CORRECT?
Answer Choices:
a. Other things held constant, the more debt a firm uses, the higher its operating margin will be.
b. Debt management ratios show the extent to which a firm’s managers are attempting to magnify returns on owners’ capital through the use of financial leverage.
c. Other things held constant, the more debt a firm uses, the higher its profit margin will be.
d. Other things held constant, the higher a firm’s total debt to total capital ratio, the higher its TIE ratio will be.
e. Debt management ratios show the extent to which a firm’s managers are attempting to reduce risk through the use of financial leverage. The higher the total debt to total capital ratio, the lower the risk.
Answer:
b
Question: Which of the following statements is most CORRECT?
Answer:
Options:
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.
Answer Choices:
a. True
b. False
Answer:
a. True
Question: Other things held constant, a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: A firm’s business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: If a firm borrows money, it is using financial leverage.
Answer Choices:
a. True
b. False
Answer:
a. True
Question: Debt management ratios show the extent to which a firm’s managers are attempting to magnify returns on owners’ capital through the use of financial leverage.
Answer Choices:
a. True
b. False
Answer:
a. True
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? The ROA would increase. The ROA would remain unchanged. The return on investors’ capital would decline. The return on investors’ capital would increase. The ROE would increase.
Answer:
Options:
Question: Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company’s total assets or operating income. Which of the following effects would occur as a result of this action?
Answer Choices:
a. The company’s current ratio increased.
b. The company’s times interest earned ratio decreased.
c. The company’s basic earning power ratio increased.
d. The company’s equity multiplier increased.
e. The company’s total debt to total capital ratio increased.
Answer:
a
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 Choices:
a. True
b. False
Answer:
a. True
Question: Which of the following statements is most CORRECT?
Answer:
Options:
Question: The Miller model begins with the Modigliani and Miller (MM) model without corporate taxes and then adds personal taxes.
Answer:
Options:
Question: Provided a firm does not use an extreme amount of debt, operating leverage typically affects only EPS, while financial leverage affects both EPS and EBIT.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: Business risk is affected by a firm’s operations. Which of the following is NOT directly associated with (or does not directly contribute to) business risk? Demand variability. Sales price variability. The extent to which operating costs are fixed. The extent to which interest rates on the firm’s debt fluctuate. Input price variability.
Answer:
Options:
Question: 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? The two companies have the same times interest earned (TIE) ratio. Firm L has a lower ROA than Firm U. Firm L has a lower ROE than Firm U. Firm L has the higher times interest earned (TIE) ratio.
Answer:
Options:
Question: Other things held constant, an increase in financial leverage will increase a firm’s market (or systematic) risk as measured by its beta coefficient.
Answer Choices:
a. True
b. False
Answer:
a. True