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Question: Which of the following statements is CORRECT, holding other things constant? Firms whose assets are relatively liquid tend to have relatively low bankruptcy costs, hence they tend to use relatively little debt. An increase in the personal tax rate is likely to increase the debt ratio of the average corporation. If changes in the bankruptcy code made bankruptcy less costly to corporations, then this would likely lead to lower debt ratios for corporations. 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. An increase in the corporate tax rate would in theory encourage companies to use more debt in their capital structure.
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Question: Financial risk refers to the extra risk borne by stockholders as a result of a firm’s use of debt as compared with their risk if the firm had used no debt.
Answer Choices:
a. True
b. False
Answer:
a. True
Question: A major contribution of the Miller model is that it demonstrates, other things held constant, that personal taxes increase the value of using corporate debt. personal taxes lower the value of using corporate debt. personal taxes have no effect on the value of using corporate debt. financial distress and agency costs reduce the value of using corporate debt. debt costs increase with financial leverage.
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Question: Modigliani and Miller (MM), in their second article, took account of taxes, bankruptcy, and other factors that were assumed away in their original article. Once they took account of all these assumptions, they concluded that every firm has a unique optimal capital structure. Moreover, a manager can use the second MM model to determine his or her firm’s optimal debt ratio.
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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: 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.
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Question: Based on the information below, what is the firm’s optimal capital structure? Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $260.50. Debt = 60%; Equity = 40%; EPS = $3.05; Stock price = $28.90. Debt = 50%; Equity = 50%; EPS = $3.18; Stock price = $312.00. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.
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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.
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Question: Which of the following statements is CORRECT? As a firm increases the operating leverage used to produce a given quantity of output, this normally leads to an increase in its fixed assets turnover ratio. normally leads to an increase in its business risk. normally leads to a decrease in the standard deviation of its expected EBIT. normally leads to a decrease in the variability of its expected EPS. normally leads to a reduction in its fixed assets turnover ratio.
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Question: Other things held constant, firms with more stable and predictable sales tend to use more debt than firms with less stable sales.
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Question: The Modigliani and Miller (MM) articles implicitly assumed that bankruptcy did not exist. That led to the development of the “trade-off” model, where the firm’s value first rises with the use of debt due to the tax shelter of debt, but later falls as more debt is added because the potential costs of bankruptcy begin to more than offset the tax shelter benefits. Under the trade-off theory, an optimal capital structure exists.
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Question: The text gives a number of valid, acceptable reasons for companies to merge. Which of the following is NOT acceptable?
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Question: A firm’s treasurer likes to be in a position to raise funds to support operations whenever such funds are needed, even in “bad times.” This is called “financial flexibility,” and the lower the firm’s debt ratio, the greater its financial flexibility, other things held constant. True False
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Question: Firms generally do not call their convertibles unless the conversion value is greater than the call price.
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Question: Which of the following statements is CORRECT?
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Question: Which of the following statements is CORRECT?
Answer Choices:
a. The use of debt financing will tend to lower the basic earning power ratio, other things held constant.
b. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.
c. If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE.
d. The numerator used in the TIE ratio is earnings before taxes (EBT). EBT is used because interest is paid with post-tax dollars, so the firm’s ability to pay current interest is affected by taxes.
e. All else equal, increasing the total debt to total capital ratio will increase the ROA.
Answer:
b
Question: Other things held constant, a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin.
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Question: The Modigliani and Miller (MM) articles implicitly assumed, among other things, that outside stockholders have the same information about a firm’s future prospects as its managers. That was called “symmetric information,” and it is questionable. The introduction of “asymmetric information” led to the development of the “signaling” theory of capital structure, which postulated that firms are reluctant to issue new stock because investors will interpret such an act as a signal that the firm’s managers are worried about its future. Other actions give off different signals, and the end result is that capital structure is affected by managers’ perceptions about how their financing decisions will affect investors’ views of the firm and thus its value.
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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. True False
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Question: Which of the following would tend to increase a firm’s target debt ratio, other things held constant? The costs associated with filing for bankruptcy increase. The corporate tax rate is increased. The personal tax rate is increased. The Federal Reserve tightens interest rates in an effort to fight inflation. The company’s stock price hits a new low.
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