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 Choices:
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. 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.
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.
Answer Choices:
a. normally leads to an increase in its fixed assets turnover ratio.
b. normally leads to an increase in its business risk.
c. normally leads to a decrease in the standard deviation of its expected EBIT.
d. normally leads to a decrease in the variability of its expected EPS.
e. normally leads to a reduction in its fixed assets turnover ratio.
Answer: e. normally leads to a reduction in its fixed assets turnover ratio.
Question: Consider each of the following bonds:
Bond A: 8-year maturity with a 7% annual coupon.
Bond B: 10-year maturity with a 9% annual coupon.
Bond C: 12-year maturity with a zero coupon.
Each bond has a face value of $1,000 and a yield to maturity of 8%. Which of the following statements is NOT correct?
Bond A sells at a discount, while Bond B sells at a premium.
If the yield to maturity on each bond falls to 7%, Bond C will have the largest percentage increase in its price.
Bond C has the most reinvestment risk.
Bond C has the most price risk.
If the yield to maturity is constant, the price of Bond A will continue to increase over its life until it finally sells at par.
Answer Choices:
a. Bond A sells at a discount, while Bond B sells at a premium.
b. If the yield to maturity on each bond falls to 7%, Bond C will have the largest percentage increase in its price.
c. Bond C has the most reinvestment risk.
d. Bond C has the most price risk.
e. If the yield to maturity is constant, the price of Bond A will continue to increase over its life until it finally sells at par.
Answer: c. Bond C has the most reinvestment risk.
Question: A spin-off is a type of divestiture in which the assets of a division are sold to another firm.
True
False
Answer Choices:
a. True
b. False
Answer: b. False
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: As the text indicates, a firm’s financial risk can and should be divided into separate market and diversifiable risk components.
Answer Choices:
a. True
b. False
Answer: b. False
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.
Answer Choices:
a. Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $260.50.
b. Debt = 60%; Equity = 40%; EPS = $3.05; Stock price = $28.90.
c. Debt = 50%; Equity = 50%; EPS = $3.18; Stock price = $312.00.
d. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40.
e. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.
Answer: c. Debt = 50%; Equity = 50%; EPS = $3.18; Stock price = $312.00.
Question: The Miller model begins with the Modigliani and Miller (MM) model without corporate taxes and then adds personal taxes.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Borrowing funds on terms that would require immediate repayment of all loans if the firm is acquired, selling off at bargain prices the assets that originally made the firm a desirable target, and granting huge “golden parachutes” that open if the firm is acquired are 3 procedures used to defend against hostile takeovers. These strategies are known as “poison pills.”
True
False
Answer Choices:
a. True
b. False
Answer: a. True
Question: Since the primary rationale for any operating merger is synergy, in planning such mergers the development of accurate pro forma cash flows is the single most important task.
True
False
Answer Choices:
a. True
b. False
Answer: a. True
Question: Modigliani and Miller (MM) won Nobel Prizes for their work on capital structure theory.
Answer Choices:
a. True
b. False
Answer: b. False