Answer Options:
a. because it has no effect on the firm’s ability to borrow to make other investments.
b. because, generally, no down payment is required, and there are no indirect interest costs.
c. because lease obligations do not affect the firm’s risk as seen by investors.
d. because the lessee owns the property at the end of the lease term.
e. because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.
Correct Answer: e
Answer:
Question: Which of the following statements is CORRECT? a. The capital structure that maximizes expected EPS also maximizes the price per share of common stock. b. The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. c. The capital structure that minimizes the required return on equity also maximizes the stock price. d. The capital structure that minimizes the WACC also maximizes the price per share of common stock. e. The capital structure that gives the firm the best bond rating also maximizes the stock price.
Answer: d. The capital structure that minimizes the WACC also maximizes the price per share of common stock.
Question: Which of the following statements is CORRECT?
Answer Options:
a. In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.
b. There is no reason to think that changes in the personal tax rate would affect firms’ capital structure decisions.
c. A firm with a relatively high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.
d. If a firm’s after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt.
e. Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity.
Correct Answer: a
Answer:
Question: The two basic types of hedges involving the futures market are long hedges and short hedges, where the words “long” and “short” refer to the maturity of the hedging instrument. For example, a long hedge might use Treasury bonds, while a short hedge might use 3-month T-bills.
Answer Options:
a. True
b. False
Answer: b. False
Question: Which of the following statements concerning risk management is NOT CORRECT? a. Risk management can reduce the volatility of cash flows, and this decreases the probability of bankruptcy. b. Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, but it doesn’t make much sense for most other firms. c. Companies with volatile earnings pay more taxes than companies with more stable earnings due to the treatment of tax credits and the rules governing corporate loss carry-forwards and carry-backs. Therefore, our tax system encourages risk management to stabilize earnings. d. Risk management can reduce the likelihood of low cash flows, and therefore reduce the probability of financial distress. e. Risk management involves identifying events that could have adverse financial consequences and then taking actions to prevent and/or to minimize the damage caused by these events.
Answer: b. Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, but it doesn’t make much sense for most other firms.
Question: Which of the following statements best describes the optimal capital structure? a. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company’s earnings per share (EPS).
Answer: a. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company’s earnings per share (EPS).
Question: Which of the following statements is CORRECT? a. Put options give investors the right to buy a stock at a certain exercise price before a specified date. b. Call options give investors the right to sell a stock at a certain exercise price before a specified date. c. Options typically sell for less than their exercise value. d. LEAPS are very short-term options that have begun trading on the exchanges in recent years. e. Option holders are not entitled to receive dividends unless they choose to exercise their option.
Answer: e. Option holders are not entitled to receive dividends unless they choose to exercise their option.
Question: Which of the following statements is CORRECT?
Answer Options:
a. Generally, debt ratios do not vary much among different industries, although they do vary among firms within a given industry.
b. Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries.
c. Airline companies tend to have very volatile earnings, and as a result they generally have high target debt-to-equity ratios.
d. Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes.
e. Since most stocks sell at or very close to their book values, book value capital structures are typically adequate for use in estimating firms’ weighted average costs of capital.
Correct Answer: d
Answer:
Question: An increase in the debt ratio will generally have no effect on which of these items?
Answer Options:
a. Business risk.
b. Total risk.
c. Financial risk.
d. Market risk.
Answer: a. Business risk.
Question: LIBOR is an acronym for London Interbank Offer Rate, which is an average of interest rates offered by London banks to smaller U.S. corporations on all deposits.
Answer Options:
a. True
b. False
Answer: b. False
Question: According to Modigliani and Miller (MM), in a world with corporate income taxes the optimal capital structure calls for approximately 100% debt financing.
Answer Options:
a. True
b. False
Answer: a. True
Question: Weisbach Electronics is considering investing in India. Which of the following factors would make the company less likely to proceed with the investment? a. The company would have the option to withdraw from the investment after 2 years if it turns out to be unprofitable. b. The investment would increase the odds of the company being able to subsequently make a successful entry into China. c. The investment would preclude the company from being able to make a profitable investment in China. d. Competitors are considering similar investments in India, and the firm can discourage them from trying by entering now. e. The new plant could be easily retrofitted to manufacture many of the firm’s other products.
Answer: c. The investment would preclude the company from being able to make a profitable investment in China.
Question: A warrant is an option, and as such it cannot be used as a “sweetener.”
Answer Options:
a. True
b. False
Correct Answer: b
Answer:
Question: One of the main reasons why foreign firms are interested in buying U.S. companies is to gain entrance to the U.S. market. A decline in the value of the dollar relative to most foreign currencies makes this competitive strategy especially attractive.
Answer Options:
a. True
b. False
Correct Answer: a
Answer:
Question: Under a sale and leaseback arrangement, the seller of the leased property is the lessee and the buyer is the lessor.
Answer Options:
a. True
b. False
Correct Answer: a
Answer:
Question: An investor who “writes” a call option without the stock in his or her portfolio to back it up is selling a(n)
Answer Options:
a. Call option.
b. Put option.
c. Out-of-the-money option.
d. Naked option.
e. Covered option.
Answer: d. Naked option
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: Leasing is often referred to as off-balance-sheet financing because lease payments are shown as operating expenses on a firm’s income statement and, under certain conditions, leased assets and associated liabilities do not appear on the firm’s balance sheet.
Answer Options:
a. True
b. False
Correct Answer: a
Answer:
Question: If an investor can obtain more of a foreign currency for a dollar in the forward market than in the spot market, then the forward currency is said to be selling at a discount to the spot rate.
Answer Options:
a. True
b. False
Answer: a. True
Question: Exchange rate risk is the risk that the cash flows from a foreign project, when converted to the parent company’s currency, will be worth less than was originally projected because of exchange rate changes.
Answer Options:
a. True
b. False
Answer: a. True
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.
Answer Options:
a. True
b. False
Answer: b. False
Question: Which of the following statements is most CORRECT?
Answer Options:
a. A conglomerate merger is one where a firm combines with another firm in the same industry.
b. Regulations in the United States prohibit acquiring firms from using common stock to purchase another firm.
c. Defensive mergers are designed to make a company less vulnerable to a takeover.
d. The equity residual method values a target firm by discounting residual cash flows at the acquiring firm’s overall cost of capital reflecting the combined firm’s post-merger capital structure.
e. A financial merger occurs when the operations of the firms involved are integrated in the hope of achieving synergistic benefits.
Correct Answer: c
Answer: