Question 1

Firms U and L both have a basic earning power ratio of 20% and each has the same amount of assetsFirm 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 a before-tax cost of 8% Both firms have positive net income Which of the following statements is CORRECT?

Accepted Answer

A)   Firm L has a lower ROA than Firm U.
B)   Firm L has a lower ROE than Firm U.
C)   Firm L has the higher times interest earned (TI
E)   ratio.
D)   Firm L has a higher EBIT than Firm U.
E)   The two companies have the same times interest earned (TI
E)   ratio.F) A) and B)
G) A) and C)

Question 2

Merriwether Building has operating income of $20 million, a tax rate of 40%, and no debt It pays out all of its net income as dividends and has a zero growth rate The current stock price is $40 per share, and it has 2.5 million shares of stock outstanding If it moves to a capital structure that has 40% debt and 60% equity (based on market values) , its investment bankers believe its weighted average cost of capital would be 10% What would its stock price be if it changes to the new capital structure?

Accepted Answer

A)   $40
B)   $48
C)   $52
D)   $54
E)   $60F) A) and C)
G) B) and D)

Question 3

Whenever a firm borrows money, it is using financial leverage.

Accepted Answer

A) True 
 B)False

Question 4

Which of these items will not generally be affected by an increase in the debt ratio?

Accepted Answer

A)   Total risk.
B)   Financial risk.
C)   Market risk.
D)   The firm's beta.
E)   Business risk.F) B) and D)
G) None of the above

Question 5

Which of the following statements is CORRECT, holding other things constant?

Accepted Answer

A)   An increase in the personal tax rate is likely to increase the debt ratio of the average corporation.
B)   If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation.
C)   An increase in the company's degree of operating leverage is likely to encourage a company to use more debt in its capital structure.
D)   An increase in the corporate tax rate is likely to encourage a company to use more debt in its capital structure.
E)   Firms whose assets are relatively liquid tend to have relatively low bankruptcy costs, hence they tend to use relatively little debt.F) All of the above
G) C) and E)

Question 6

trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

Accepted Answer

A) True 
 B)False

Question 7

operationally similar companies, HD and LD, have identical amounts of assets, operating income (EBIT) , tax rates, and business risk Company HD, however, has a much higher debt ratio than LD Company HD's basic earning power ratio (BEP)  exceeds its cost of debt (rd)  Which of the following statements is CORRECT?

Accepted Answer

A)   Company HD has a higher times interest earned (TI
E)   ratio than Company LD.
B)   Company HD has a higher return on equity (RO
E)   than Company LD, and its risk, as measured by the standard deviation of ROE, is also higher than LD's.
C)   The two companies have the same ROE.
D)   Company HD's ROE would be higher if it had no debt.
E)   Company HD has a higher return on assets (RO
A)   than Company LD.F) D) and E)
G) A) and E)

Exam 15: Cap Structure

Correct Answer
verified

trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

Correct Answer
verified

Correct Answer
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Whenever a firm borrows money, it is using financial leverage.

Correct Answer
verified

Which of these items will not generally be affected by an increase in the debt ratio?

Correct Answer
verified

Which of the following statements is CORRECT, holding other things constant?

Correct Answer
verified

Correct Answer
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Exam 15: Cap Structure

Correct AnswerverifiedShow Answer

trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Whenever a firm borrows money, it is using financial leverage.

Correct AnswerverifiedShow Answer

Which of these items will not generally be affected by an increase in the debt ratio?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT, holding other things constant?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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