Question 1

According to the signaling theory, what is symmetric information?

Accepted Answer

A)   The situation in which investors and managers have identical information about the firm's prospects
B)   The situation in which employees and managers have identical information about the firm's prospects
C)   The situation in which investors and creditors have identical information about the firm's prospects
D)   The situation in which managers have different (better)  information about their firm's prospects than outside investors
E)   The situation in which employees have different (better)  information about their firm's prospects than managersF) D) and E)
G) B) and E)

Question 2

In 2015, a company had a total debt of $7 million. In 2016, the debt increased to $9 million. The change in earnings per share (EPS)  of the company will be a direct result of change in its:

Accepted Answer

A)   level of operations.
B)   net operating income.
C)   coefficient of variation.
D)   capital structure
E)   standard deviation.F) C) and E)
G) B) and D)

Question 3

The fact that interest is tax-deductible makes corporate debt less expensive than common stock or preferred stock.

Accepted Answer

A) True 
 B)False

Question 4

From a tax standpoint, in countries where capital gains are taxed, investors should show a preference for stocks compared to investors in countries that do not have capital gains taxes.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following is an example of business risk?

Accepted Answer

A)   Default risk
B)   Prepayment risk
C)   Strategic risk
D)   Currency risk
E)   Equity riskF) C) and D)
G) B) and D)

Question 6

One implication of information asymmetry between investors and firm managers is that if the firm raises new capital by issuing debt rather than by selling stock, it will signal that the firm has very good prospects.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following is an advantage of debt financing?

Accepted Answer

A)   Interest charges on debt is very minimal.
B)   Interest charges on debt are tax deductible.
C)   Interest charges on debt are based on the net income of the firm.
D)   The higher the interest charges, the lower the bankruptcy costs.
E)   Firms that are entirely debt financed have to pay very minimal taxes.F) None of the above
G) A) and E)

Question 8

Which of the following intensifies the business risk borne by the common stockholders of a firm?

Accepted Answer

A)   Fixed-income securities
B)   Sales variability
C)   Input price variability
D)   Operating leverage
E)   Firm-specific riskF) All of the above
G) C) and D)

Question 9

The degree of operating leverage is defined as the percentage change in operating earnings associated with a given percentage change in sales.

Accepted Answer

A) True 
 B)False

Question 10

If a firm with favorable prospects sells new shares, _____.

Accepted Answer

A)   the debt/assets ratio of the firm will increase
B)   the marginal bankruptcy-related costs of the firm will increase
C)   the retained earnings of the firm will decrease
D)   the tax payable by the firm will decrease
E)   the value of the firm's stock will decrease.F) A) and D)
G) C) and D)

Question 11

Which of the following assumptions outlined by Modigliani and Miller (MM)  theory is realistic?

Accepted Answer

A)   Brokerage costs do not exist.
B)   Personal income taxes do not exist.
C)   Bankruptcy does not exist.
D)   The value of a firm will be maximized by financing almost entirely with debt.
E)   Interest on capital debt is tax deductibile.F) None of the above
G) A) and D)

Question 12

As a general rule, the optimal capital structure is the one that:

Accepted Answer

A)   maximizes expected EPS and the price per share of common stock.
B)   minimizes the interest rate on debt and maximizes the expected earnings per share.
C)   minimizes the required rate on equity and maximizes the stock price.
D)   maximizes the price per share of common stock and minimizes the weighted average cost of capital.
E)   minimizes the expected earnings per share and maximizes the weighted average cost of capital.F) A) and D)
G) None of the above

Question 13

According to the trade-off theory, which of the following is the least expensive form of financing?

Accepted Answer

A)   Common stock
B)   Preferred stock
C)   Corporate debt
D)   Retained earnings
E)   Government subsidiesF) A) and D)
G) B) and E)

Question 14

A degree of operating leverage of 1.5 times indicates that _____.

Accepted Answer

A)   for every 1 percent change in EPS there will be a 1.5 percent change in sales
B)   for every 1 percent change in interest there will be a 1.5 percent change in EBIT
C)   for every 1 percent change in sales there will be a 1.5 percent change in EBIT
D)   for every 1 percent change in EBIT there will be a 1.5 percent change in EPS
E)   for every 1 percent change in sales there will be a 1.5 percent change in EPSF) C) and D)
G) B) and C)

Question 15

Which of the following types of businesses can take on more debt than other types of businesses?

Accepted Answer

A)   Single-product firms
B)   Non-cyclical firms
C)   Seasonal-product firms
D)   Small firms
E)   Cyclical firmsF) None of the above
G) All of the above

Question 16

The optimal capital structure will always be lower than the debt/assets ratio that maximizes the _____.

Accepted Answer

A)   expected EPS
B)   weighted average cost of capital
C)   beta coefficients
D)   degree of financial leverage
E)   net operating incomeF) A) and C)
G) A) and E)

Question 17

According to the signaling theory, which of the following is considered a signal from an investor's point of view?

Accepted Answer

A)   A small company raising any required new capital by issue of new shares
B)   A mature company raising any required new capital by issue of new shares
C)   A small company maintaining a reserve borrowing capacity
D)   A mature company maintaining a reserve borrowing capacity
E)   A mature company raising any required new capital using debt beyond the normal target capital structureF) B) and C)
G) B) and D)

Question 18

With which of the followingis a firm's target capital structure consistent?

Accepted Answer

A)   Maximum earnings per share
B)   Minimum cost of debt (rd) 
C)   Minimum risk
D)   Minimum cost of equity (rs) 
E)   Minimum weighted average cost of capitalF) B) and C)
G) A) and E)

Question 19

If a mature firm announces a new stock offering, the price of its stock will decline. To avoid this, the firm should _____.

Accepted Answer

A)   repurchase the existing stock
B)   finance only through debt
C)   maintain a reserve borrowing capacity
D)   convert all common stock into preferred stock
E)   maintain a minimum amount of floating stockF) B) and D)
G) B) and C)

Question 20

If a firm uses no debt, the uncertainty inherent in projections of future returns on equity can be described as business risk.

Accepted Answer

A) True 
 B)False

Exam 12: Capital Structure

The degree of operating leverage is defined as the percentage change in operating earnings associated with a given percentage change in sales.

Correct AnswerverifiedShow Answer

Which of the following assumptions outlined by Modigliani and Miller (MM) theory is realistic?

Correct AnswerverifiedShow Answer

If a mature firm announces a new stock offering, the price of its stock will decline. To avoid this, the firm should _____.

Correct AnswerverifiedShow Answer

From a tax standpoint, in countries where capital gains are taxed, investors should show a preference for stocks compared to investors in countries that do not have capital gains taxes.

Correct AnswerverifiedShow Answer

If a firm with favorable prospects sells new shares, _____.

Correct AnswerverifiedShow Answer

If a firm uses no debt, the uncertainty inherent in projections of future returns on equity can be described as business risk.

Correct AnswerverifiedShow Answer

In 2015, a company had a total debt of $7 million. In 2016, the debt increased to $9 million. The change in earnings per share (EPS) of the company will be a direct result of change in its:

Correct AnswerverifiedShow Answer

A degree of operating leverage of 1.5 times indicates that _____.

Correct AnswerverifiedShow Answer

Which of the following intensifies the business risk borne by the common stockholders of a firm?

Correct AnswerverifiedShow Answer

Which of the following is an advantage of debt financing?

Correct AnswerverifiedShow Answer

The fact that interest is tax-deductible makes corporate debt less expensive than common stock or preferred stock.

Correct AnswerverifiedShow Answer

As a general rule, the optimal capital structure is the one that:

Correct AnswerverifiedShow Answer

Which of the following types of businesses can take on more debt than other types of businesses?

Correct AnswerverifiedShow Answer

With which of the followingis a firm's target capital structure consistent?

Correct AnswerverifiedShow Answer

The optimal capital structure will always be lower than the debt/assets ratio that maximizes the _____.

Correct AnswerverifiedShow Answer

Which of the following is an example of business risk?

Correct AnswerverifiedShow Answer

According to the signaling theory, what is symmetric information?

Correct AnswerverifiedShow Answer

One implication of information asymmetry between investors and firm managers is that if the firm raises new capital by issuing debt rather than by selling stock, it will signal that the firm has very good prospects.

Correct AnswerverifiedShow Answer

According to the trade-off theory, which of the following is the least expensive form of financing?

Correct AnswerverifiedShow Answer

According to the signaling theory, which of the following is considered a signal from an investor's point of view?

Correct AnswerverifiedShow Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified