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Exam 13: Capital Structure and Leverage

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Question 31

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Your company plans to produce a new product,a wireless computer mouse.Two machines can be used to make the mouse,Machines A and B.The price per mouse will be $25.00 regardless of which machine is used.The fixed and variable costs associated with the two machines are shown below.At the expected sales level of 30,000 units,how much higher or lower will the firm's expected EBIT be if it uses Machine B with high fixed costs rather than Machine A with low fixed costs,i.e. ,what is EBIT_B - EBIT_A ? ​

A) $-102,000
B) $-129,600
C) $-93,600
D) $-118,800
E) $-120,000

F) C) and D)
G) None of the above

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Question 32

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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) .
B) The optimal capital structure is the mix of debt,equity,and preferred stock that maximizes the company's stock price.
C) The optimal capital structure is the mix of debt,equity,and preferred stock that minimizes the company's cost of equity.
D) The optimal capital structure is the mix of debt,equity,and preferred stock that minimizes the company's cost of debt.
E) The optimal capital structure is the mix of debt,equity,and preferred stock that minimizes the company's cost of preferred stock.

F) C) and D)
G) A) and B)

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Question 33

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Confu Inc.expects to have the following data during the coming year.What is the firm's expected ROE? ​

The Miller model begins with the Modigliani and Miller (MM)model without corporate taxes and then adds personal taxes.

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

Other things held constant,the lower a firm's tax rate,the more logical it is for the firm to use debt.

Firms HD and LD are identical except for their use of debt and the interest rates they pay--HD has more debt and thus must pay a higher interest rate.Based on the data given below,how much higher or lower will HD's ROE be versus that of LD,i.e. ,what is ROE_HD - ROE_LD? Do not round your intermediate calculations. ​

According to the signaling theory of capital structure,firms first use common equity for their capital,then use debt if and only if they can raise no more equity on "reasonable" terms.This occurs because the use of debt financing signals to investors that the firm's managers think that the future does not look good.

Which of the following events is likely to encourage a company to raise its target debt ratio,other things held constant?

Which of the following statements is CORRECT?

Your firm has $500 million of investor-supplied capital,its return on investors' capital (ROIC) is 15%,and it currently has no debt in its capital structure .The CFO is contemplating a recapitalization where it would issue debt at an after-tax cost of 10% and use the proceeds to buy back some of its common stock,such that the percentage of common equity in the capital structure (w_c) is 1 - w_d.If the company goes ahead with the recapitalization,its operating income,the size of the firm (i.e. ,total assets) ,total investor-supplied capital,and tax rate would remain unchanged.Which of the following is most likely to occur as a result of the recapitalization?

Which of the following statements is CORRECT?

The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage,other things held constant.

Your uncle is considering investing in a new company that will produce high quality stereo speakers.The sales price would be set at 1.70 times the variable cost per unit;the variable cost per unit is estimated to be $75.00;and fixed costs are estimated at $1,170,000.What sales volume would be required to break even,i.e. ,to have EBIT = zero?

Assume that you and your brother plan to open a business that will make and sell a newly designed type of sandal.Two robotic machines are available to make the sandals,Machine A and Machine B.The price per pair will be $30.00 regardless of which machine is used.The fixed and variable costs associated with the two machines are shown below.What is the difference between the break-even points for Machines A and B? Do not round your intermediate calculations.(Hint: Find BE_B - BE_A) ​

You plan to invest in one of two home delivery pizza companies,High and Low,that were recently founded and are about to commence operations.They are identical except for their use of debt (w_d) and the interest rates on their debt--High uses more debt and thus must pay a higher interest rate.Based on the data given below,how much higher or lower will High's expected EPS be versus that of Low,i.e. ,what is EPS_High - EPS_Low? Do not round your intermediate calculations. ​

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.

Which of the following statements is CORRECT?

Your company,which is financed entirely with common equity,plans to manufacture a new product,a cell phone that can be worn like a wristwatch.Two robotic machines are available to make the phone,Machine A and Machine B.The price per phone will be $260.00 regardless of which machine is used to make it.The fixed and variable costs associated with the two machines are shown below,along with the capital (all equity) that must be invested to purchase each machine.The expected sales level is 27,000 units.Your company has tax loss carry-forwards that will cause its tax rate to be zero for the life of the project,so T = 0.How much higher or lower will the project's ROE be if you select the machine that produces the higher ROE,i.e. ,what is ROE_B - ROE_A? (Hint: Since the firm uses no debt and its tax rate is zero,ROE = EBIT/Required investment. ) ​

If two firms have the same expected earnings per share (EPS)and the same standard deviation of expected EPS,then they must have the same amount of business risk.