FiltersDone

Question type

Essay

Multiple Choice

Short Answer

True False

Matching

Exam 14: Capital Structure and Leverage

Show Answer

Share

---

All types

Filters

Study FlashcardsPractice ExamLearn

Question 21

Multiple Choice

Review LaterAdd Note

Review Later

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

A) Firms whose assets are relatively liquid tend to have relatively low bankruptcy costs,hence they tend to use relatively little debt.
B) An increase in the personal tax rate is likely to increase the debt ratio of the average corporation.
C) If changes in the bankruptcy code make bankruptcy less costly to corporations,then this would likely lead to lower debt ratios for corporations.
D) An increase in the company's degree of operating leverage would tend to encourage the firm to use more debt in its capital structure so as to keep its total risk unchanged.
E) An increase in the corporate tax rate would in theory encourage companies to use more debt in their capital structures.

F) All of the above
G) A) and D)

Correct Answer

verified

Show Answer

Question 22

Multiple Choice

Review LaterAdd Note

Review Later

Which of the following statements is CORRECT?

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.

F) B) and E)
G) D) and E)

Correct Answer

verified

Show Answer

Question 23

Multiple Choice

Review LaterAdd Note

Which of the following statements is CORRECT?

According to Modigliani and Miller (MM),in a world without corporate income taxes the use of debt has no effect on the firm's value.

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

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 $23.00 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 40,000 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 ? ​

According to Modigliani and Miller (MM),in a world with corporate income taxes the optimal capital structure calls for approximately 100% debt financing.

Business risk is affected by a firm's operations.Which of the following is NOT directly associated with (or does not directly contribute to) business risk?

Different borrowers have different risks of bankruptcy,and if a borrower goes bankrupt,its lenders will probably not get back the full amount of funds that they loaned.Therefore,lenders charge higher rates to borrowers judged to be more likely to go bankrupt.

You were hired as the CFO of a new company that was founded by three professors at your university.The company plans to manufacture and sell a new product,a cell phone that can be worn like a wrist watch.The issue now is how to finance the company,with equity only or with a mix of debt and equity.The price per phone will be $250.00 regardless of how the firm is financed.The expected fixed and variable operating costs,along with other data,are shown below.How much higher or lower will the firm's expected ROE be if it uses 60% debt rather than only equity,i.e. ,what is ROE_L - ROE_U? ​

Other things held constant,firms with more stable and predictable sales tend to use more debt than firms with less stable sales.

Companies HD and LD have the same total assets,total investor-supplied capital,operating income (EBIT) ,tax rate,and business risk.Company HD,however,has a much higher debt ratio than LD.Also,both companies' returns on investors' capital (ROIC) exceed their after-tax costs of debt,r_d(1 - T) .Which of the following statements is CORRECT?

Which of the following would tend to increase a firm's target debt ratio,other things held constant?

You have been hired by a new firm that is just being started.The CFO wants to finance with 60% debt,but the president thinks it would be better to hold the percentage of debt in the capital structure (w_d) to only 10%.Both companies are small,so they are not subject to the interest deduction limitation.Other things held constant,and based on the data below,if the firm uses more debt,by how much would the ROE change,i.e. ,what is ROE_Higher - ROE_Lower? Do not round your intermediate calculations. ​

Dye Industries currently uses no debt,but its new CFO is considering changing the capital structure to 61.0% debt (w_d) by issuing bonds and using the proceeds to repurchase and retire some common shares so the percentage of common equity in the capital structure (w_c) = 1 - w_d.Given the data shown below,by how much would this recapitalization change the firm's cost of equity,i.e. ,what is r_L - r_U? Do not round your intermediate calculations. ​

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?

Based on the information below,what is the firm's optimal capital structure?

Modigliani and Miller's second article,which assumed the existence of corporate income taxes,led to the conclusion that a firm's value would be maximized,and its cost of capital minimized,if it used (almost)100% debt.However,this model did not take account of bankruptcy costs.The existence of bankruptcy costs leads to the assumption of an optimal capital structure where the debt ratio is less than 100%.

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