Question 1

Two firms, although they operate in different industries, have the same expected earnings per share and the same standard deviation of expected EPS. Thus, the two firms must have the same business risk.

Accepted Answer

A) True 
 B)False

Question 2

Wilson Dover Inc.
The total value (debt plus equity)  of Wilson Dover Inc. is $500 million and the face value of its 1-year coupon debt is $200 million. The volatility (σ)  of Wilson Dover's total value is 0.60, and the risk-free rate is 5%. Assume that N(d1)  = 0.9720 and N(d2)  = 0.9050.
​
-Refer to the data for Wilson Dover Inc. What is the value (in millions)  of Wilson Dover's debt if its equity is viewed as an option?

Accepted Answer

A)   $167.57
B)   $186.19
C)   $204.81
D)   $225.29
E)   $247.82F) A) and B)
G) A) and C)

Question 3

Bailey and Sons has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40%. What would Bailey's beta be if it used no debt, i.e., what is its unlevered beta?

Accepted Answer

A)   0.64
B)   0.67
C)   0.71
D)   0.75
E)   0.79F) C) and E)
G) D) and E) E

Question 4

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Accepted Answer

A) True 
 B)False

Question 5

A new company to produce state-of-the-art car stereo systems is being considered by Jagger Enterprises. The sales price would be set at 1.5 times the variable cost per unit; the VC/unit is estimated to be $2.50; and fixed costs are estimated at $120,000. What sales volume would be required in order to break even, i.e., to have an EBIT of zero for the stereo business?

Accepted Answer

A)   86,640
B)   91,200
C)   96,000
D)   100,800
E)   105,840F) B) and D)
G) A) and E)

Question 6

Which of the following statements best describes the optimal capital structure? The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's ____.

Accepted Answer

A)   stock price.
B)   cost of equity.
C)   cost of debt.
D)   cost of preferred stock.
E)   earnings per share (EPS) .F) All of the above
G) B) and D)

Question 7

Which of the following statements is CORRECT?

Accepted Answer

A)   A change in the personal tax rate should not affect firms' capital structure decisions.
B)   "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage.
C)   The optimal capital structure is the one that simultaneously (1)  maximizes the price of the firm's stock, (2)  minimizes its WACC, and (3)  maximizes its EPS.
D)   If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation.
E)   If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.F) A) and B)
G) C) and E)

Question 8

Wilson Dover Inc.
The total value (debt plus equity)  of Wilson Dover Inc. is $500 million and the face value of its 1-year coupon debt is $200 million. The volatility (σ)  of Wilson Dover's total value is 0.60, and the risk-free rate is 5%. Assume that N(d1)  = 0.9720 and N(d2)  = 0.9050.
​
-Refer to the data for Wilson Dover Inc. What is the yield on Wilson Dover's debt?

Accepted Answer

A)   6.04%
B)   6.36%
C)   6.70%
D)   7.05%
E)   7.42%F) C) and E)
G) None of the above

Question 9

Serendipity Inc. is re-evaluating its debt level. Its current capital structure consists of 80% debt and 20% common equity, its beta is 1.60, and its tax rate is 35%. However, the CFO thinks the company has too much debt, and he is considering moving to a capital structure with 40% debt and 60% equity. The risk-free rate is 5.0% and the market risk premium is 6.0%. By how much would the capital structure shift change the firm's cost of equity?

Accepted Answer

A)   −5.20%
B)   −5.78%
C)   −6.36%
D)   −6.99%
E)   −7.69%F) B) and E)
G) A) and C)

Question 10

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

Accepted Answer

A) True 
 B)False

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A)   The factors that affect a firm's business risk are affected by industry characteristics and economic conditions. Unfortunately, these factors are generally beyond the control of the firm's management.
B)   One of the benefits to a firm of being at or near its target capital structure is that this eliminates any risk of bankruptcy.
C)   A firm's financial risk can be minimized by diversification.
D)   The amount of debt in its capital structure can under no circumstances affect a company's business risk.
E)   A firm's business risk is determined solely by the financial characteristics of its industry.F) B) and D)
G) C) and E)

Question 12

Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Accepted Answer

A)   The costs that would be incurred in the event of bankruptcy increase.
B)   Management believes that the firm's stock has become overvalued.
C)   Its degree of operating leverage increases.
D)   The corporate tax rate increases.
E)   Its sales become less stable over time.F) C) and D)
G) B) and D)

Question 13

Pennewell Publishing Inc. (PP) 
Pennewell Publishing Inc. (PP)  is a zero growth company. It currently has zero debt and its earnings before interest and taxes (EBIT)  are $80,000. PP's current cost of equity is 10%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $48.00.
-Refer to the data for Pennewell Publishing Inc. (PP) . Assume that PP is considering changing from its original capital structure to a new capital structure with 35% debt and 65% equity. This results in a weighted average cost of capital equal to 9.4% and a new value of operations of $510,638. Assume PP raises $178,723 in new debt and purchases T-bills to hold until it makes the stock repurchase. What is the stock price per share immediately after issuing the debt but prior to the repurchase?

Accepted Answer

A)   $45.90
B)   $48.12
C)   $51.06
D)   $53.33
E)   $58.75F) C) and E)
G) A) and C)

Question 14

Which of the following statements is CORRECT?

Accepted Answer

A)   There is no reason to think that changes in the personal tax rate would affect firms' capital structure decisions.
B)   A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.
C)   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.
D)   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 financing.
E)   In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.F) A) and B)
G) All of the above E

Question 15

Which of the following statements is CORRECT?

Accepted Answer

A)   The optimal capital structure simultaneously maximizes EPS and minimizes the WACC.
B)   The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price.
C)   The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC.
D)   The optimal capital structure simultaneously maximizes stock price and minimizes the WACC.
E)   As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.F) A) and E)
G) None of the above

Question 16

The Miller model begins with the MM model with corporate taxes and then adds personal taxes.

Accepted Answer

A) True 
 B)False

Question 17

Pennewell Publishing Inc. (PP) 
Pennewell Publishing Inc. (PP)  is a zero growth company. It currently has zero debt and its earnings before interest and taxes (EBIT)  are $80,000. PP's current cost of equity is 10%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $48.00.
-Refer to the data for Pennewell Publishing Inc. (PP) . PP is considering changing its capital structure to one with 30% debt and 70% equity, based on market values. The debt would have an interest rate of 8%. The new funds would be used to repurchase stock. It is estimated that the increase in risk resulting from the added leverage would cause the required rate of return on equity to rise to 12%. If this plan were carried out, what would be PP's new value of operations?

Accepted Answer

A)   $484,359
B)   $487,805
C)   $521,173
D)   $560,748
E)   $584,653F) B) and E)
G) B) and C) B

Question 18

Which of the following statements is CORRECT?

Accepted Answer

A)   If a firm lowered its fixed costs while increasing its variable costs, holding total costs at the present level of sales constant, this would decrease its operating leverage.
B)   The debt ratio that maximizes EPS generally exceeds the debt ratio that maximizes share price.
C)   If a company were to issue debt and use the money to repurchase common stock, this action would have no impact on its basic earning power ratio. (Assume that the repurchase has no impact on the company's operating income.) 
D)   If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation's debt ratio.
E)   Increasing financial leverage is one way to increase a firm's basic earning power (BEP) .F) B) and C)
G) A) and C)

Question 19

When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.

Accepted Answer

A) True 
 B)False

Question 20

Daylight Solutions is considering a recapitalization that would increase its debt ratio and increase its interest expense. The company would issue new bonds and use the proceeds to buy back shares of its common stock. The company's CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share (EPS) . Assuming the CFO's estimates are correct, which of the following statements is CORRECT?

Accepted Answer

A)   If the plan reduces the WACC, the stock price is also likely to decline.
B)   Since the plan is expected to increase EPS, this implies that net income is also expected to increase.
C)   If the plan does increase the EPS, the stock price will automatically increase at the same rate.
D)   Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds.
E)   Since the proposed plan increases Daylight's financial risk, the company's stock price still might fall even if EPS increases.F) A) and E)
G) A) and D)

Exam 15: Capital Structure Decisions

Two firms, although they operate in different industries, have the same expected earnings per share and the same standard deviation of expected EPS. Thus, the two firms must have the same business risk.

Correct Answer
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Correct Answer
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Bailey and Sons has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40%. What would Bailey's beta be if it used no debt, i.e., what is its unlevered beta?

Correct Answer
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E

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Correct Answer
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Correct Answer
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Which of the following statements best describes the optimal capital structure? The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's ____.

Correct Answer
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Which of the following statements is CORRECT?

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

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Correct Answer
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Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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E

Which of the following statements is CORRECT?

Correct Answer
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The Miller model begins with the MM model with corporate taxes and then adds personal taxes.

Correct Answer
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Correct Answer
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B

Which of the following statements is CORRECT?

Correct Answer
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When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.

Correct Answer
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Correct Answer
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Exam 15: Capital Structure Decisions

Two firms, although they operate in different industries, have the same expected earnings per share and the same standard deviation of expected EPS. Thus, the two firms must have the same business risk.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Bailey and Sons has a levered beta of 1.10, its capital structure consists of 40% debt and 60% equity, and its tax rate is 40%. What would Bailey's beta be if it used no debt, i.e., what is its unlevered beta?

Correct AnswerverifiedE

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements best describes the optimal capital structure? The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's ____.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedE

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

The Miller model begins with the MM model with corporate taxes and then adds personal taxes.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedB

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct Answer
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Correct Answer
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Correct Answer
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E

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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E

Correct Answer
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B

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Correct Answer
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