Q&A Hero

Q: Everything else equal, if a firm increases the dividend that it pays from $4 to $5: a. more money will be available to invest in capital budgeting projects. b. its future growth rate will decrease. c. demand for the stock will decrease among investors who prefer to receive current income from their investments. d. the firm should expect many of the investors who held the stock prior to the increase to sell their stock e. its operating income will increase.

Q: The dividend policy that strikes a balance between current dividends and the firm's future growth is called the ______ policy. a. optimal dividend b. dividend irrelevance c. compromise dividend d. dividend signaling e. dividend preference

Q: The ______ effect is the tendency of a firm to attract the type of investor who prefers its dividend policy. a. residual dividend b. clientele c. signaling d. investor e. dividend preference

Q: In the United States, equity monitoring costs are lower than most other developed countries. a. True b. False

Q: In countries where capital gains are not taxed, investors should prefer to own stocks rather than debt compared to investors in countries where capital gains are taxed. a. True b. False

Q: Companies in Italy and Japan use less debt in their capital structures than companies in the United States and Canada. a. True b. False

Q: According to the signaling theory to explain differences in firms' capital structures, an announcement of a new stock issue by a mature, seasoned firm that has numerous financing alternatives generally is seen as a signal that the its future prospects are very positive. a. True b. False

Q: The probability of incurring bankruptcy increases as a firm's debt/equity ratio decreases. a. True b. False

Q: At the time Modigliani and Miller (MM) developed their capital structure theory, the assumptions that they made were realistic. a. True b. False

Q: If a firm's times-interest-earned (TIE) ratio decreases, the probability that it will default on its outstanding debt also decreases. a. True b. False

Q: It is fairly easy to determine how changes in a firm's degree of financial leverage (DFL) affect its P/E ratio. a. True b. False

Q: If the debt/assets ratio increases, the costs of both debt and equity normally decrease. a. True b. False

Q: A firm's risk can be partitioned into financial risk and business risk. An increase in the financial risk results in a decrease in business risk. a. True b. False

Q: The optimal capital structure is the capital structure that strikes a balance between risk and return such that the firm's stock price is maximized. a. True b. False

Q: The degree of operating leverage is defined as the percentage change in earnings before interest and taxes (EBIT) associated with a given percentage change in sales. a. True b. False

Q: Which of the following statements is true of the capital structure of companies in Germany? a. Companies in Germany use the lowest proportion of debt of industrialized countries. b. Companies in Germany use only equity to finance their projects. c. The corporate debt raised by companies in Germany mostly consists of publicly issued bonds. d. Debt monitoring costs are high in Germany because of stringent audit requirements. e. Companies in Germany raise most of their corporate debt through bank loans.

Q: Which of the following statements concerning differences in capital structures and financing alternatives around the world is correct? a. In most countries, the capital gains taxes paid by investors are substantially higher than in the United States. b. In many countries, the costs to monitor companies' debt are lower than in the United States because foreign firms use substantially greater amounts of bank loans to finance assets than do U.S. companies. c. Bank loans to businesses are of little amounts in foreign countries. d. In most countries, neither the interest nor the dividends firms pay are tax deductible. e. The threat of potential bankruptcy is high in firms that are primarily financed with equity than in firms that are financed with bank loans.

Q: Equity monitoring costs are lower in the United States than in other countries because: a. debt that corporations use in the United States consists primarily of bank loans. b. capital gains are not taxed in the United States unless they exceed some minimum amount. c. U.S. companies must comply with fairly stringent financial audit requirements. d. dividends in the United States are exempt from personal taxes; i.e., investors are not required to pay taxes on the dividends they receive. e. banks in the United States hold a significant proportion of long-term bonds (debt) issued by companies, which means they can better monitor companies' debt than can banks in other countries.

Q: Which of the following statements is correct? a. In countries where there are no taxes, corporations should use debt. b. In countries where capital gains are taxed, investors should prefer to own stocks rather than bonds. c. In countries where capital gains are not taxed, equity capital costs should be high. d. In countries where dividends are not taxed, the investors should prefer to own bonds rather than stocks. e. In countries where capital gains are not taxed, investors should prefer to own stocks rather than bonds.

Q: Which of the following statements concerning the capital structures of Japanese companies is correct? a. Companies in Japan are financed nearly entirely with equity. b. Companies in Japan use greater proportions of debt than companies in most other countries. c. The capital structures of most Japanese companies contain little debt that is issued in Japan; that is, most firms are financed with foreign debt. d. Debt monitoring costs are extremely high in Japan. e. Companies in Japan raise most of their funds using publicly-issued corporate bonds.

Q: Among industrialized countries, which of the following uses the lowest proportion of debt? a. The United States b. Canada c. Italy d. The United Kingdom e. Japan

Q: Which of the following statements concerning capital structures around the world is correct? a. There have been no significant observed differences between the capital structures of U.S. corporations and their German and Japanese counterparts. b. All countries use essentially the same international accounting conventions with respect to reporting assets on foreign companies' financial statements. c. Differences among countries in both bankruptcy costs and equity reporting costs leads to the conclusion that U.S. firms should have more equity and less debt than firms in Japan and Germany. d. Equity monitoring costs are higher in the United States than in Japan and Germany. e. Debt monitoring costs are lower in the United States than in Japan and Germany.

Q: Everything else equal, if a firm with favorable future prospects raises funds by issuing new shares of common stock, _____. a. its debt/assets ratio should increase b. its marginal bankruptcy-related costs should increase c. its retained earnings will increase immediately d. its taxable income should decrease e. the price of its stock will increase when future profits are realized by the firm

Q: According to the signaling theory, a firm with unfavorable future prospects might issue common stock in an effort to: a. share any losses with new stockholders (owners). b. increase bankruptcy costs associated with the firm. c. skip the regular dividend payments on common stock. d. maintain a reserve borrowing capacity. e. increase the tax benefit it derives from dividend payments to stockholders.

Q: According to the signaling theory that has been proposed to explain differences in firms' capital structures, which of the following actions by the management is taken as a signal that a firm's future prospects are not bright (i.e., not good)? (Assume that the firm has multiple financing alternatives.) a. A small company raises new capital by issuing of new shares of common stock. b. A mature company raises new capital by issuing of new shares of common stock. c. A small company maintains a reserve borrowing capacity that can be used if good investments are discovered in the future. d. A mature company maintains a reserve borrowing capacity that can be used if good investments are discovered in the future. e. A mature company raises new capital by issuing debt beyond the amount that is indicated by its normal target capital structure.

Q: According to the signaling theory, when should a firm use debt to finance beyond the normal target capital structure? a. When the debt/assets ratio is greater than one b. When marginal tax shelter benefits are equal to marginal bankruptcy-related costs c. When investors and managers have identical information about the firm's prospects d. When the firm has favorable prospects e. When the firm is entirely equity financed

Q: The situation in which managers have different (better) information about their firm's prospects than outside investors is known as _____ information. a. symmetric b. contingent c. asymmetric d. favorable e. unfavorable

Q: Symmetric information is defined as the situation in which _______. a. investors and managers have identical information about the firm's prospects b. employees and managers have identical information about the firm's prospects c. investors and creditors have identical information about the firm's prospects d. managers have different (better) information about their firm's prospects than outside investors e. employees have different (better) information about their firm's prospects than managers

Q: Which of the following is a major advantage of debt financing? a. Market interest rates on debt normally do not exceed 5 percent, which is much lower than market rates associated with common stock. b. Interest payments on debt are a tax-deductible expense to the issuing firm. c. Generally, interest payments on debt are based on the firm's net income, which means the interest is not paid unless the firm has enough income to cover the payments. d. Normally the market values of bonds remain fairly stable, whereas common stock prices change substantially every day. e. Firms that use great amounts of debt do not pay much in corporate taxes.

Q: According to the trade-off theory that has been suggested as a possible explanation for the differences in firms' capital structures that we observe in the real world, which of the following securities is the least expensive form of financing for a particular firm? a. Common stock b. Preferred stock c. Corporate debt d. Retained earnings e. Classified stock

Q: According to the capital structure theory proposed by the Modigliani and Miller (MM), a firm's optimal capital structure is the mix of debt and equity that minimizes its weighted average cost of capital (WACC), which occurs when the firm is financed almost entirely with debt. MM argued that their conclusion is valid primarily because, in the real world, ______. a. there are no flotation costs associated with issuing debt b. investors pay less personal income taxes on the interest they earn on their investments in bonds than they pay on the dividends they receive from corporations c. firms that issue large amounts of debt have much less probability of going bankrupt than firms that have little or no debt in their capital structures. d. the amount of debt a firm uses to finance its assets does not affect its market value e. interest paid on corporate debt is a taxdeductible expense to the firm, whereas dividends paid to stockholders are not.

Q: According to the basic capital structure theory proposed by Modigliani and Miller (MM), when will a firm's value be maximum? a. When it is financed entirely with equity. b. When its capital structure contains 50 percent debt and 50 percent equity. c. When it is financed entirely with retained earnings. d. When it is financed with almost 100 percent through debt. e. When its assets are financed with 50 percent equity and 50 percent retained earnings.

Q: This year, Ferro Inc. generated sales of $10 million. Its fixed operating cost is $1 million and its variable cost ratio is 30 percent of sales. Ferro has $60 million of debt outstanding with a before-tax cost of 12 percent. Which of the following statements about Ferro's times interest earned (TIE) ratio is correct? a. Ferro's TIE ratio is 1.20, which suggests it has enough earnings to meet the required interest payments. b. Ferro's TIE ratio is 0.83, which suggests it does not have enough earnings to meet the required interest payments. c. Ferro's TIE ratio is 0.83, which suggests it has enough earnings to meet the required interest payments. d. Ferro's TIE ratio is 1.39, which suggests it does not have enough earnings to meet the required interest payments. e. Ferro's TIE ratio is 1.00, which suggests it has just enough earnings to meet the required interest payments.

Q: A times-interest-earned (TIE) ratio that is less than 1 suggests that a firm _____. a. is using a low proportion of debt financing in its capital structure b. has a low probability of defaulting on its loans c. might not be able to meet its annual interest obligations on its debt d. is financed with equity only e. has an extremely low debt/assets ratio

Q: Which of the following statements concerning a firm's times-interest earned (TIE) ratio is correct? a. Generally the lower its TIE ratio, the higher the probability that the firm will default on its debt. b. The TIE ratio is calculated by dividing net income by interest charges. c. The TIE ratio increases if the debt/assets ratio increases, and vice versa. d. The TIE ratio is always greater than 1. e. The TIE ratio shows the effects of both operating leverage and financial leverage.

Q: What is the formula for calculating the times-interest earned (TIE) ratio? a. TIE ratio = Interest charges Total liabilities b. TIE ratio = Earnings per share Interest charges c. TIE ratio = Sales Interest charges d. TIE ratio = Earnings before interest and taxes Interest charges e. TIE ratio = Interest charges Net income

Q: Which of the following statements is true about the relationship between the debt/assets ratio and the times-interest-earned ratio (TIE) of a firm? Consider everything else equal. a. If the debt/assets ratio increases, the TIE ratio will also increase. b. If the debt/assets ratio decreases, the TIE ratio will increase. c. If the debt/assets ratio decreases, the TIE ratio will also decrease. d. The debt/assets ratio will always be equal to the TIE ratio. e. The debt/assets ratio and the TIE ratio are not related to each other.

Q: ________ is a measure that indicates a firm's ability to meet the annual interest obligations on its outstanding debt. a. Times-interest-earned (TIE) ratio b. Degree of operating leverage (DOL) c. Debt/assets ratio d. Dividend payout ratio e. Current ratio

Q: Which of the following statements concerning a firm's degree of financial leverage (DFL) is correct? Assume everything else is equal. a. If the firm issues additional common stock, its DFL should increase. b. Compared to a lower DFL, a higher DFL implies a greater financial risk. c. Compared to a higher DFL, a lower DFL implies a greater financial risk. d. If the firm issues additional long-term debt, its DFL should decrease. e. The firm's DFL cannot be negative.

Q: A firm's assets are finance with 60 percent debt and 40 percent common equity. As a result, we know that the firm must have: a. a degree of operating leverage (DOL) that is greater than 1.0. b. a degree of financial leverage (DFL) that is greater than 1.0. c. a degree of equity leverage (DEL) that is greater than 1.0. d. fixed operating costs. e. paid common stock dividends last year.

Q: The percentage change in earnings per share (EPS) that results from a given percentage change in sales is known as the firm's degree of_____ leverage. a. financial b. operating c. working capital d. current asset e. total

Q: What does a degree of financial leverage (DFL) of 2.0 indicate? a. For every 1 percent change in its sales, the firm's EBIT will change by 2 percent. b. For every 1 percent change in its EPS, the firm's sales will change by 0.5 percent. c. For every 1 percent change in its EBIT, the firm's EPS will change by 2 percent. d. For every 1 percent change in its EPS, the firm's EBIT will change by 0.5 percent. e. For every 1 percent change in its EBIT, the firm's sales will change by 2 percent.

Q: Suppose that a firm has a degree of financial leverage (DFL) that is greater than 1.0; that is, DFL > 1. If the firm's sales decrease by 1 percent, its ______ will decrease by more than 1 percent. a. earnings per share (EPS) b. net operating income (NOI) c. interest expense d. variable costs e. fixed financing costs

Q: Top-Shelf Construction discovered that for every 1 percent decrease in its sales, its earnings before interest and taxes (EBIT) decrease by 3.2 percent. Based on this information, we know that Top-Shelf Construction has a: a. debt/assets ratio equal to 3.2 times its debt/equity ratio. b. degree of operating leverage (DOL) equal to 3.2. c. current ratio (= Current assets/Current liabilities) equal to 3.2. d. degree of total leverage equal to 3.2. e. degree of financial leverage (DFL) equal to 3.2.

Q: Everything else equal, in which of the following situations will a firm's degree of operating leverage (DOL) increase? Assume the firm currently generates a positive net operating income. a. Sales increase substantially. b. The firm issues preferred stock. c. Fixed costs are decreased. d. The firm takes advantage of quantity discounts for the first time. e. The firm's sales move closer to its operating breakeven point.

Q: A degree of operating leverage (DOL) equal to 1.5 times indicates that for every 1 percent change in _____. a. earnings per share (EPS) there will be a 1.5 percent change in sales b. interest there will be a 1.5 percent change in earnings before interest and taxes (EBIT) c. sales there will be a 1.5 percent change in earnings before interest and taxes (EBIT) d. earnings before interest and taxes (EBIT) there will be a 1.5 percent change in earnings per share (EPS) e. sales there will be a 1.5 percent change in earnings per share (EPS)

Q: Bell Brothers has $3,000,000 in sales. Its fixed costs are estimated to be $200,000, and its variable costs are equal to 50 percent of sales. The company has $1,000,000 in debt outstanding with a before-tax cost of 10 percent. If Bell Brothers' sales increase by 20 percent, by what percent should its earnings per share (EPS) change? a. 16.00% b. 20.00% c. 21.67% d. 23.08% e. 25.00%

Q: The degree of leverage concept is designed to show how changes in sales affect earnings before interest and taxes (EBIT) and earnings per share (EPS). If a 10 percent increase in sales causes EPS to increase from $1.00 to $1.50 and if the firm uses no debt, then what is its degree of operating leverage? a. 0.5 b. 1.5 c. 2.0 d. 5.0 e. 7.5

Q: Assume that a firm's degree of financial leverage (DFL) is 1.2. If sales this year increase by 20 percent, the firm expects a 60 percent increase in earnings per share (EPS). What is the firm's degree of operating leverage of the firm? a. 2.5 b. 3.0 c. 1.8 d. 0.4 e. 3.6

Q: A firm expects to have a 15 percent increase in sales this year. If its degree of operating leverage is 1.2 and its degree of financial leverage is 3.5, what will be the percentage change in earnings per share (EPS) this year? a. 4.2% b. 48.05% c. 63.0% d. 52.5% e. 18.0%

Q: Quick Launch Rocket Company, expects its sales to increase by 50 percent in the coming year. The firm's current earnings per share (EPS) is $3.25. Its degree of operating leverage is 1.6 and its degree of financial leverage is 2.1. What is the firm's projected EPS for the coming year? a. $3.25 b. $5.46 c. $10.92 d. $8.71 e. $19.63

Q: Following are the results of the capital structure analysis SoCal Irrigation just completed: Proportion Stock Price Earnings per of Debt (per share) Share (EPS) 20% $44.50 $1.20 40 45.15 1.26 60 45.20 1.22 80 44.95 1.18 According to this information, what is SoCal's optimal capital structure? a. 20% b. 40% c. 60% d. 80% e. To determine the optimal capital structure, the market value of the stock must be known.

Q: According to the following information, what is the firm's optimal capital structure? Proportion Earnings Per Weighted Average Cost of Debt Share (EPS) of Capital (WACC) 30% $2.50 13.2% 40 3.80 12.7 50 4.75 12.4 60 5.25 12.8 a. 30% b. 40% c. 50% d. 60% e. To determine the optimal capital structure, the market value of the stock must be known.

Q: Olson Corporation has a beta coefficient of 1.5 at a debt/assets ratio equal to 40 percent. The risk-free rate of return, rRF, is 5 percent and the market return, rM, is 9 percent. Based on the capital asset pricing model (CAPM), what is Olson's required rate of return on its common equity? a. 18.5% b. 13.5% c. 11.0% d. 15.0% e. 6.0%

Q: Trueware Corporation is a start-up firm with a capital structure that includes 25 percent debt. Trueware has no preferred stock. The firm has two possible scenarios for its operations: Ruby or Emerald. The Ruby scenario has a 70 percent probability of occurring and the forecast earnings before interest and taxes (EBIT) in this scenario is $80,000. The Emerald scenario has a 30 percent chance of occurring and the EBIT is expected to be $32,000. Further, the firm's cost of debt is 10 percent. The firm has $500,000 in total assets and its marginal tax rate is 30 percent. The company has 22,000 shares of common stock outstanding. Calculate the difference in earnings per share (EPS) for the capital structure a. $1.53 b. $1.20 c. $1.48 d. $2.24 e. $3.15

Q: Copybold Corporation is a start-up company that has a capital structure with a debt/assets ratio equal to 0.75. Copybold has no preferred stock. There are two possible scenarios with respect to the firm's operations: Feast or Famine. The Feast scenario has a 60 percent probability of occurring, and the forecast earnings before interest and taxes (EBIT) in this scenario is $60,000. The Famine scenario has a 40 percent chance of occurring, and the EBIT is expected to be $20,000. Further, the firm's cost of debt is 12 percent. The firm has $400,000 in total assets, and its marginal tax rate is 40 percent. The company has 10,000 shares of stock outstanding. What is the difference between the earnings per share (EPS) forecasts for the Feast scenario and the Famine scenario? a. $1.44 per share b. $2.40 per share c. $1.48 per share d. $0.48 per share e. $0.96 per share

Q: A firm sets a target capital structure to use when raising new funds in an effort to: a. maximize its earnings per share (EPS). b. minimize its cost of debt (rd). c. maximize the dividend per share it pays commons stockholders. d. minimize its cost of equity (rs). e. minimize its weighted average cost of capital (WACC).

Q: A company's capital structure consists of common stock only, which amounts to $14 million. However, this year, the company plans to issue $7 million of debt, and use the proceeds to repurchase $7 million of its existing equity. The stock repurchase should not change the size of the company. As a result, any change in the firm's earnings per share (EPS) must be a result of the change in its: a. level of operations. b. beta coefficient. c. EPS coefficient of variation. d. capital structure. e. EPS standard deviation.

Q: At its optimal capital structure, the firm's debt/assets ratio will always be lower than the one that maximizes its _____. a. expected earnings per share (EPS) b. weighted average cost of capital c. beta coefficient d. degree of financial leverage e. net operating income

Q: As a general rule, the optimal capital structure is the one that: a. maximizes both the firm's expected EPS and its stock price. b. minimizes the interest rate on its debt and maximizes its expected earnings per share. c. minimizes its required rate on equity and maximizes its stock price. d. maximizes its stock price and minimizes its weighted average cost of capital. e. minimizes its expected earnings per share and maximizes its weighted average cost of capital.

Q: The combination of debt financing and equity financing that maximizes a firm's value is known as its: a. optimum degree of financial leverage (DFL). b. maximum weighted average cost of capital (WACC). c. maximum business risk. d. optimal capital structure. e. optimal indifference point.

Q: A firm should raise capital according to its optimal capital structure so as to maximize its _____. a. earnings per share (EPS) b. stock price c. weighted average cost of capital (WACC) d. net income e. retained earnings

Q: A firm's optimal capital structure is the combination of debt financing and equity financing that ______. a. maximizes its expected earnings per share (EPS). b. simultaneously maximizes its EPS and minimizes its weighted average cost of capital (WACC). c. minimizes its cost of equity, which is a necessary condition for maximizing the firm's stock price. d. simultaneously minimizes its cost of debt, its cost of equity, and its WACC. e. maximizes its stock price.

Q: Operating leverage refers to the presence of _____. a. fixed-income securities b. beta risks c. firm-specific risks d. variable operating costs e. fixed operating costs

Q: The presence of fixed operating costs is known as _____. a. financial leverage b. operating leverage c. beta risk d. market risk e. firm-specific risk

Q: Everything else equal, and for one particular firm, in which of the following capital structures would the common stockholders have to bear the greatest amount of of business risk? a. 100 percent equity b. 25 percent equity and 75 percent debt c. 50 percent equity and 50 percent debt d. 1 percent equity and 99 percent debt e. 75 percent equity and 25 percent debt

Q: Financial leverage is the: a. presence of fixed operating costs. b. portion of earnings that is paid out as dividends to the common stockholders. c. risk associated with a firm's operations. d. combination of the debt and the equity a firm uses to finance its assets. e. extent to which fixed-income securities are used in a firm's capital structure.

Q: Which of the following situations would intensify the business risk borne by a firm's common stockholders? a. The firm issues new fixed-income securities, such as bonds, to raise funds to support operations. b. The firm takes actions to stabilize its annual sales. c. The firm starts purchasing from a supplier that allows it to renegotiate raw materials costs every six months. d. The firm reduces its use of fixed operating costs. e. The firm issues new common stock to raise funds.

Q: The risk associated with a firm's operations, ignoring any financing effects, is known as _____ risk. a. market b. business c. leverage d. liquidity e. inflation

Q: Which of the following is considered a component of financial risk? a. Fixed operating costs b. Variable operating costs c. The variability of a product's selling price d. Interest payments on bonds e. Fixed labor costs

Q: If a firm increases the proportions of debt and preferred stock that are contained in its capital structure, its _____. a. financial risk will increase b. business risk will decrease c. tax liability will increase d. operating leverage will decrease e. financial leverage will decrease

Q: Which of the following factors would tend to reduce a firm's business risk? a. The firm changes its operations to make them more cyclical. b. The firm increases its operating leverage. c. The firm increases the fixed costs that are associated with the manufacture of its products. d. The firm shifts its sales strategy in an effort to sell substantially more high-priced durable goods than low-priced staple goods, which reverses the sales trend that occurred during the past decade. e. The firm takes actions to improve the stability of its day-to-day operations.

Q: Which of the following industries normally has relatively low business risk? a. Durable goods manufacturers, such as automobile manufacturers b. Firms that produce staple goods, such as grocery stores and utility companies c. Cyclical companies, such as construction companies d. Firms that engage in fairly risky research and development, such as pharmaceutical research companies. e. Small, single-product firms, especially those that sell primarily to a single customer

Q: Which of the following would be considered part of a firm's business risk? a. The firm's default risk b. The risk that some of the firm's bonds will be repaid prior to their maturities c. The general liability that is associated with the product line the firm manufactures and sells d. Risk of loss due to currency fluctuations e. Interest rate reinvestment risk

Q: A firm's ______ is the combination of debt and equity it uses to finance its assets. a. capital budgeting plan b. business risk c. asset structure d. securitization table e. capital structure

Q: A firm's cost of capital (WACC) represents the maximum rate of return that a firm can earn from its capital budgeting projects to ensure that the value of the firm does not decrease. a. True b. False

Q: A firm should continue to invest in capital budgeting projects to the point where the marginal cost of capital (MCC) equals the marginal return (internal rate of return, IRR) generated by the last project that is purchased. a. True b. False

Q: Even if a firm obtains all of its common equity financing from retained earnings, its marginal cost of capital (MCC) schedule could still increase if very large amounts of new capital are raised. a. True b. False

Q: The marginal cost of capital (MCC) is the weighted average cost of the last dollar of new capital that the firm raises. The MCC generally declines as greater amounts of a specific type of capital are raised during a given period. a. True b. False

Q: Because the value of a firm's stock depends on the after-tax cash flows it generates during its life, after-tax component costs of capital (i.e., the after-tax cost of debt) are used when computing a firm's weighted average cost of capital (WACC). a. True b. False