Q&A Hero

Q: A disaster recovery plan is a comprehensive statement of all actions to be taken after a disaster.

Q: 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?a. $484,359b. $487,805c. $521,173d. $560,748e. $584,653

Q: The database administrator should be separated from systems development.

Q: LeCompte Learning Solutions is considering making a change to its capital structure in hopes of increasing its value. The company's capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:Percent financed Percent financed Debt-to-equity Bond Before-taxwith debt (wd) with equity (wc) ratio (D/S) Rating cost of debt0.10 0.90 0.10/0.90 = 0.11 AAA 7.0%0.20 0.80 0.20/0.80 = 0.25 AA 7.20.30 0.70 0.30/0.70 = 0.43 A 8.00.40 0.60 0.40/0.60 = 0.67 BBB 8.80.50 0.50 0.50/0.50 = 1.00 BB 9.6 The company uses the CAPM to estimate its cost of common equity, rs. The risk-free rate is 5% and the market risk premium is 6%. LeCompte estimates that if it had no debt its beta would be 1.0. (Its "unlevered beta," bU, equals 1.0.) The company's tax rate, T, is 40%.On the basis of this information, what is LeCompte's optimal capital structure, and what is the firm's cost of capital at this optimal capital structure?a. wc = 0.9; wd = 0.1; WACC = 14.96%b. wc = 0.8; wd = 0.2; WACC = 10.96%c. wc = 0.7; wd = 0.3; WACC = 7.83%d. wc = 0.6; wd = 0.4; WACC = 10.15%e. wc = 0.5; wd = 0.5; WACC = 10.18%

Q: Distributed data processing reduces the risk of operational inefficiencies.

Q: Cartwright Communications is considering making a change to its capital structure to reduce its cost of capital and increase firm value. Right now, Cartwright has a capital structure that consists of 20% debt and 80% equity, based on market values. (Its D/S ratio is 0.25.) The risk-free rate is 6% and the market risk premium, rM − rRF, is 5%. Currently the company's cost of equity, which is based on the CAPM, is 12% and its tax rate is 40%. What would be Cartwright's estimated cost of equity if it were to change its capital structure to 50% debt and 50% equity?a. 13.00%b. 13.64%c. 14.35%d. 14.72%e. 15.60%

Q: To improve control and efficiency, new systems development and program maintenance should be performed by the same individual or group.

Q: An all-equity firm with 200,000 shares outstanding, Antwerther Inc., has $2,000,000 of EBIT, which is expected to remain constant in the future. The company pays out all of its earnings, so earnings per share (EPS) equal dividends per shares (DPS). Its tax rate is 40%.The company is considering issuing $5,000,000 of 10.0% bonds and using the proceeds to repurchase stock. The risk-free rate is 6.5%, the market risk premium is 5.0%, and the beta is currently 0.90, but the CFO believes beta would rise to 1.10 if the recapitalization occurs.Assuming that the shares can be repurchased at the price that existed prior to the recapitalization, what would the price be following the recapitalization?a. $65.77b. $69.23c. $72.69d. $76.33e. $80.14

Q: Laramie Trucking's CEO is considering a change to the company's capital structure, which currently consists of 25% debt and 75% equity. The CFO believes the firm should use more debt, but the CEO is reluctant to increase the debt ratio. The risk-free rate, rRF, is 5.0%, the market risk premium, RPM, is 6.0%, and the firm's tax rate is 40%. Currently, the cost of equity, rs, is 11.5% as determined by the CAPM. What would be the estimated cost of equity if the firm used 60% debt? (Hint: You must first find the current beta and then the unlevered beta to solve the problem.)a. 10.95%b. 11.91%c. 12.94%d. 14.07%e. 15.29%

Q: Certain duties that are deemed incompatible in a manual system may be combined in a computer-based information system environment.

Q: 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?a. −5.20%b. −5.78%c. −6.36%d. −6.99%e. −7.69%

Q: An advantage of distributed data processing is that redundant tasks are greatly eliminated

Q: Morales Publishing's tax rate is 40%, its beta is 1.10, and it uses no debt. However, the CFO is considering moving to a capital structure with 30% debt and 70% equity. If 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?a. 1.53%b. 1.70%c. 1.87%d. 2.05%e. 2.26%

Q: Distributed data processing places the control IT recourses under end users.

Q: The following information has been presented to you about the Gibson Corporation.Total assets $3,000 million Tax rate 40%Operating income (EBIT) $800 million Debt ratio 0%Interest expense $0 million WACC 10%Net income $480 million M/B ratio 1.00×Share price $32.00 EPS = DPS $3.20The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values) that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%. If the company makes this change, what would be the total market value (in millions) of the firm?a. $3,200b. $3,600c. $4,000d. $4,200e. $4,800

Q: 44IT governance focuses on the management and assessment of strategic IT resources

Q: 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?a. 0.64b. 0.67c. 0.71d. 0.75e. 0.79

Q: Some systems professionals have unrestricted access to the organization's programs and data.

Q: Two operationally similar companies, HD and LD, have identical amounts of assets, operating income (EBIT), tax rates, and business risk. Company HD, however, has a much higher debt ratio than LD. Company HD's return on invested capital (ROIC) exceeds its after-tax cost of debt, (1-T)rd. Which of the following statements is CORRECT? a. Company HD has a higher times interest earned (TIE) ratio than Company LD. b. Company HD has a higher return on equity (ROE) than Company LD, and its risk, as measured by the standard deviation of ROE, is also higher than LD's. c. The two companies have the same ROE. d. Company HD's ROE would be higher if it had no debt. e. Company HD has a higher return on assets (ROA) than Company LD.

Q: To ensure sound internal control, program coding and program processing should be separated.

Q: Which of the following statements is CORRECT? a. The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share. b. All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio. c. Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC. d. Since debt is cheaper than equity, increasing a company's debt ratio will always reduce its WACC. e. When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase.

Q: To fulfill the segregation of duties control objective, computer processing functions (like authorization of credit and billing) are separated.

Q: Although IT governance is a broad area, only three of them are discussed in the chapter. Name them and explain why these topics were chosen.

Q: Two operationally similar companies, HD and LD, have the same total assets, operating income (EBIT), tax rate, and business risk. Company HD, however, has a much higher debt ratio than LD. Also HD'sreturn on invested capital (ROIC)exceeds its after-tax cost of debt, (1-T)rd. Which of the following statements is CORRECT? a. HD should have a higher times interest earned (TIE) ratio than LD. b. HD should have a higher return on equity (ROE) than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD's. c. Given that ROIC > (1-T) rd, HD's stock price must exceed that of LD. d. Given that ROIC > (1-T) rd, LD's stock price must exceed that of HD. e. HD should have a higher return on assets (ROA) than LD.

Q: Firms U and L both have a return on invested capital (ROIC) of 12% and each has the same amount of assets. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm L's debt has an after-tax cost of 4.8%. Both firms have positive net income. Which of the following statements is CORRECT? a. Firm L has a lower ROA than Firm U. b. Firm L has a lower ROE than Firm U. c. Firm L has the higher times interest earned (TIE) ratio. d. Firm L has a higher EBIT than Firm U. e. The two companies have the same times interest earned (TIE) ratio.

Q: Explain how IT outsourcing can lead to loss of strategic advantage.

Q: Companies HD and LD have identical tax rates, total assets, and return on invested capital (ROIC), and their ROIC exceeds their after-tax cost of debt, (1-T)rd. However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT? a. Company HD has a lower ROA than Company LD. b. Company HD has a lower ROE than Company LD. c. The two companies have the same ROA. d. The two companies have the same ROE. e. Company HD has a higher net income than Company LD.

Q: Explain why reduced security is an outsourcing risk.

Q: Which of the following statements is CORRECT? 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).

Q: Explain vendor exploitation.

Q: Which of the following statements is CORRECT? 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.

Q: Explain the outsourcing risk of failure to perform.

Q: The firm's target capital structure should be consistent with which of the following statements? a. Minimize the cost of debt (rd). b. Obtain the highest possible bond rating. c. Minimize the cost of equity (rs). d. Minimize the weighted average cost of capital (WACC). e. Maximize the earnings per share (EPS).

Q: What is a disaster recovery plan? What are the key features?

Q: Which of the following statements is CORRECT? 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.

Q: Compare and contrast the following disaster recovery options: empty shell, recovery operations center, and internally provided backup. Rank them from most risky to least risky, as well as most costly to least costly.

Q: 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 ____. a. stock price. b. cost of equity. c. cost of debt. d. cost of preferred stock. e. earnings per share (EPS).

Q: Auditors examine the physical environment of the computer center as part of their audit. Many characteristics of computer centers are of interest to auditors. What are they? Discuss.

Q: Based on the information below for Benson Corporation, what is the optimal capital structure? a. Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90. b. Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20. c. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40. d. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00. e. Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.

Q: Discuss the advantages and disadvantages of the second site backup options.

Q: Which of the following statements is CORRECT? a. The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. b. The capital structure that minimizes the required return on equity also maximizes the stock price. c. The capital structure that minimizes the WACC also maximizes the price per share of common stock. d. The capital structure that gives the firm the best credit rating also maximizes the stock price. e. The capital structure that maximizes expected EPS also maximizes the price per share of common stock.

Q: Describe how a Corporate Computer Services Function can overcome some of the problems associated with distributed data processing.

Q: Which of the following statements is CORRECT? a. Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC. b. Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing. However, this action still may raise the company's WACC. c. Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing. However, this action still may lower the company's WACC. d. Since a firm's beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity. e. Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.

Q: What are the objectives of IT Governance?

Q: Which of the following statements is CORRECT? a. Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. b. Drug companies (prescription, not illegal!) generally have high debt-to-equity ratios because their earnings are very stable and, thus, they can cover the high interest costs associated with high debt levels. c. 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. d. Since most stocks sell at or very close to their book values, book value capital structures are almost always adequate for use in estimating firms' costs of capital. e. Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry.

Q: List five risks associated with IT outsourcing.

Q: Eccles Inc.Eccles Inc., a zero growth firm, has an expected EBIT of $100,000 and a corporate tax rate of 30%. Eccles uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.Refer tothe data for Eccles Inc.Assume that the firm's gain from leverage according to the Miller model is $126,667. If the effective personal tax rate on stock income is TS = 20%, what is the implied personal tax rate on debt income?a. 16.4%b. 18.2%c. 20.2%d. 22.5%e. 25.0%

Q: Define specific asset.

Q: Eccles Inc.Eccles Inc., a zero growth firm, has an expected EBIT of $100,000 and a corporate tax rate of 30%. Eccles uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.Refer to the data for Eccles Inc.What is the firm's cost of equity according to MM with corporate taxes?a. 21.0%b. 23.3%c. 25.9%d. 28.8%e. 32.0%

Q: What are the often cited benefits of IT outsourcing?

Q: Eccles Inc.Eccles Inc., a zero growth firm, has an expected EBIT of $100,000 and a corporate tax rate of 30%. Eccles uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.Refer to the data for Eccles Inc.What is the value of the firm according to MM with corporate taxes?a. $475,875b. $528,750c. $587,500d. $646,250e. $710,875

Q: What is contained in the SSAE 16 attest report?

Q: Which of the following statements concerning capital structure theory is NOT CORRECT?a. Under MM with zero taxes, financial leverage has no effect on a firm's value.b. Under MM with corporate taxes, the value of a levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt.c. Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing.d. Under MM with corporate taxes, the effect of business risk is automatically incorporated because rsL is a function of rsU.e. The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt.

Q: Briefly outline transaction cost economics as it relates to IT outsourcing.

Q: The major contribution of the Miller model is that it demonstrates that a. personal taxes decrease the value of using corporate debt. b. financial distress and agency costs reduce the value of using corporate debt. c. equity costs increase with financial leverage. d. debt costs increase with financial leverage. e. personal taxes increase the value of using corporate debt.

Q: What are commodity IT assets?

Q: The MM model is the same as the Miller model, but with zero corporate taxes. a. True b. False

Q: Briefly explain the core-competency theory.

Q: The MM model with corporate taxes is the same as the Miller model, but with zero personal taxes. a. True b. False

Q: The Miller model begins with the MM model without corporate taxes and then adds personal taxes. a. True b. False

Q: Why should the tasks of systems development and maintenance be segregated from operations?

Q: What is IT Governance?

Q: The Miller model begins with the MM model with corporate taxes and then adds personal taxes. a. True b. False

Q: Which of the following statements is CORRECT? a. The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price. b. The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes its earnings per share. c. If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio must reduce its WACC. d. Other things held constant, if corporate tax rates declined, then the Modigliani-Miller tax-adjusted tradeoff theory would suggest that firms should increase their use of debt. e. A firm can use retained earnings without paying a flotation cost. Therefore, while the cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of debt.

Q: What is an auditor looking for when testing computer center controls?

Q: Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant? a. An increase in the corporate tax rate. b. An increase in the personal tax rate. c. The Federal Reserve tightens interest rates in an effort to fight inflation. d. The company's stock price hits a new low. e. An increase in costs incurred when filing for bankruptcy.

Q: Describe two tests that an auditor would perform to ensure that the disaster recovery plan is adequate.

Q: Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant? a. An increase in the personal tax rate. b. An increase in the company's operating leverage. c. The Federal Reserve tightens interest rates in an effort to fight inflation. d. The company's stock price hits a new high. e. An increase in the corporate tax rate.

Q: The distributed data processing approach carries some control implications of which accountants should be aware. Discuss two.

Q: What is a recovery operations center? What is its purpose?

Q: If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal. a. True b. False

Q: The trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing. a. True b. False

Q: What is a mirrored data center?

Q: Describe the components of a disaster recovery plan.

Q: Firms HD and LD are identical except for their level of debt and the interest rates they pay on debt⎯HD has more debt and pays a higher interest rate on that debt. Based on the data given below, what is the difference between the two firms' ROEs?Applicable to Both Firms Firm HD's Data Firm LD's DataAssets $200 Debt ratio 50% Debt ratio 30%EBIT $40 Interest rate 12% Interest rate 10%Tax rate 35% a. 2.18%b. 2.29%c. 2.41%d. 2.54%e. 2.66%

Q: List three pairs of system functions that should be separated in the centralized computer services organization. Describe a risk exposure if the functions are not separated.Functions to Separate Risk Exposure__________________________ ____________________________________________________ ____________________________________________________ __________________________

Q: A venture capital investment group received a proposal from Wireless Solutions to produce a new smart phone. The variable cost per unit is estimated at $250, the sales price would be set at twice the VC/unit, fixed costs are estimated at $750,000, and the investors will put up the funds if the project is likely to have an operating income of $500,000 or more. What sales volume would be required in order to meet this profit goal?a. 4,513b. 4,750c. 5,000d. 5,250e. 5,513

Q: For disaster recovery purposes, what criteria are used to identify an application or data as critical?

Q: After an intensive research and development effort, two methods for producing playing cards have been identified by the Turner Company. One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards. The other method would use a less expensive machine (fixed cost = $5,000), but it would require greater variable costs ($1.50 per deck of cards). If the selling price per deck of cards will be the same under each method, at what level of output will the two methods produce the same net operating income (EBIT)? a. 5,000 decks b. 10,000 decks c. 15,000 decks d. 20,000 decks e. 25,000 decks

Q: What are some risks associated with DDP?