Question 1

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 (wc)  is 1 - wd. 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?

Accepted Answer

A)   The ROA would increase.
B)   The ROA would remain unchanged.
C)   The return on investors' capital would decline.
D)   The return on investors' capital would increase.
E)   The ROE would increase.F) A) and B)
G) C) and D)

Question 2

Companies HD and LD have identical amounts of assets, investor-supplied capital, operating income Which of the following statements is CORRECT?

Accepted Answer

A)   Company HD has a higher return on assets (RO
A)   than Company LD.
B)   Company HD has a higher times interest earned (TI
E)   ratio than Company LD.
C)   Company HD has a higher return on equity (RO
E)   than Company LD, and its risk as measured by the standard deviation of ROE is also higher than LD's.
D)   The two companies have the same ROE.
E)   Company HD's ROE would be higher if it had no debt.F) All of the above
G) A) and B)

Question 3

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

Accepted Answer

A) True 
 B)False

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)   The capital structure that maximizes expected EPS also maximizes the price per share of common stock.
B)   The capital structure that minimizes the interest rate on debt also maximizes the expected EPS.
C)   The capital structure that minimizes the required return on equity also maximizes the stock price.
D)   The capital structure that minimizes the WACC also maximizes the price per share of common stock.
E)   The capital structure that gives the firm the best bond rating also maximizes the stock price.F) A) and B)
G) All of the above

Question 5

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

Accepted Answer

A)   Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.
B)   Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90.
C)   Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20.
D)   Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40.
E)   Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.F) A) and B)
G) None of the above

Question 6

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 $250.00 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 25,000 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 ROEB - ROEA? (Hint: Since the firm uses no debt and its tax rate is zero, ROE = EBIT/Required investment.)

Accepted Answer

A)   6.00%
B)   6.67%
C)   7.00%
D)   7.35%
E)   7.72%F) A) and B)
G) D) and E)

Question 7

An increase in the debt ratio will generally have no effect on which of these items?

Accepted Answer

A)   Business risk.
B)   Total risk.
C)   Financial risk.
D)   Market risk.
E)   The firm's beta.F) D) and E)
G) B) and E)

Question 8

A firm's capital structure does not affect its free cash flows as discussed in the text, because FCF reflects only operating cash flows, which are available to service debt, to pay dividends to stockholders, and for other purposes.

Accepted Answer

A) True 
 B)False

Question 9

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

Accepted Answer

A) True 
 B)False

Question 10

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

Accepted Answer

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) A) and B)
G) B) and E)

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A)   If Congress lowered corporate tax rates while other things were held constant, and if the Modigliani-Miller tax-adjusted theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.
B)   A change in the personal tax rate should not affect firms' capital structure decisions.
C)   "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.
D)   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.
E)   If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation's debt ratio.F) A) and E)
G) C) and D)

Question 12

According to Modigliani and Miller (MM), in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Accepted Answer

A) True 
 B)False

Question 13

A firm's treasurer likes to be in a position to raise funds to support operations whenever such funds are needed, even in "bad times." This is called "financial flexibility," and the lower the firm's debt ratio, the greater its financial flexibility, other things held constant.

Accepted Answer

A) True 
 B)False

Question 14

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 (wd)  to only 10%. 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 ROENew - ROEOld?

Accepted Answer

A)   5.44%
B)   5.73%
C)   6.03%
D)   6.33%
E)   6.65%F) A) and D)
G) A) and C)

Question 15

A major contribution of the Miller model is that it demonstrates, other things held constant, that

Accepted Answer

A)   personal taxes increase the value of using corporate debt.
B)   personal taxes lower the value of using corporate debt.
C)   personal taxes have no effect on the value of using corporate debt.
D)   financial distress and agency costs reduce the value of using corporate debt.
E)   debt costs increase with financial leverage.F) A) and B)
G) A) and C)

Question 16

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 ROEL - ROEU?

Accepted Answer

A)   5.68%
B)   5.94%
C)   6.22%
D)   6.52%
E)   6.83%F) A) and C)
G) None of the above

Question 17

The Modigliani and Miller (MM) articles implicitly assumed, among other things, that outside stockholders have the same information about a firm's future prospects as its managers. That was called "symmetric information," and it is questionable. The introduction of "asymmetric information" led to the development of the "signaling" theory of capital structure, which postulated that firms are reluctant to issue new stock because investors will interpret such an act as a signal that the firm's managers are worried about its future. Other actions give off different signals, and the end result is that capital structure is affected by managers' perceptions about how their financing decisions will affect investors' views of the firm and thus its value.

Accepted Answer

A) True 
 B)False

Question 18

Which of the following statements is CORRECT?

Accepted Answer

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) A) and C)

Question 19

As a consultant to First Responder Inc., you have obtained the following data (dollars in millions) . The company plans to pay out all of its earnings as dividends, hence g = 0. Also, no net new investment in operating capital is needed because growth is zero. The CFO believes that a move from zero debt to 20.0% debt would cause the cost of equity to increase from 10.0% to 12.0%, and the interest rate on the new debt would be 8.0%. What would the firm's total market value be if it makes this change? Hints: Find the FCF, which is equal to NOPAT = EBIT(1 - T)  because no new operating capital is needed, and then divide by (WACC - g) .

Accepted Answer

A)   $2,982
B)   $3,314
C)   $3,682
D)   $4,091
E)   $4,545F) A) and B)
G) None of the above

Question 20

A group of venture investors is considering putting money into Lemma Books, which wants to produce a new reader for electronic books. The variable cost per unit is estimated at $250, the sales price would be set at twice the VC/unit, or $500, and fixed costs are estimated at $750,000. 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 the minimum profit goal? (Hint: Use the break-even formula, but include the required profit in the numerator.)

Accepted Answer

A)   4,513
B)   4,750
C)   5,000
D)   5,250
E)   5,513F) A) and B)
G) B) and E)

Exam 15: Capital Structure

Correct Answer
verified

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

A firm's capital structure does not affect its free cash flows as discussed in the text, because FCF reflects only operating cash flows, which are available to service debt, to pay dividends to stockholders, and for other purposes.

Correct Answer
verified

Correct Answer
verified

An increase in the debt ratio will generally have no effect on which of these items?

Correct Answer
verified

Correct Answer
verified

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

Correct Answer
verified

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

Correct Answer
verified

Correct Answer
verified

Companies HD and LD have identical amounts of assets, investor-supplied capital, operating income Which of the following statements is CORRECT?

Correct Answer
verified

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

Correct Answer
verified

A firm's treasurer likes to be in a position to raise funds to support operations whenever such funds are needed, even in "bad times." This is called "financial flexibility," and the lower the firm's debt ratio, the greater its financial flexibility, other things held constant.

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

According to Modigliani and Miller (MM), in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Correct Answer
verified

A major contribution of the Miller model is that it demonstrates, other things held constant, that

Correct Answer
verified

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

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Exam 15: Capital Structure

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

A firm's capital structure does not affect its free cash flows as discussed in the text, because FCF reflects only operating cash flows, which are available to service debt, to pay dividends to stockholders, and for other purposes.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

An increase in the debt ratio will generally have no effect on which of these items?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Companies HD and LD have identical amounts of assets, investor-supplied capital, operating income Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

A firm's treasurer likes to be in a position to raise funds to support operations whenever such funds are needed, even in "bad times." This is called "financial flexibility," and the lower the firm's debt ratio, the greater its financial flexibility, other things held constant.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

According to Modigliani and Miller (MM), in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Correct AnswerverifiedShow Answer

A major contribution of the Miller model is that it demonstrates, other things held constant, that

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified