Chapter 17 Quiz, Does Debt Policy Matter?
1.
Capital structure of the firm can be defined as:
A.
The firm's mix of different securities
B.
The firm's debt-equity ratio
C.
The market imperfection that the firm's manager can exploit
D.
All of the above
2.
Modigliani and Miller's Proposition I states that:
A.
The market value of a firm's common stock is independent of its capital structure
B.
The market value of a firm's debt is independent of its capital structure
C.
The market value of any firm is independent of its capital structure
D.
None of the above
3.
The law of conservation of value implies that:
A.
The mix of senior and subordinated debt does not affect the value of the firm
B.
The mix of convertible and non-convertible debt does not affect the value of the firm
C.
The mix of common stock and preferred stock does not affect the value of the firm
D.
All of the above
4.
For an all equity firm,
A.
As earnings before interest and taxes (EBIT) increases, the earnings per share (EPS) increases by the same percent
B.
As EBIT increases, the EPS increases by a larger percent
C.
As EBIT increases, the EPS decreases
D.
None of the above
5.
When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of operating income because:
A.
Interest payments on the debt vary with EBIT levels
B.
Interest payments on the debt stay fixed leaving less income to be distributed over less shares
C.
Interest payments on the debt stay fixed, leaving more income to be distributed over less shares
D.
Interest payments on the debt stay fixed, leaving less income to be distributed over more shares
E.
Interest payments on the debt stay fixed, leaving more income to be distributed over more shares
6.
Earn and Learn Company is financed entirely by Common stock which is priced to offer a 20% expected return. If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%, what is the expected return on the common stock after refinancing?
A.
20%
B.
28%
C.
32%
D.
None of the above
7.
The cost of capital for a firm, r
WACC
, in a tax free environment is:
A.
Equal to the expected EBIT divided by market value of the unlevered firm
B.
Equal to r
A
, the rate of return for that business risk class
C.
Equal to the overall rate of return required on the levered firm
D.
All of the above
E.
None of the above
8.
A firm has a debt-to-equity ratio of 0.50. Its cost of debt is 12%. Its overall cost of capital is 16%. What is its cost of equity if there are no taxes?
A.
13%
B.
16%
C.
15%
D.
18%
E.
None of the above
9.
The beta of an all equity firm is 1.2 If the firm changes its capital structure to 50% debt and 50% equity using 8% debt financing, what will be the beta of the levered firm? The beta of debt is 0.2. (Assume no taxes.)
A.
1.2
B.
2.4
C.
2.2
D.
None of the above
10.
The Seifert Company is financed by $2 million (market value) in debt and $3 million (market value) in equity. The cost of debt is 10% and the cost of equity is 15%. Calculate the weighted average cost of capital. (Assume no taxes.)
A.
10%
B.
15%
C.
13%
D.
None of the above
11.
Minimizing the weighted average cost of capital is the same as:
A.
Maximizing the market value of the firm
B.
Maximizing the market value of the firm only if MM's Proposition I holds
C.
Maximizing the profits of the firm
D.
None of the above
12.
Financial leverage increases the expected return and risk of the shareholder.
A.
True
B.
False
13.
Expected return on assets depends on several factors including the firm's capital structure.
A.
True
B.
False
14.
The beta of the firm is equal to the weighted average of the betas on its debt and equity.
A.
True
B.
False
15.
Since the expected rate of return on debt is less than the expected rate of return on equity, the weighted average cost of capital declines as more debt is issued.
A.
True
B.
False
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