ch 16 2

A firm may file for Chapter 11 bankruptcy: I. in an attempt to gain a competitive advantage. II. using a prepack. III. while allowing the current management to continue running the firm. IV. only after the firm becomes insolvent. A. I and III only B. I and II only C. I, II, and IV only D. I, II, and III only E. I, II, III, and IV

1 2 3

Which of the following statements related to financial risk are correct? I. Financial risk is the risk associated with the use of debt financing. II. As financial risk increases so too does the cost of equity. III. Financial risk is wholly dependent upon the financial policy of a firm. IV. Financial risk is the risk that is inherent in a firm's operations. A. I and III only B. II and IV only C. II and III only D. I, II, and III only E. I, II, III, and IV

1 2 3

Which of the following are correct according to pecking-order theory? I. Firms stockpile internally-generated cash. II. There is an inverse relationship between a firm's profit level and its debt level. III. Firms avoid external debt at all costs. IV. A firm's capital structure is dictated by its need for external financing. A. I and III only B. II and IV only C. I, III, and IV only D. I, II, and IV only E. I, II, III, and IV

1 2 4

The present value of the interest tax shield is expressed as: A. (T C × D)/R A. B. V U + (T C × D). C. [EBIT × (T C × D)]/R U . D. [EBIT × (T C × D)]/R A. E. T c × D.

T x D

M & M Proposition II is the proposition that: A. the capital structure of a firm has no effect on the firm's value. B. the cost of equity depends on the return on debt, the debt-equity ratio, and the tax rate. C. a firm's cost of equity is a linear function with a slope equal to (R A - R D ). D. the cost of equity is equivalent to the required rate of return on a firm's assets. E. the size of the pie does not depend on how the pie is sliced.

a firms cost of equity is a linear function with a slope equal to ( RA - RD )

M & M Proposition I with tax supports the theory that: A. a firm's weighted average cost of capital decreases as the firm's debt-equity ratio increases. B. the value of a firm is inversely related to the amount of leverage used by the firm. C. the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield. D. a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm. E. a firm's cost of equity increases as the debt-equity ratio of the firm decreases.

a firms weighted average cost of capital decreases as the firms debt-equity ratio increases

Based on M & M Proposition II with taxes, the weighted average cost of capital: A. is equal to the aftertax cost of debt. B. has a linear relationship with the cost of equity capital. C. is unaffected by the tax rate. D. decreases as the debt-equity ratio increases. E. is equal to R U × (1 - T C ).

decresed as the debt equity ratio increased

The static theory of capital structure advocates that the optimal capital structure for a firm: A. is dependent on a constant debt-equity ratio over time. B. remains fixed over time. C. is independent of the firm's tax rate. D. is independent of the firm's weighted average cost of capital. E. equates the tax savings from an additional dollar of debt to the increased bankruptcy costs related to that additional dollar of debt.

equates the tax savings from an additional dollar of debt to the increases bankruptcy costs related to that additional dollar of debt

The business risk of a firm: A. depends on the firm's level of unsystematic risk. B. is inversely related to the required return on the firm's assets. C. is dependent upon the relative weights of the debt and equity used to finance the firm. D. has a positive relationship with the firm's cost of equity. E. has no relationship with the required return on a firm's assets according to M & M Proposition II.

has a positive relationship with the firms cost of equity

M & M Proposition II with taxes: A. has the same general implications as M & M Proposition II without taxes. B. states that a firm's capital structure is irrelevant. C. supports the argument that business risk is determined by the capital structure decision. D. supports the argument that the cost of equity decreases as the debt-equity ratio increases. E. concludes that the capital structure decision is irrelevant to the value of a firm.

has the same general implications as M and M proposition 2 without taxes

Which form of financing do firms prefer to use first according to the pecking-order theory? A. regular debt B. convertible debt C. common stock D. preferred stock E. internal funds

internal funds

A firm is technically insolvent when: A. it has a negative book value. B. total debt exceeds total equity. C. it is unable to meet its financial obligations. D. it files for bankruptcy protection. E. the market value of its stock is less than its book value.

it is unable to meet its financial obligations

Which one of the following has the greatest tendency to increase the percentage of debt included in the optimal capital structure of a firm? A. exceptionally high depreciation expenses B. very low marginal tax rate C. substantial tax shields from other sources D. low probabilities of financial distress E. minimal taxable income

low probabilities of financial distress

The capital structure that maximizes the value of a firm also: A. minimizes financial distress costs. B. minimizes the cost of capital. C. maximizes the present value of the tax shield on debt. D. maximizes the value of the debt. E. maximizes the value of the unlevered firm.

minimizes the cost of capital

Which one of the following is a direct bankruptcy cost? A. company CEO's time spent in bankruptcy court B. maintaining cash reserves C. maintaining a debt-equity ratio that is lower than the optimal ratio D. losing a key company employee E. paying an outside accountant fees to prepare bankruptcy reports

paying an outside accountant fees to prepare bankruptcy reports

Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding? A. consumer claim B. dividend payment to preferred shareholder C. company contribution to the employees' retirement account D. payment to an unsecured creditor E. payment of employee wages

payment of employee wages

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005: A. permits creditors to file a prepack immediately after a firm files for bankruptcy protection. B. prevents creditors from submitting any reorganization plans. C. prevents firms from filing for bankruptcy protection more than once. D. permits key employee retention plans only if an employee has another job offer. E. allows firms to pay bonuses to all key employees to entice those employees to remain in the firm's employ.

permits key employee retention plans only if an employee has another job offer

The interest tax shield is a key reason why: A. the required rate of return on assets rises when debt is added to the capital structure. B. the value of an unlevered firm is equal to the value of a levered firm. C. the net cost of debt to a firm is generally less than the cost of equity. D. the cost of debt is equal to the cost of equity for a levered firm. E. firms prefer equity financing over debt financing.

the net cost of debt to a firm is generally less than the cost of equity

The basic lesson of M & M Theory is that the value of a firm is dependent upon: A. the firm's capital structure. B. the total cash flow of the firm. C. minimizing the marketed claims. D. the amount of marketed claims to that firm. E. size of the stockholders' claims.

the total cash flow of the firm

M & M Proposition I with taxes is based on the concept that: A. the optimal capital structure is the one that is totally financed with equity. B. the capital structure of a firm does not matter because investors can use homemade leverage. C. a firm's WACC is unaffected by a change in the firm's capital structure. D. the value of a firm increases as the firm's debt increases because of the interest tax shield. E. the cost of equity increases as the debt-equity ratio of a firm increases.

the value of a firm increases as the firms debt increases because of the interest tax shield

Bankruptcy: A. creates value for a firm. B. transfers value from shareholders to bondholders. C. technically occurs when total equity equals total debt. D. costs are limited to legal and administrative fees. E. is an inexpensive means of reorganizing a firm.

transfers value from shareholders to bondholders

Which one of the following statements related to Chapter 7 bankruptcy is correct? A. A firm in Chapter 7 bankruptcy is reorganizing its operations such that it can return to being a viable concern. B. Under a Chapter 7 bankruptcy, a trustee will assume control of the firm's assets until those assets can be liquidated. C. Chapter 7 bankruptcies are always involuntary on the part of the firm. D. Under a Chapter 7 bankruptcy, the claims of creditors are paid prior to the administrative costs of the bankruptcy. E. Chapter 7 bankruptcy allows a firm to restructure its equity such that new shares of stock are generally issued prior to the firm coming out of bankruptcy.

under chapter 7 bankruptcy a trustee will assume control of the firm assets until those assets can be liquidated

Corporations in the U.S. tend to: A. minimize taxes. B. underutilize debt. C. rely less on equity financing than they should. D. have relatively similar debt-equity ratios across industry lines. E. rely more heavily on debt than on equity as the major source of financing.

underutilize debt

If a firm has the optimal amount of debt, then the: A. direct financial distress costs must equal the present value of the interest tax shield. B. value of the levered firm will exceed the value of the firm if it were unlevered. C. value of the firm is minimized. D. value of the firm is equal to V L + T C × D. E. debt-equity ratio is equal to 1.0.

value of the levered firm will exceed the value of the firm if it were unlevered

In general, the capital structures used by U.S. firms: A. tend to overweigh debt in relation to equity. B. generally result in debt-equity ratios between 0.45 and 0.60. C. are fairly standard for all SIC codes. D. tend to be those which maximize the use of the firm's available tax shelters. E. vary significantly across industries.

vary significantly across industries

The optimal capital structure: A. will be the same for all firms in the same industry. B. will remain constant over time unless the firm changes its primary operations. C. will vary over time as taxes and market conditions change. D. places more emphasis on operations than on financing. E. is unaffected by changes in the financial markets.

will vary over times as taxes and market conditions change

The interest tax shield has no value when a firm has a: I. tax rate of zero. II. debt-equity ratio of 1. III. zero debt. IV. zero leverage. A. I and III only B. II and IV only C. I, III, and IV only D. II, III, and IV only E. I, II, and IV only

zeros