Corporate Finance Final

Which answer is correct in order of priority of payment: 1) Payment to common shareholders. 2) Bankruptcy administrative expenses. 3)Consumer claims. 4)Wages, salaries, and commissions

2) 4) 3) 1)

Which one the followings is the operating cycle in order from first to last. 1. Sell the finished product, 2. Order inventory, and 3. Collect cash from the sale

2.1.3

Between the 1960's and the present time, current liabilities have risen from about 20% of total liabilities to almost _______ percent.

30

Receivables period equals ______ days divided by the receivables turnover.

365

nventory period equals ______ days divided by the inventory turnover.

365

Which of the following represents a use of cash?

Accounts receivable increases Repurchasing stock Paying off a loan

Which of the following are examples of cash disbursements?

Capital expenditures Payments of accounts payable Wages and taxes

A corporation gains no value from an interest tax shield if which of the following are true?

Corporate tax rates are zero. The corporation is an all-equity firm. The corporation has no debt.

What does a receivables turnover ratio of 57 mean?

Customers took, on average, 57 days to pay.

What does maturity hedging involve?

Financing fixed assets with long-term financing and inventories with short-term financing

Which of the following activities decrease cash?

Increasing fixed assets Decreasing equity

Bankruptcy is very valuable because

It can be used strategically to improve a firm's competitive position. Payments to creditors cease pending the outcome of the bankruptcy process. Answers: It can be used strategically to improve a firm's competitive position.

What is generally the most important component of direct bankruptcy costs?

Legal costs

Which of the following are direct costs of financial distress?

Legal fees Administrative expenses

Which of the following is not a characteristic of commercial paper?

Maturities of 1 year or more

Which of the following activities by a firm will increase cash?

Obtaining a loan Selling bonds Selling stock

Which activities are primary to short-term finance?

Operating activities Financing activities

Which of the following are shortage costs?

Order costs Safety reserve costs

The present value of the interest tax shield equals what?

TC x D

How does the level of debt affect the weighted average cost of capital (WACC)?

The WACC initially falls and then rises as debt increases.

According to MM Proposition I, the value of a firm is the same for debt financing as it is for equity financing because of which of the following?

The asset to be financed is the same MM demonstrated that debt financing is neither better nor worse than equity financing The asset to be financed is the same.

Which of the following will apply when a firm's debt levels are extremely high?

The benefits of debt financing may be more than offset by the costs of financial distress. The possibility of financial distress will become a chronic problem.

Which of the following are generally true about the cost of equity and the cost of debt?

The cost of equity may increase with leverage. The cost of debt is generally lower than the cost of equity. The cost of debt increases with leverage.

Which of the following statements are true regarding the effect of financial leverage and the firm's operating earnings (EBIT)?

The rate of return on assets is unaffected by leverage.

What is the expression for the value of a levered firm in the presence of corporate taxes?

Value of Levered Firm = Value of Unlevered Firm + Tax Benefit of Debt

An investor who invests in the stock of a levered firm rather than in an all-equity firm will require

a higher expected return

Although flexible short-term financial polices are more costly, they result in

a reduced probability of financial distress

A flexible short-term financing strategy implies:

a relatively large pool of marketable securities cash surpluses

A restrictive short-term financing strategy implies

a small investment in net working capital possible cash shortages

Current liabilities are firm obligations that will require cash payment within

a year

The ___ period is the time between the receipt of inventory and actually paying for that inventory.

accounts payable

The cash cycle is equal to the operating cycle minus the ______ period.

accounts payable

What is the primary duty as payables manager.

accounts payables

The operating cycle equals the sum of the inventory period and the ______ period.

accounts receivable

What is the primary duty as credit manager.

accounts receviable

Bankruptcy costs may exceed the tax shield benefits of ________

debt

The optimal level of debt in the presence of corporate taxes and bankruptcy costs occurs at the point at which the present value of distress costs _____ the present value of the tax shield benefits.

equals

Shortage costs are those that ______ when the level of investment in current assets is high.

fall

Based on MM Proposition I, even including taxes, capital structure does not matter to the firm.

false

Cash collections equals beginning cash times sales.

false

Current assets are cash and other assets that are expected to convert to cash within 1-5 years.

false

An optimal capital structure will

minimize the cost of capital maximize the value of the firm

The possibility of bankruptcy costs has a(n) ______ effect on the value of the firm.

negative

The value of a levered firm in MM Proposition I with corporate taxes equals the value of an all equity firm

plus the tax rate times the value of debt

Either stock-out or cash-out costs occur when a firm

runs out of inventory to sell runs out of available cash

Unsecured bank loans are:

short term

Ideally, short-term assets are financed with

short term liabilities

The financing of current assets is measured by the proportion of:

short-term debt and long-term debt used to finance current assets

It is possible for the present value of distress costs to exceed the present value of tax savings.

true

MM demonstrated that debt financing is neither better nor worse than equity financing.

true

Non-committed lines of credit...

are informal arrangements generally specify a maximum amount that can be borrowed

The costs of financial distress depend mostly on how easily the ownership of the firm's ________ can be transferred.

assets

The optimal balance of current ________ occurs where the sum of the carrying costs and the shortage costs is at a minimum.

assets

The fact that failure to meet debt obligations can result in bankruptcy is

bad for the firm

The gap between short-term cash inflows and outflows can be filled by ___.

borrowing maintaining a liquidity reserve

The equity risk that comes from the nature of a firm's operating activities is known as:

business risk

Short-term finance is concerned with current assets and current liabilities, whereas long-term finance is concerned with

capital budgeting dividend policy capital structure

The time between paying cash for inventory and receiving cash from selling a product is called the ______.

cash cycle

A committed line of credit is a more formal arrangement typically involving a

commitment fee

Ending accounts receivable equals starting accounts receivable plus ______ minus collections.

credit sales

Commercial paper is an example of a:

debt security

The cost of debt will begin to increase as the:

degree of leverage increases

Which costs of financial distress are easier to measure?

direct costs

Which two of the following are broad types of costs of financial distress?

direct costs, indirect costs

According to M&M Proposition I, a firm's capital structure choices:

do not affect the value of the firm

Direct costs are very difficult to measure and, thus, are often estimated.

false

Holding equity in an unlevered firm has no risk.

false

Other important sources of short-term financing for a company include short-term stocks.

false

The legal process of bankruptcy is typically quick and inexpensive.

false

An investor who buys the common stock of a levered firm is subject to more risk due to the addition of

financial risk

The equity risk that comes from the financial policy or capital structure decisions of the firm is known as:

financial risk

Uses of cash can involve increasing a(n) ______ account.

fixed asset non cash current asset

A short-term financial policy involving a higher proportion of long-term debt than short-term debt is classified as a(n) ______ policy.

flexible

The tax deductibility of interest payments is?

good for the firm

The value of a levered firm will be_______, Incorrect Unavailable than the value of an identical unlevered firm because the levered firm's taxes will be

greater lower

Equity carries risk thus an investor should expect a ________, Correct Unavailable return than that on less risky debt.

higher

An individual can duplicate a levered firm through a strategy called ______ leverage where the investor uses his own funds plus borrowed funds to buy stocks.

homemade

With ______ ______, an investor is able to replicate a corporation's capital structure by borrowing funds and using those funds along with their own money to buy the company's stock

homemade leverage

M&M Proposition I states if the assets and operations (left-hand side of the balance sheet) for two firms are the same, then

how the firms are financed is irrelevant the value of the two firms is equal

If the degree of leverage increases, the cost of debt will

increase

Which of the two types of costs of bankruptcy are more difficult to quantify?

indirect costs

With the flexible approach, the firm finances ________, while with the restrictive approach, the firm finances

internally, externally

The time it takes to acquire and sell inventory is called the ______ period.

inventory

For US corporations, current assets have fallen from 50% of total assets in the 1960s to 40% of total assets today primarily because of more efficient:

inventory management cash management

MM Proposition I does not work with corporate taxes because:

levered firms pay lower taxes than unlevered firms

The value of a levered firm will be greater than the value of an identical unlevered firm because the levered firm's taxes will be

lower

What decision has to be made when companies sell a product?

should credit be extended?

It is often in everyone's best interest to devise a "workout" strategy that avoids bankruptcy because:

the bankruptcy process can be long and expensive

MM Proposition II shows that

the cost of equity rises with leverage.

The two major elements of a firm's short-term financial policy are

the financing of current assets the size of the firm's investment in current assets

A beneficial rule to follow is to set the firm's capital structure so that ___.

the firm's value is maximized

The Static Theory of Capital Structure suggests employing debt to the point that its cost equals the cost of

the increased probability of bankruptcy

The tax savings attained by a firm from the tax deductibility of interest expense is called

the interest tax shield

Other important sources of short-term financing besides secured and unsecured borrowing for a company are:

trade credit commercial pape

The idea that a firm borrows to the point that the tax benefit of debt is exactly equal to the increased probability of financial distress is called the _________ theory of capital structure

trade-off

Current liabilities are obligations that are expected to require cash payment within one year.

true

Firm value is maximized when the WACC is minimized.

true

The net payments receivable equals the cash collections minus the cash disbursements.

true

The payables turnover equals the cost of goods sold divided by the average payables.

true

What decision has to be made when companies buy raw materials?

what is the desired level of inventory?