FIN 300 CH 12
12.6 Q01: Among industrialized countries, which of the following uses the lowest proportion of debt?
The United Kingdom
12.5 Q01: According to the basic capital structure theory proposed by Modigliani and Miller (MM), when will a firm's value be maximum?
When it is financed with almost 100 percent through debt.
12.5 Q07: According to the signaling theory, when should a firm use debt to finance beyond the normal target capital structure?
When the firm has favorable prospects
12.3 03: A firm's assets are finance with 60 percent debt and 40 percent common equity. As a result, we know that the firm must have:
a degree of financial leverage (DFL) that is greater than 1.0.
12.5 Q13: The situation in which managers have different (better) information about their firm's prospects than outside investors is known as _____ information.
asymmetric
12.4 Q02: If a firm's times-interest-earned (TIE) ratio decreases, the probability that it will default on its outstanding debt also decreases.
false
12.4 Q04: It is fairly easy to determine how changes in a firm's degree of financial leverage (DFL) affect its P/E ratio.
false
12.5 Q05: According to the signaling theory to explain differences in firms' capital structures, an announcement of a new stock issue by a mature, seasoned firm that has numerous financing alternatives generally is seen as a signal that the its future prospects are very positive.
false
12.5 Q09: At the time Modigliani and Miller (MM) developed their capital structure theory, the assumptions that they made were realistic.
false
12.5 Q12: The probability of incurring bankruptcy increases as a firm's debt/equity ratio decreases.
false
12.1 05: If a firm increases the proportions of debt and preferred stock that are contained in its capital structure, its _____.
financial risk will increase
12.1 06: Operating leverage refers to the presence of _____.
fixed operating costs
12.5 Q10: Everything else equal, if a firm with favorable future prospects raises funds by issuing new shares of common stock, _____.
the price of its stock will increase when future profits are realized by the firm
12.3 12: The percentage change in earnings per share (EPS) that results from a given percentage change in sales is known as the firm's degree of_____ leverage. financial
total
12.1 07: The degree of operating leverage is defined as the percentage change in earnings before interest and taxes (EBIT) associated with a given percentage change in sales.
true
12.1 08: The optimal capital structure is the capital structure that strikes a balance between risk and return such that the firm's stock price is maximized.
true
12.5 Q06: According to the signaling theory to explain differences in firms' capital structures, if a firm raises new capital by issuing debt rather than by issuing stock, it is a signal that the firm has very good future prospects.
true
12.6 Q04: In countries where capital gains are not taxed, investors should prefer to own stocks rather than debt compared to investors in countries where capital gains are taxed.
true
12.1 04: Financial leverage is the:
extent to which fixed-income securities are used in a firm's capital structure.
12.2 10: If the debt/assets ratio increases, the costs of both debt and equity normally decrease.
false
12.1 03: Everything else equal, and for one particular firm, in which of the following capital structures would the common stockholders have to bear the greatest amount of business risk?
1 percent equity and 99 percent debt
12.3 15: Which of the following statements concerning a firm's degree of financial leverage (DFL) is correct?
A higher DFL suggests that higher risk is associated with the firm's mix of debt and equity financing.
12.5 Q04: According to the signaling theory that has been proposed to explain differences in firms' capital structures, which of the following actions by the management is taken as a signal that a firm's future prospects are not bright (i.e., not good)? (Assume that the firm has multiple financing alternatives.)
A mature company raises new capital by issuing of new shares of common stock.
12.6 Q10: Which of the following statements is true of the capital structure of companies in Germany?
Companies in Germany raise most of their corporate debt through bank loans.
12.6 Q08: Which of the following statements concerning the capital structures of Japanese companies is correct?
Companies in Japan use greater proportions of debt than companies in most other countries.
12.3 16: Which of the following statements concerning a firm's degree of financial leverage (DFL) is correct? Assume everything else is equal.
Compared to a lower DFL, a higher DFL implies a greater financial risk.
12.5 Q08: According to the trade-off theory that has been suggested as a possible explanation for the differences in firms' capital structures that we observe in the real world, which of the following securities is the least expensive form of financing for a particular firm?
Corporate debt
12.6 Q06: Which of the following statements concerning capital structures around the world is correct?
Differences among countries in both bankruptcy costs and equity reporting costs leads to the conclusion that U.S. firms should have more equity and less debt than firms in Japan and Germany.
12.3 09: The degree of financial leverage (DFL) is defined as the percentage change in ______ that results from a particular percentage change in _____.
EPS; EBIT
12.1 02: A firm's risk can be partitioned into financial risk and business risk. An increase in the financial risk results in a decrease in business risk.
False
12.6 Q02: Companies in Italy and Japan use less debt in their capital structures than companies in the United States and Canada. True
False
12.1 12: Which of the following industries normally has relatively low business risk?
Firms that produce staple goods, such as grocery stores and utility companies
12.3 14: What does a degree of financial leverage (DFL) of 2.0 indicate?
For every 1 percent change in its EBIT, the firm's EPS will change by 2 percent.
12.4 Q07: Which of the following statements concerning a firm's times-interest earned (TIE) ratio is correct?
Generally the lower its TIE ratio, the higher the probability that the firm will default on its debt.
12.4 Q08: Which of the following statements is true about the relationship between the debt/assets ratio and the times-interest-earned ratio (TIE) of a firm? Consider everything else equal.
If the debt/assets ratio decreases, the TIE ratio will increase.
12.6 Q09: Which of the following statements is correct?
In countries where capital gains are not taxed, investors should prefer to own stocks rather than bonds.
12.6 Q07: Which of the following statements concerning differences in capital structures and financing alternatives around the world is correct?
In many countries, the costs to monitor companies' debt are lower than in the United States because foreign firms use substantially greater amounts of bank loans to finance assets than do U.S. companies.
12.1 13: Which of the following is considered a component of financial risk?
Interest payments on bonds
12.5 Q14: Which of the following is a major advantage of debt financing?
Interest payments on debt are a tax-deductible expense to the issuing firm.
12.4 Q06: What is the formula for calculating the times-interest earned (TIE) ratio?
TIE ratio = Earnings before interest and taxes ÷ Interest charges
12.1 14: Which of the following situations would intensify the business risk borne by a firm's common stockholders?
The firm issues new fixed-income securities, such as bonds, to raise funds to support operations.
12.1 11: Which of the following factors would tend to reduce a firm's business risk?
The firm takes actions to improve the stability of its day-to-day operations.
12.3 06: Everything else equal, in which of the following situations will a firm's degree of operating leverage (DOL) increase? Assume the firm currently generates a positive net operating income.
The firm's sales move closer to its operating breakeven point.
12.1 15: Which of the following would be considered part of a firm's business risk?
The general liability that is associated with the product line the firm manufactures and sells
12.4 Q03: ________ is a measure that indicates a firm's ability to meet the annual interest obligations on its outstanding debt.
Times-interest-earned (TIE) ratio
12.6 Q05: In the United States, equity monitoring costs are lower than most other developed countries.
True
12.6 Q03: Equity monitoring costs are lower in the United States than in other countries because:
U.S. companies must comply with fairly stringent financial audit requirements.
12.2 07: At its optimal capital structure, the firm's debt/assets ratio will always be lower than the one that maximizes its _____.
expected earnings per share (EPS)
12.1 10: The risk associated with a firm's operations, ignoring any financing effects, is known as _____ risk.
business
12.1 01: A firm's ______ is the combination of debt and equity it uses to finance its assets.
capital structure
12.2 02: A company's capital structure consists of common stock only, which amounts to $14 million. However, this year, the company plans to issue $7 million of debt, and use the proceeds to repurchase $7 million of its existing equity. The stock repurchase should not change the size of the company. As a result, any change in the firm's earnings per share (EPS) must be a result of the change in its:
capital structure
12.3 13: Top-Shelf Construction discovered that for every 1 percent decrease in its sales, its earnings before interest and taxes (EBIT) decrease by 3.2 percent. Based on this information, we know that Top-Shelf Construction has a:
degree of operating leverage (DOL) equal to 3.2.
12.3 08: Suppose that a firm has a degree of financial leverage (DFL) that is greater than 1.0; that is, DFL > 1. If the firm's sales decrease by 1 percent, its ______ will decrease by more than 1 percent.
earnings per share (EPS)
12.5 Q02: According to the capital structure theory proposed by the Modigliani and Miller (MM), a firm's optimal capital structure is the mix of debt and equity that minimizes its weighted average cost of capital (WACC), which occurs when the firm is financed almost entirely with debt. MM argued that their conclusion is valid primarily because, in the real world, ______.
interest paid on corporate debt is a tax-deductible expense to the firm, whereas dividends paid to stockholders are not.
12.5 Q11: Symmetric information is defined as the situation in which _______.
investors and managers have identical information about the firm's prospects
12.2 06: As a general rule, the optimal capital structure is the one that:
maximizes its stock price and minimizes its weighted average cost of capital.
12.2 05: A firm's optimal capital structure is the combination of debt financing and equity financing that ______.
maximizes its stock price.
12.4 Q01: A times-interest-earned (TIE) ratio that is less than 1 suggests that a firm _____.
might not be able to meet its annual interest obligations on its debt
12.2 03: A firm sets a target capital structure to use when raising new funds in an effort to:
minimize its weighted average cost of capital (WACC).
12.1 09: The presence of fixed operating costs is known as _____.
operating leverage
12.3 11:The percentage change in earnings before interest and taxes (EBIT) associated with a given percentage change in sales is known as the degree of _____.
operating leverage
12.2 12: The combination of debt financing and equity financing that maximizes a firm's value is known as its:
optimal capital structure.
12.3 01: A degree of operating leverage (DOL) equal to 1.5 times indicates that for every 1 percent change in _____.
sales there will be a 1.5 percent change in earnings before interest and taxes (EBIT)
12.5 Q03: According to the signaling theory, a firm with unfavorable future prospects might issue common stock in an effort to:
share any losses with new stockholders (owners).
12.2 04: A firm should raise capital according to its optimal capital structure so as to maximize its _____.
stock price