Fin6300-Ch15

Which of the following statements is CORRECT?

All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio.

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

An increase in the corporate tax rate is likely to encourage a company to use more debt in its capital structure.

Companies HD and LD have identical amounts of assets, operating income (EBIT), tax rates, and business risk. Company HD, however, has a much higher debt ratio than LD. Company HD's basic earning power ratio (BEP) exceeds its cost of debt (rd). Which of the following statements is CORRECT?

Company HD has a higher return on equity (ROE) than Company LD, and its risk, as measured by the standard deviation of ROE, is also higher than LD's.

Companies HD and LD have identical tax rates, total assets, and basic earning power ratios, and their basic earning power exceeds their before-tax cost of debt, rd. However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT?

Company HD has a lower ROA than Company LD.

Which of the following statements is CORRECT?

If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.

Firms U and L each have the same amount of assets, and both have a basic earning power ratio of 20%. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm L's debt has a before-tax cost of 8%. Both firms have positive net income. Which of the following statements is CORRECT?

Firm L has a lower ROA than Firm U.

Companies HD and LD have the same total assets, operating income (EBIT), tax rate, and business risk. Company HD, however, has a much higher debt ratio than LD. Also HD's basic earning power (BEP) exceeds its cost of debt (rd). Which of the following statements is CORRECT?

HD should have a higher return on equity (ROE) than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD's.

Which of the following statements is CORRECT?

In general, a firm with low operating leverage also has a proportion of its total costs in the form of fixed costs.

The firm's target capital structure should be consistent with which of the following statements?

Minimize the weighted average cost of capital (WACC)

Blemker Corporation has $500 million of total assets, its basic earning power is 15%, and it currently has no debt in its capital structure. The CFO is contemplating a recapitalization where it will issue debt at a cost of 10% and use the proceeds to buy back shares of the company's common stock, paying book value. If the company proceeds with the recapitalization, its operating income, total assets, and tax rate will remain unchanged. Which of the following is most likely to occur as a result of the recapitalization?

The ROE would increase.

Which of the following statements is CORRECT?

The capital structure that maximizes the stock price is also the capital structure that minimizes the weighted average cost of capital (WACC).

Which of the following statements is CORRECT?

The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price.

Reynolds Resorts is currently 100% equity financed. The CFO is considering a recapitalization plan under which the firm would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock. The recapitalization would not change the company's total assets, nor would it affect the firm's basic earning power, which is currently 15%. The CFO believes that this recapitalization would reduce the WACC and increase stock price. Which of the following would also be likely to occur if the company goes ahead with the recapitalization plan?

The company's cost of equity would increase.

Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

The corporate tax rate increases.

Which of the following statements is CORRECT?

The debt ratio that maximizes EPS generally exceeds the debt ratio that maximizes share price.

Which of the following statements is CORRECT?

The factors that affect a firm's business risk are affected by industry characteristics and economic conditions. Unfortunately, these factors are generally beyond the control of the firm's management.

Which of the following statements is CORRECT?

The optimal capital structure simultaneously maximizes stock price and minimizes the WACC.

If debt financing is used, which of the following is CORRECT?

The percentage change in net income will be greater than the percentage change in net operating income.

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT? As a firm increases the operating leverage used to produce a given quantity of output, this will

normally lead to an increase in its fixed assets turnover ratio.