Capital Structure connect
________ risk is the type of equity risk related to a firm's capital structure policy. -Market -Systematic Static -Business -Financial
Financial
Which one of the following is a direct cost of bankruptcy? -Bypassing a positive NPV project to avoid additional debt - Investing in cash reserves -Maintaining a debt-equity ratio that is lower than the optimal ratio -Losing a key company employee - -Paying an outside accountant to prepare bankruptcy reports
Paying an outside accountant to prepare bankruptcy reports
The symbol "RU" refers to the cost of capital for a(n) ______ while "RA" represents the: -privately owned entity; unlevered cost of capital. -all-equity company; weighted average cost of capital. -levered company; cost of capital for an all-equity company. -levered company; weighted average cost of capital. -unlevered company; average cost of equity.
all-equity company; weighted average cost of capital.
According to pecking-order theory: -there is a direct relationship between a company's profits and its debt levels. -companies avoid external debt except as a last resort. -a company's capital structure is independent of its need for external funding. -companies stockpile internally generated cash. -every company has an optimal capital structure.
companies stockpile internally generated cash.
Ignoring taxes, at the break-even point between a levered and an unlevered capital structure, the:
company is earning just enough to pay for the cost of the debt.
The interest tax shield is a key reason why:
the net cost of debt is generally less than the cost of equity.
Which one of these statements related to Chapter 11 bankruptcy is accurate? -Prepacks apply only to Chapter 7, not Chapter 11, bankruptcies. -Senior management must be replaced prior to exiting a Chapter 11 bankruptcy. - A company can only file for Chapter 11 after it becomes totally insolvent. -Companies sometimes file for Chapter 11 in an attempt to gain a competitive advantage. -Chapter 11 involves the total liquidation of the bankrupt firm.
Companies sometimes file for Chapter 11 in an attempt to gain a competitive advantage.
The optimal capital structure has been achieved when the:
debt-equity ratio results in the lowest possible weighted average cost of capital.
Based on M&M Proposition I with taxes, the weighted average cost of capital: -is equal to the aftertax cost of debt. -has a linear relationship with the cost of equity capital. -is unaffected by the tax rate. -- -decreases as the debt-equity ratio increases. -is equal to RU(1 − TC).
decreases as the debt-equity ratio increases.
In an effort to avoid bankruptcy, a firm may incur certain costs, called ________ costs. -flotation direct -bankruptcy -indirect bankruptcy -financial solvency -capital structure
inderect bankruptcy
The absolute priority rule determines:
which parties receive payment first in a bankruptcy proceeding.
________ risk is the type of equity risk that is most related to the daily operations of a firm. Extrinsic Market Systematic Business Financial
Business
Which one of the following is a marketed claim against the cash flows of a company?
Dividend payment to shareholders
The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as _____ costs.
direct bankruptcy
According to ________, a company borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs. -the static theory of capital structure -M&M Proposition I with taxes -M&M Proposition II with taxes the -- -pecking-order theory -the open markets theorem
the static theory of capital structure
Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Ignore taxes. -At the break-even point, there is no advantage to debt. -The earnings per share will equal zero when EBIT is zero for a levered firm. -The advantages of leverage are inversely related to the level of EBIT. -The use of leverage at any level of EBIT increases the EPS. -EPS are more sensitive to changes in EBIT when a firm is unlevered.
At the break-even point, there is no advantage to debt.
Which one of the following is a marketed claim against the cash flows of a company? -Tax payment to the IRS Dividend -payment to shareholders -Payment of employees' wages -Payment for warranty work on a product produced by the company -Payment of legal claim against the company
Dividend payment to shareholders
The concept of homemade leverage is most associated with: -M&M Proposition I with no tax. -M&M Proposition II with no tax. -M&M Proposition I with tax. M&M Proposition II with tax. -the static theory proposition.
M&M Proposition I with no tax.
According to ________, the value of a company is unrelated to its capital structure. -the homemade leverage principle M&M Proposition I, -no tax M&M Proposition II, -no tax the pecking-order theory the static theory of capital structure
M&M Proposition I, no tax
According to ________, the cost of equity capital is directly and proportionally related to capital structure. -the static theory of capital structure -M&M Proposition I -M&M Proposition II -the homemade leverage principle the -pecking-order theory
M&M Proposition II
According to ________, the cost of equity capital is directly and proportionally related to capital structure.
M&M Proposition II
Which one of the following statements is accurate? A. Capital structure has no effect on shareholder value. B.The optimal capital structure occurs when the cost of equity is minimized. -C.The optimal capital structure maximizes shareholder value. D.Shareholder value is maximized when WACC is also maximized. E. Unlevered firms have more value than levered firms when firms are profitable.
The optimal capital structure maximizes shareholder value.
According to M&M Proposition II, without taxes, which of the following statements is accurate? -The cost of equity remains constant as the debt-equity ratio increases. -The cost of equity is inversely related to the debt-equity ratio. -The required return on assets is equal to the weighted average cost of capital. -Financial risk determines the return on assets. -Financial risk is unaffected by the debt-equity ratio.
The required return on assets is equal to the weighted average cost of capital.
Which one of the following statements related to Chapter 7 bankruptcy is correct? -A company in Chapter 7 bankruptcy is reorganizing its operations such that it can return to being a viable concern. -- -Under a Chapter 7 bankruptcy, a trustee will assume control of the company's assets until those assets can be liquidated. -Chapter 7 bankruptcies are always involuntary on the part of the firm. Under a Chapter 7 bankruptcy, the claims of creditors are paid prior to the administrative costs of the bankruptcy. -Chapter 7 bankruptcy allows a firm to restructure its equity such that new shares of stock can be issued.
Under a Chapter 7 bankruptcy, a trustee will assume control of the company's assets until those assets can be liquidated.
M&M Proposition I with tax implies that the:
WACC decreases as the debt-equity ratio increases.
M&M Proposition II, without taxes, is the proposition that: -the capital structure of a company has no effect on that company's value. the cost of equity depends on the return on debt, the debt-equity ratio, and the tax rate. -a company's cost of equity is a linear function with a slope equal to (RA − RD). the cost of equity is equivalent to the required rate of return on assets. - the size of the pie does not depend on how the pie is sliced.
a company's cost of equity is a linear function with a slope equal to (RA − RD).
M&M Proposition I with no tax supports the argument that: -business risk has no effect on the return on assets. -the cost of equity rises as leverage rises. -a company's debt-equity ratio is completely irrelevant. -business risk is irrelevant. -homemade leverage is irrelevant.
a company's debt-equity ratio is completely irrelevant.
Ignoring taxes, at the break-even point between a levered and an unlevered capital structure, the: -company is earning just enough to pay for the cost of the debt. -company's earnings before interest and taxes are equal to zero. -earnings per share for the levered option are exactly double those of the unlevered option. - advantages of leverage exceed the disadvantages of leverage. -company has a debt-equity ratio of .50.
company is earning just enough to pay for the cost of the debt.
The optimal capital structure has been achieved when the: -debt-equity ratio is equal to 1. -weight of equity is equal to the weight of debt. -cost of equity is maximized given a pretax cost of debt. -debt-equity ratio is such that the cost of debt exceeds the cost of equity. ---debt-equity ratio results in the lowest possible weighted average cost of capital.
debt-equity ratio results in the lowest possible weighted average cost of capital.
Financial risk is: -The risks inherent in a company's operations. -a type of unsystematic risk. -inversely related to the cost of equity. -dependent upon a company's capital structure. -irrelevant to the value of a company.
dependent upon a company's capital structure.
The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as _____ costs. -flotation -issue -direct bankruptcy -indirect bankruptcy -unlevered
direct bankruptcy
According to the static theory of capital structure, the optimal capital structure for a company: -is highly dependent upon a constant debt-equity ratio over time. -remains fixed over time. -is independent of the company's tax rate. - is independent of the company's debt-equity ratio. -equates marginal tax savings from additional debt to the marginal increased bankruptcy costs of that debt.
equates marginal tax savings from additional debt to the marginal increased bankruptcy costs of that debt.
M&M Proposition II with taxes: -has the same general implications as M&M Proposition II without taxes. -states that capital structure is irrelevant to shareholders. -supports the argument that business risk is determined by the capital structure decision. -supports the argument that the cost of equity decreases as the debt-equity ratio increases. -concludes that the capital structure decision is irrelevant to the value of a firm.
has the same general implications as M&M Proposition II without taxes.
The existence of ________ makes the capital structure of a company irrelevant.
homemade leverage
In an effort to avoid bankruptcy, a firm may incur certain costs, called ________ costs.
indirect bankruptcy
By increasing its interest expense by $2,500 last year, Bishara Foods was able to reduce its taxes by $525. This $525 amount is called the: -interest tax shield. -interest credit. -homemade leverage shield. -current tax yield. -tax-loss interest.
interest tax shield.
According to the pecking-order theory, firms prefer to use ________ before any other form of financing. -regular -debt convertible -debt common stock -preferred stock -internal funds
internal funds
Homemade leverage is employed when a(n) ________: -corporation uses debt to pay dividends to shareholders. -corporation uses debt exclusively to fund a corporate expansion project. -investor uses debt to change his or her exposure to financial leverage. -firm increases its level of debt. -firm employs any amount of debt in its capital.
investor uses debt to change his or her exposure to financial leverage.
Bankruptcy Fraud -occurs when total equity is negative. -is a legal proceeding. -occurs when a company cannot meet its financial obligations. -refers to a loss of value for debt holders. - is an inexpensive means of reorganizing a company.
is a legal proceeding.
The business risk of a company: -depends on the company's level of unsystematic risk. -is inversely related to the required return on the company's assets. -is dependent upon the relative weights of the debt and equity used to finance the company. -is positively related to the company's cost of equity. -has no relationship with the required return on a company's assets according to M&M theory.
is positively related to the company's cost of equity.
A company is technically insolvent when: -it has a negative book value. -its total debt exceeds its total equity. -it is unable to meet its financial obligations. -it files for bankruptcy protection. - the market value of its stock is less than its book value.
it is unable to meet its financial obligations.
A company that has a(n) ________ would be most likely to have a high percentage of debt in its optimal capital structure. -exceptionally high level of depreciation expense - very low marginal tax rate -substantial level of tax shields from other sources -low probability of financial distress - -minimal level of taxable income
low probability of financial distress
The optimal capital structure of a company: -minimizes the company's tax payments. maximizes the value of that company's marketed claims. -minimizes both the marketed and nonmarketed claims against that company. -eliminates all nonmarketed claims against that company. -equates the company's marketed and nonmarketed claims.
maximizes the value of that company's marketed claims.
A firm should select the capital structure that: -produces the highest cost of capital. -maximizes the value of the firm. -minimizes taxes. -is fully unlevered. -equates the value of debt with the value of equity.
maximizes the value of the firm.
The capital structure that maximizes the value of a company also: -minimizes financial distress costs. -- -minimizes the cost of capital. -\-- -maximizes the present value of the tax shield on debt. -maximizes the value of the debt. - -maximizes the present value of the bankruptcy costs.
minimizes the cost of capital.
Eleanor invested in Hwajin stock when the company was unlevered. Since then, Hwajin has changed its capital structure and now has a debt-equity ratio of .42. To unlever her position, Eleanor needs to: -borrow money and purchase additional shares of Hwajin stock. -maintain her current equity position as the debt of the firm does not affect her personally. - sell 42 percent of her shares of Hwajin stock and hold the proceeds in cash. - sell 42 percent of her shares of Hwajin stock and lend out the sale proceeds. create a personal debt-equity ratio of .42.
sell 42 percent of her shares of Hwajin stock and lend out the sale proceeds.
The interest tax shield is a key reason why: -the required rate of return on assets rises when debt is added to the capital structure. -the value of an unlevered company is equal to the value of a levered company. -the net cost of debt is generally less than the cost of equity. -the cost of debt is equal to the cost of equity for a levered company. -companies prefer equity financing over debt financing.
the net cost of debt is generally less than the cost of equity.
The basic lesson of M&M theory is that the value of a company is dependent upon: -the company's capital structure. -the total cash flows of that company. --minimizing the marketed claims. -the amount of the company's marketed claims. -size of the stockholders' claims.
the total cash flows of that company
if a company has the optimal amount of debt, then the: -value of the firm is equal to VL + TCD. -direct financial distress costs must equal the present value of the interest tax shield. -debt-equity ratio is equal to 1. -value of the levered company will exceed the value of the unlevered company. -company has no financial distress costs.
value of the levered company will exceed the value of the unlevered company.
M&M Proposition I with tax implies that the: -weighted average cost of capital decreases as the debt-equity ratio increases. -value of a company is inversely related to the amount of leverage used by that company. -value of an unlevered company equals the value of a levered company plus the value of the interest tax shield. - cost of capital is the same regardless of the mix of debt and equity used cost of equity increases as the debt-equity ratio decreases.
weighted average cost of capital decreases as the debt-equity ratio increases.
The value of a firm is maximized when the:
weighted average cost of capital is minimized.
The value of a firm is maximized when the: -cost of equity is maximized. -tax rate equals the cost of capital. -levered cost of capital is maximized. -weighted average cost of capital is minimized. -debt-equity ratio is minimized.
weighted average cost of capital is minimized.
The optimal capital structure: -will be the same for all companies within the same industry. -will remain constant over time unless the company changes its primary operations. -will vary over time as taxes and market conditions change. -places more emphasis on operations than on financing. - is unaffected by changes in the financial markets.
will vary over time as taxes and market conditions change.
