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c. Business risk

A decrease in the debt ratio will generally have no effect on . a. Financial risk. b. Total risk. c. Business risk. d. Market risk. e. None of the above is correct. (It will affect each type of risk above.)

d. Changes in required returns due to financing decisions.

Business risk is concerned with the operations of the firm. Which of the following is not associated with (or not a part of) business risk? a. Demand variability. b. Sales price variability. c. The extent to which operating costs are fixed. d. Changes in required returns due to financing decisions. e. The ability to change prices as costs change.

d. Statements a and b are correct.

Company A and Company B have the same tax rate, the same total assets, and the same basic earning power. Both companies have a basic earning power that exceeds their before-tax costs of debt, kd. However, Company A has a higher debt ratio and higher interest expense than Company B. Which of the following statements is most correct? a. Company A has a lower net income than B. b. Company A has a lower ROA than B. c. Company A has a lower ROE than B. d. Statements a and b are correct. e. None of the statements above is correct.

b. Issue equity to share the burden of decreased equity returns between old and new shareholders.

If you know that your firm is facing relatively poor prospects but needs new capital, and you know that investors do not have this information, signaling theory would predict that you would a. Issue debt to maintain the returns of equity holders. b. Issue equity to share the burden of decreased equity returns between old and new shareholders. c. Be indifferent between issuing debt and equity. d. Postpone going into capital markets until your firm's prospects improve. e. Convey your inside information to investors using the media to eliminate the information asymmetry.

d. Yes, EBIT increases by $8,050.

Musgrave Corporation has fixed costs of $46,000 and variable costs that are 30 percent of the current sales price of $2.15. At a price of $2.15, Musgrave sells 40,000 units. Musgrave can increase sales by 10,000 units by cutting its unit price from $2.15 to $1.95, but variable cost per unit won't change. Should it cut its price? a. No, EBIT decreases by $6,000. b. No, EBIT decreases by $250. c. Yes, EBIT increases by $11,500. d. Yes, EBIT increases by $8,050. e. Yes, EBIT increases by $5,050.

e. Minimum weighted average cost of capital (WACC).

The firm's target capital structure is consistent with which of the following? a. Maximum earnings per share (EPS). b. Minimum cost of debt (kd). c. Minimum risk. d. Minimum cost of equity (ks). e. Minimum weighted average cost of capital (WACC).

a. An increase in the corporate tax rate.

Which of the following factors is likely to encourage a company to increase its debt ratio? a. An increase in the corporate tax rate. b. An increase in the personal tax rate. c. Its assets become less liquid. d. Both statements a and c are correct. e. All of the statements above are correct.

d. Maximizes the price per share of common stock also minimizes the weighted average cost of capital.

As a general rule, the capital structure that a. Maximizes expected EPS also maximizes the price per share of common stock. b. Minimizes the interest rate on debt also maximizes the expected EPS. c. Minimizes the required rate on equity also maximizes the stock price. d. Maximizes the price per share of common stock also minimizes the weighted average cost of capital. e. None of the statements above is correct.

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

Company A and Company B have the same total assets, operating income (EBIT), tax rate, and business risk. Company A, however, has a much higher debt ratio than Company B. Company A's basic earning power (BEP) exceeds its cost of debt financing (kd). Which of the following statements is most correct? a. Company A has a higher return on assets (ROA) than Company B. b. Company A has a higher times interest earned (TIE) ratio than Company B. c. Company A has a higher return on equity (ROE) than Company B, and its risk, as measured by the standard deviation of ROE, is also higher than Company B's. d. Statements b and c are correct. e. All of the statements above are correct.

d. $200,000

Elephant Books sells paperback books for $7 each. The variable cost per book is $5. At current annual sales of 200,000 books, the publisher is just breaking even. It is estimated that if the authors' royalties are reduced, the variable cost per book will drop by $1. Assume authors' royalties are reduced and sales remain constant; how much more money can the publisher put into advertising (a fixed cost) and still break even? a. $600,000 b. $466,667 c. $333,333 d. $200,000 e. $175,225

b. Firm L has a lower ROA than Firm U.

Firm U and Firm L each have the same total assets. Both firms also have a basic earning power of 20 percent. Firm U is 100 percent equity financed, while Firm L is financed with 50 percent debt and 50 percent equity. Firm L's debt has a before-tax cost of 8 percent. Both firms have positive net income. Which of the following statements is most correct? a. The two companies have the same times interest earned (TIE) ratio. b. Firm L has a lower ROA than Firm U. c. Firm L has a lower ROE than Firm U. d. Statements a and b are correct. e.Statements b and c are correct

c. Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20.

From the information below, select the optimal capital structure for Minnow Entertainment Company. a. Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50. b. Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90. c. Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20. d. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40. e. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.

b. 175,000 units

Hensley Corporation uses breakeven analysis to study the effects of expansion projects it considers. Currently, the firm's plastic bag business segment has fixed costs of $120,000, while its unit price per carton is $1.20 and its variable unit cost is $0.60. The firm is considering a new bag machine and an automatic carton folder as modifications to its existing production lines. With the expansion, fixed costs would rise to $240,000, but variable cost would drop to $0.41 per unit. One key benefit is that Hensley can lower its wholesale price to its distributors to $1.05 per carton (that is, its selling price), and this would likely more than double its market share, as it will become the lowest cost producer. What is the change in the breakeven volume with the proposed project? a. 100,000 units b. 175,000 units c. 75,000 units d. 200,000 units e. 0 units

c. The company's cost of equity will increase.

Jones Co. currently is 100 percent equity financed. The company is considering changing its capital structure. More specifically, Jones' CFO is considering a recapitalization plan in which the firm would issue long-term debt with a yield of 9 percent and use the proceeds to repurchase common stock. The recapitalization would not change the company's total assets nor would it affect the company's basic earning power, which is currently 15 percent. The CFO estimates that the recapitalization will reduce the company's WACC and increase its stock price. Which of the following is also likely to occur if the company goes ahead with the planned recapitalization? a. The company's net income will increase. b. The company's earnings per share will decrease. c. The company's cost of equity will increase. d. The company's ROA will increase. e. The company's ROE will decrease.

c. $ 805,556

Martin Corporation currently sells 180,000 units per year at a price of $7.00 per unit; its variable cost is $4.20 per unit; and fixed costs are $400,000. Martin is considering expanding into two additional states, which would increase its fixed costs to $650,000 and would increase its variable unit cost to an average of $4.48 per unit. If Martin expands, it expects to sell 270,000 units at $7.00 per unit. By how much will Martin's breakeven sales dollar level change? a. $ 183,333 b. $ 456,500 c. $ 805,556 d. $ 910,667 e. $1,200,000

d. Statements a and b are correct.

Ridgefield Enterprises has total assets of $300 million. The company currently has no debt in its capital structure. The company's basic earning power is 15 percent. The company is contemplating a recapitalization where it will issue debt at 10 percent and use the proceeds to buy back shares of the company's common stock. If the company proceeds with the recapitali-zation its operating income, total assets, and tax rate will remain the same. Which of the following will occur as a result of the recapitalization? a. The company's ROA will decline. b. The company's ROE will increase. c. The company's basic earning power will decline. d. Statements a and b are correct. e. All of the statements above are correct.

a. $2.24

Texas Products Inc. has a division that makes burlap bags for the citrus industry. The division has fixed costs of $10,000 per month, and it expects to sell 42,000 bags per month. If the variable cost per bag is $2.00, what price must the division charge in order to break even? a. $2.24 b. $2.47 c. $2.82 d. $3.15 e. $2.00

a. 100% equity

The Altman Company has a debt ratio of 33.33 percent, and it needs to raise $100,000 to expand. Management feels that an optimal debt ratio would be 16.67 percent. Sales are currently $750,000, and the total assets turnover is 7.5. How should the expansion be financed so as to produce the desired debt ratio? a. 100% equity b. 100% debt c. 20 percent debt, 80 percent equity d. 40 percent debt, 60 percent equity e. 50 percent debt, 50 percent equity

b. 10,000 decks

The Congress Company has identified two methods for producing playing cards. One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards. The other method would use a less expensive machine (fixed cost = $5,000), but it would require greater variable costs ($1.50 per deck of cards). If the selling price per deck of cards will be the same under each method, at what level of output will the two methods produce the same net operating income? a. 5,000 decks b. 10,000 decks c. 15,000 decks d. 20,000 decks e. 25,000 decks

e. $6.21

The Price Company will produce 55,000 widgets next year. Variable costs will equal 40 percent of sales, while fixed costs will total $110,000. At what price must each widget be sold for the company to achieve an EBIT of $95,000? a. $2.00 b. $4.45 c. $5.00 d. $5.37 e. $6.21

a. Since the proposed plan increases Volga's financial risk, the company's stock price still might fall even though its EPS is expected to increase.

Volga Publishing is considering a proposed increase in its debt ratio, which will also increase the company's interest expense. The plan would involve the company issuing new bonds and using the proceeds to buy back shares of its common stock. The company's CFO expects that the plan will not change the company's total assets or operating income. How-ever, the company's CFO does estimate that it will increase the company's earnings per share (EPS). Assuming the CFO's estimates are correct, which of the following statements is most correct? a. Since the proposed plan increases Volga's financial risk, the company's stock price still might fall even though its EPS is expected to increase. b. If the plan reduces the company's WACC, the company's stock price is also likely to decline. c. Since the plan is expected to increase EPS, this implies that net income is also expected to increase. d. Statements a and b are correct. e. Statements a and c are correct.

d. All of the statements above are correct.

Which of the following are practical difficulties associated with capital structure and degree of leverage analyses? a. It is nearly impossible to determine exactly how P/E ratios or equity capitalization rates (ks values) are affected by different degrees of financial leverage. b. Managers' attitudes toward risk differ and some managers may set a target capital structure other than the one that would maximize stock price. c. Managers often have a responsibility to provide continuous service; they must preserve the long-run viability of the enterprise. Thus, the goal of employing leverage to maximize short-run stock price and minimize capital cost may conflict with long-run viability. d. All of the statements above are correct. e. None of the statements above represents a serious impediment to the practical application of leverage analysis in capital structure determination.

a. An increase in the corporate tax rate.

Which of the following factors is likely to encourage a corporation to increase the proportion of debt in its capital structure? a. An increase in the corporate tax rate. b. An increase in the personal tax rate. c. An increase in the company's degree of operating leverage. d. The company's assets become less liquid. e.An increase in expected bankruptcy costs

d. Statements a and b are correct.

Which of the following factors would affect a company's business risk? a. The level of uncertainty regarding the demand for its product. b. The degree of operating leverage. c. The amount of debt in its capital structure. d. Statements a and b are correct. e. All of the statements above are correct.

d. Statements a and c are correct.

Which of the following is likely to encourage a company to use more debt in its capital structure? a. An increase in the corporate tax rate. b. An increase in the personal tax rate. c. A decrease in the company's degree of operating leverage. d. Statements a and c are correct. e. All of the statements above are correct.

d. Statements a and c are correct.

Which of the following statements about capital structure theory is most correct? a. Signaling theory suggests firms should in normal times maintain reserve borrowing capacity that can be used if an especially good investment opportunity comes along. b. In general, an increase in the corporate tax rate would cause firms to use less debt in their capital structures. c. According to the "trade-off theory," an increase in the costs of bankruptcy would lead firms to reduce the amount of debt in their capital structures. d. Statements a and c are correct. e. All of the statements above are correct.

e. Statements b and c are correct.

Which of the following statements best describes the optimal capital structure? a. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's earnings per share (EPS). b. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's stock price. c. The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company's weighted average cost of capital (WACC). d. Statements a and b are correct. e. Statements b and c are correct.

c. 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.

Which of the following statements is correct? a. "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage. b. 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 increase their use of debt. c. 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. d. The optimal capital structure is the one that simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS. e. None of the statements above is correct.

e. None of the statements above is correct.

Which of the following statements is likely to encourage a firm to increase its debt ratio in its capital structure? a. Its sales become less stable over time. b. Its corporate tax rate declines. c. Management believes that the firm's stock is overvalued. d. Statements a and b are correct. e. None of the statements above is correct.

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

Which of the following statements is most correct? a. A firm can use retained earnings without paying a flotation cost. Therefore, while the cost of retained earnings is not zero, the cost of retained earnings is generally lower than the after-tax cost of debt financing. b. The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes the firm's stock price. c. The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes the firm's earnings per share. d. If a firm finds that the cost of debt financing is currently less than the cost of equity financing, an increase in its debt ratio will always reduce its weighted average cost of capital. e. Statements a and b are correct.

d. The firm's financial risk may have both market risk and diversifiable risk components.

Which of the following statements is most correct? a. A firm's business risk is solely determined by the financial characteristics of its industry. b. The factors that affect a firm's business risk are determined partly by industry characteristics and partly by economic conditions. Unfortunately, these and other factors that affect a firm's business risk are not subject to any degree of managerial control. c. One of the benefits to a firm of being at or near its target capital structure is that financial flexibility becomes much less important. d. The firm's financial risk may have both market risk and diversifiable risk components. e. None of the statements above is correct.

e. None of the statements above is correct.

Which of the following statements is most correct? a. A reduction in the corporate tax rate is likely to increase the debt ratio of the average corporation. b. An increase in the personal tax rate is likely to increase the debt ratio of the average corporation. c. If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation. d. All of the statements above are correct. e. None of the statements above is correct.

e. None of the statements above is correct.

Which of the following statements is most correct? a. As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. b. The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. c. The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. d. The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. e. None of the statements above is correct.

e. None of the statements above is correct.

Which of the following statements is most correct? a. Firms whose sales are very sensitive to changes in the business cycle are more likely to rely on debt financing. b. Firms with large tax loss carry forwards are more likely to rely on debt financing. c. Firms with a high operating leverage are more likely to rely on debt financing. d. Statements a and c are correct. e. None of the statements above is correct.

c. If a company were to issue debt and use the money to increase assets, this action would increase the company's return on equity. (Assume that the company's return on assets remains unchanged.)

Which of the following statements is most correct? a. If Congress were to pass legislation that increases the personal tax rate, but decreases the corporate tax rate, this would encourage companies to increase their debt ratios. b. If a company were to issue debt and use the money to repurchase common stock, this action would have no impact on the company's return on assets. (Assume that the repurchase has no impact on the company's operating income.) c. If a company were to issue debt and use the money to increase assets, this action would increase the company's return on equity. (Assume that the company's return on assets remains unchanged.) d. Statements a and b are correct. e. Statements b and c are correct.

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

Which of the following statements is most correct? a. In general, a firm with low operating leverage has a small proportion of its total costs in the form of fixed costs. b. An increase in the personal tax rate would not affect firms' capital structure decisions. c. A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal. d. Statements a and b are correct. e.All of the statements above are correct

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

Which of the following statements is most correct? a. Increasing financial leverage is one way to increase a firm's basic earning power (BEP). b. Firms with lower fixed costs tend to have greater operating leverage. c. The debt ratio that maximizes EPS generally exceeds the debt ratio that maximizes share price. d. Statements a and b are correct. e. Statements a and c are correct.

e. None of the statements above is correct.

Which of the following statements is most correct? a. Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase the company's WACC. b. Since debt financing is cheaper than equity financing, increasing a company's debt ratio will always reduce the company's WACC. c. Increasing a company's debt ratio will typically reduce the marginal costs of both debt and equity financing; however, it still may raise the company's WACC. d. Statements a and c are correct. e. None of the statements above is correct.

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

Which of the following statements is most correct? a. The capital structure that maximizes stock price is also the capital structure that minimizes the weighted average cost of capital (WACC). b. The capital structure that maximizes stock price is also the capital structure that maximizes earnings per share. c. The capital structure that maximizes stock price is also the capital structure that maximizes the firm's times interest earned (TIE) ratio. d. Statements a and b are correct. e. Statements b and c are correct.

d. Statements a and c are correct.

Which of the following statements is most correct? a. The optimal capital structure minimizes the WACC. b. If the after-tax cost of equity financing exceeds the after-tax cost of debt financing, firms are always able to reduce their WACC by increasing the amount of debt in their capital structure. c. Increasing the amount of debt in a firm's capital structure is likely to increase the costs of both debt and equity financing. d. Statements a and c are correct. e. Statements b and c are correct.

e. None of the statements above is correct.

Which of the following statements is most correct? a. When a company increases its debt ratio, the costs of both equity and debt capital increase. Therefore, the weighted average cost of capital (WACC) must also increase. b. The capital structure that maximizes stock price is generally the capital structure that also maximizes earnings per share. c. Since debt financing is cheaper than equity financing, increasing a company's debt ratio will always reduce the company's WACC. d. The capital structure that maximizes stock price is generally the capital structure that also maximizes the company's WACC. e. None of the statements above is correct.

c. 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 most correct? a. When a company increases its debt ratio, the costs of equity and debt capital both increase. Therefore, the weighted average cost of capital (WACC) must also increase. b. The capital structure that maximizes stock price is generally the capital structure that also maximizes earnings per share. c. All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio. d. Statements a and b are correct. e. Statements a and c are correct.

e. Statements b and d are correct.

Which of the following would increase the likelihood that a company would increase its debt ratio in its capital structure? a. An increase in costs incurred when filing for bankruptcy. b. An increase in the corporate tax rate. c. An increase in the personal tax rate. d. A decrease in the firm's business risk. e. Statements b and d are correct.