FIN 125 Chapter 16

Which one of the following makes the capital structure of a company irrelevant? Select one: Taxes Interest tax shield 100 percent dividend payout ratio Debt-equity ratio that is greater than 0 but less than 1 Homemade leverage

Homemade leverage

Westover Mills reduced its taxes last year by $210 by increasing its interest expense by $1,000. Which one of the following terms is used to describe this tax savings? Select one: Interest tax shield Interest credit Homemade leverage shield Current tax yield Tax-loss interest

Interest tax shield

Which form of financing do companies prefer to use first according to the pecking-order theory? Select one: Regular debt Convertible debt Common stock Preferred stock Internal funds

Internal funds

The concept of homemade leverage is most associated with: Select one: 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.

Which one of the following states that the value of a company is unrelated to the company's capital structure? Select one: Homemade leverage M&M Proposition I, no tax M&M Proposition II, no tax Pecking-order theory Static theory of capital structure

M&M Proposition I, no tax

The present value of the interest tax shield is expressed as: Select one: TCD/RA. VU + TCD. TCDRA. [EBIT(TCD)]/RA. TCD.

TCD.

Which one of the following statements is correct in relation to M&M Proposition II, without taxes? Select one: 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.

You have computed the break-even point between a levered and an unlevered capital structure. Ignore taxes. At the break-even level, the: Select one: 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: Select one: 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.

M&M Proposition II with taxes: Select one: 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 costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs. Select one: flotation direct bankruptcy indirect bankruptcy financial solvency capital structure

indirect bankruptcy

A firm should select the capital structure that: Select one: 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 basic lesson of M&M theory is that the value of a company is dependent upon: Select one: the total cash flows of that company.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. Feedback

the total cash flows of that company.

M&M Proposition I with taxes is based on the concept that: Select one: the optimal capital structure is the one that is totally financed with equity. capital structure is irrelevant because investors and companies have differing tax rates. WACC is unaffected by a change in the company's capital structure. the value of a taxable company increases as the level of debt increases. the cost of equity increases as the debt-equity ratio increases.

the value of a taxable company increases as the level of debt increases.

If a company has the optimal amount of debt, then the: Select one: direct financial distress costs must equal the present value of the interest tax shield. value of the levered company will exceed the value of the unlevered company. company has no financial distress costs. Value of the firm is equal to VL + TCD. debt-equity ratio is equal to 1.

value of the levered company will exceed the value of the unlevered company.