Finance 4610 final

The pecking order states that firms should: A. use internal financing first. B. always issue debt then the market won't know when management thinks the security is overvalued. C. issue new equity first. D. issue debt first. E. always issue equity to avoid financial distress costs.

A. use internal financing first.

16. The reason that MM Proposition I does not hold in the presence of corporate taxation is because: A. levered firms pay less taxes compared with identical unlevered firms. B. bondholders require higher rates of return than stockholders do. C. earnings per share are no longer relevant with taxes. D. dividends become a tax shield. E. debt is more expensive than equity.

A. levered firms pay less taxes compared with identical unlevered firms.

27. When firms issue more debt, the present value of the tax shield on debt _____ while the present value of financial distress costs: A. decreases; decreases. B. increases; increases. C. decreases; remains constant. D. decreases; increases. E. increases; remains constant.

B. increases; increases.

2. If a project's debt level is known over the life of the project, one should use A. WACC. B. APV. C. FTE. D. either APV or FTE. E. either FTE or WACC.

B. APV.

25. If a firm issues debt and includes protective covenants in the indenture then the firm's debt will probably be issued at _____ similar debt without thecovenants. A. a variable interest rate rather than the fixed rate paid on B. a lower interest rate than C. a significantly higher interest rate than D. an interest rate equal to that of E. a slightly higher interest rate than

B. a lower interest rate than

6. The APV method is comprised of the all-equity NPV of a project plus the NPV of financing effects. The four financing side effects are: A. tax subsidy of dividends, cost of issuing new securities, subsidy of financial distress, and cost of debt financing. B. cost of issuing new securities, cost of financial distress, tax subsidy of debt, and other subsidies to debt financing. C. cost of issuing new securities, cost of financial distress, tax subsidy of dividends, and cost of debt financing. D. subsidy of financial distress, tax subsidy of debt, cost of other debt financing, and cost of issuing new securities. E. cost of financial distress, tax subsidy of debt, increased cost of equity capital, and cost of issuing new securities.

B. cost of issuing new securities, cost of financial distress, tax subsidy of debt, and other subsidies to debt financing.

24. According to MM Proposition II with no taxes, the: A. return on assets is determined by financial risk. B. required return on equity is a linear function of the firm's debt-equity ratio. C. cost of equity in inversely related to the firm's debt-equity ratio. D. cost of debt must equal the cost of equity. E. required return on assets exceeds the weighted average cost of capital.

B. required return on equity is a linear function of the firm's debt-equity ratio.

3. The proposition that the cost of equity is a positive linear function of capital structure is called: A. the capital asset pricing model. B. MM Proposition I (no taxes). C. MM Proposition II (no taxes). D. the law of one price. E. the efficient markets hypothesis.

C. MM Proposition II (no taxes).

1. The flow-to-equity (FTE) approach in capital budgeting is defined as the: A. discounting of all project cash flows at the overall cost of capital. B. scale enhancing discount process. C. discounting of a project's levered cash flows to the equityholders at the required return on equity. D. dividends and capital gains that may flow to shareholders of a firm. E. discounting of a project's unlevered cash flows to the equityholders at the WACC.

C. discounting of a project's levered cash flows to the equityholders at the required return on equity.

10. The optimal capital structure: A. will be the same for all firms in the same industry. B. will remain constant over time unless the firm makes an acquisition. C. of a firm will vary over time as taxes and market conditions change. D. places more emphasis on the operations of a firm rather than the financing of a firm.

C. of a firm will vary over time as taxes and market conditions change

18. The APV method is least useful in which one of these situations? A. leveraged buyout B. project involving interest subsidies C. project based on a target debt-to-value ratio D. project with flotation costs E. lease-versus-purchase decision

C. project based on a target debt-to-value ratio

16. One of the indirect costs of bankruptcy is the incentive for managers to take large risks. When following this strategy: A. the firm will rank all projects and select the project which results in the highest expected firm value. B. bondholders expropriate value from stockholders by selecting high-risk projects. C. stockholders expropriate value from bondholders by selecting high-risk projects. D. the firm will always select the lowest-risk project available. E. the firm will select only all-equity financed projects.

C. stockholders expropriate value from bondholders by selecting high-risk projects.

9. The optimal capital structure will tend to include more debt for firms with: A. the highest depreciation deductions. B. the lowest marginal tax rate. C. substantial tax shields from other sources. D. lower probability of financial distress. E. less taxable income.

D. lower probability of financial distress.

1. The explicit costs, such as the legal expenses, associated with corporate default are classified as _____ costs. A. flotation B. beta conversion C. direct bankruptcy D. indirect bankruptcy E. unlevered

Direct Bankruptcy

4. Indirect costs of financial distress: A. effectively limit the amount of equity a firm issues. B. serve as an incentive to increase the financial leverage of a firm. C. include costs such as legal and accounting fees. D. tend to increase as the debt-equity ratio decreases. E. include the costs incurred by a firm as it tries to avoid seeking bankruptcy protection.

E. include the costs incurred by a firm as it tries to avoid seeking bankruptcy protection.