Finance Final 13
The firm's target capital structure is consistent with which of the following? Minimum weighted average cost of capital (WACC). Minimum cost of equity (ks). Minimum risk. Minimum cost of debt (kd). Maximum earnings per share (EPS).
WACC
Which of the following events is likely to encourage a corporation to increase its debt ratio? An increase in the corporate tax rate. An increase in the personal tax rate. An increase in the company's degree of operating leverage. An increase in the expected cost of bankruptcy. Increased uncertainty about the level of sales and output prices.
An increase in the corporate tax rate.
Business risk is concerned with the operations of the firm. Which of the following is not a part of business risk? Demand variability. Sales price variability. The extent to which operating costs are fixed. Changes in required returns due to financing decisions. The ability to change prices as costs change.
Changes in RR due to financing decisions
According to Miller and Modigliani (M&M), in a world without taxes, the optimal capital structure for a firm should approach 100 percent debt financing.
F
Financial risk refers to the extra risk stockholders bear as a result of the use of debt as compared with the risk they would bear if no debt were used.
F
The degree of financial risk is the single most important determinant of a firm's capital structure.
F
Two firms which have the same operating leverage must also have the same ROA, since operating leverage and ROA both measure the effective utilization of assets by the firm.
F
As long as a firm is near its target capital structure it will not have to concern itself with financial flexibility.
F
Assume that a firm's financial analysts determine that a decrease in the firm's debt ratio will cause a decrease in both the component cost of debt (Rd)(1 - T) and the component cost of equity (Rs). This information tells us that the firm's present debt ratio is above its optimal ratio.
F
At the firm's accounting break-even point, total revenues and total variable costs are equal.
F
Business risk will not affect a firm's beta, because beta is determined by the market and thus is outside the control of the firm.
F
Business risk, which is the risk inherent in a firm's assets if it uses less than its optimal amount of debt, is one important influence in the capital structure decision.
F
Financial leverage affects both EPS and EBIT, while operating leverage only affects EBIT.
F
At the point at which the Weighted Average Cost of Capital (WACC) is minimized, the value of the firm is also maximized and so the stock price will be at a maximum.
T
Because creditors can foresee, to at least some extent, the costs of bankruptcy, they charge an interest rate that has a premium built into it to compensate for the present value of bankruptcy costs.
T
If a firm uses no debt, the uncertainty inherent in projections of future returns on equity can be described as business risk.
T
If a firm utilizes debt financing, a decrease in earnings before interest and taxes (EBIT) will result in a more than proportionate decrease in earnings per share.
T
In a world with no taxes and bankruptcy costs, Miller and Modigliani (M&M) show that the capital structure of a firm does not affect the value of the firm. However, when taxes are considered, M&M show a positive relationship between debt and firm value.
T
The optimal capital structure is that which results in the lowest WACC because that will ensure maximum stock price.
T
Which of the following is a key determinant of operating leverage? Technology. Level of debt. Physical location of production facilities. Cost of debt. Capital structure.
Technology
