Ch. 13 Qualitative
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.
True
If a firm uses no debt, the uncertainty inherent in projections of future returns on equity can be described as business risk.
True
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.
True
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.
True
The optimal capital structure is that which results in the lowest WACC because that will ensure maximum stock price.
True
Business risk is concerned with the operations of the firm. Which of the following is not a part of business risk?
Changes in required returns 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.
False
As long as a firm is near its target capital structure it will not have to concern itself with financial flexibility.
False
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.
False
At the firm's accounting breakeven point, total revenues and total variable costs are equal.
False
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.
False
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.
False
Financial leverage affects both EPS and EBIT, while operating leverage only affects EBIT.
False
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.
False
The degree of financial risk is the single most important determinant of a firm's capital structure.
False
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.
False
