Test 4

Which statement is correct, all else held constant?

A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.

Which one of the following best defines legal bankruptcy?

A legal proceeding for liquidating or reorganizing a business

The argument that dividend policy is irrelevant tends to be supported by which one of these factors?

Current equilibrium in the clientele dividend market

Which one of the following is a direct bankruptcy cost?

Legal and accounting fees related to a bankruptcy proceeding

Of the following, which two are the best reasons for doing a reverse stock split? I. Return a stock to its normal trading range II. Eliminate small shareholders III. Reduce shareholder costs IV. Avoid delisting

II and IV

Which one of the following states that a firm's cost of equity capital is a positive linear function of the firm's capital structure?

M&M Proposition II without taxes

Which one of the following is a key provision of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005?

Right granted to creditors to file their own reorganization plan once a firm is in bankruptcy for 18 months

All of the following are means of reducing the number of outstanding shares with the exception of a(n):

Rights offer

Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?

Risk level of the project

Which statement is correct?

Stock dividends may come at the expense of forgoing positive net present value projects.

This morning, Structural Steel purchased 3,500 of its outstanding shares in the open market. What type of transaction was this?

Stock repurchase

Kate is the CFO of a major firm and has the job of assigning discount rates to each project under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases and a lower rate as the risk level declines. Kate is applying the ___ approach.

Subjective

Which one of the following statements is correct related to the dividend growth model approach to computing the cost of equity?

The annual dividend used in the computation must be for Year 1 if you are Time 0's stock price to compute the return.

Kelly's uses the firm's WACC as the required return for some of its projects. For other projects, the firms uses a rate equal to WACC plus one percent, while another set of projects is assigned rates equal to WACC minus some amount. Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning a discount rate to a specific project?

The perceived risk level of project

Which one of the following is an implication of M&M Proposition II without taxes?

The risk of equity is affected by both financial and operating leverage.

Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered. Which one of the following statements is correct regarding these two firms?

The unlevered firm will have higher EPS at relatively low levels of EBIT.

Which one of the following statements matches M&M Proposition I without taxes?

The value of a firm is independent of the firm's capital structure.

Two weeks ago, Jensen's declared a dividend of $1.34 a share. The ex-dividend date is tomorrow. All else constant, which one of the following is the best estimate of Jensen's opening stock price tomorrow?

Today's closing price minus an amount approximately equal to the aftertax value of the dividend

M&M Proposition I with taxes states that:

a firm's capital structure is irrelevant

M&M Proposition II, without taxes, states that the:

cost of equity increases as a firm increases its debt-equity ratio.

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:

automatically gives preferential treatment in the allocation of funds to its riskiest division.

When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return that:

best matches the risk level of the proposed investment.

Marine Expeditors has three divisions. Division A is the core of the business and represents 80 percent of the firm's operations. Division B is involved only with contractual short-term projects and therefore has about ten percent less risk than Division A. Division C develops and markets new products and is about ten percent riskier than Division A and about equal in size to Division B. The manager of Division A has suggested that the operations of his division be increased by 10 percent next year. The proposed project should probably be assigned a required return that is equal to _____ percent of the firm's weighted average cost of capital.

100

The results of the dividend growth model:

Are sensitive to the rate of dividend growth

Which one of the following events must occur before a firm can offer a liquidating dividend?

Asset sale

Which one of the following statements concerning financial leverage is correct?

Changes in the capital structure of a firm will generally change the firm's earnings per share.

On which one of the following dates is the determination made as to which shareholders will receive a dividend payment?

Date of record

Which one of the following is a payment by a firm to its shareholders from any source other than current or accumulated retained earnings?

Distribution

KL Electronics has paid a quarterly dividend of $.42 per share for the past two years. This quarter, the firm plans to pay $.42 plus an additional $.05 per share. The firm has stated that it is uncertain whether it will pay $.42 or $.47 per share next quarter. Which one of the following is the best description of the additional $.05 that is being paid this quarter?

Extra dividend

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Financial risk

You want to use the pure play approach to assign a cost of capital to a proposed investment. Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm?

Firm operations

The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as:

Homemade leverage

A firm that uses its weighted average cost of capital as the required return for all of its investments will:

Increase the risk level of the firm over time

What is the primary reason why the cash flow from assets (CFA) is adjusted when used to value a firm?

Interest expense is a financing cost and thus the tax benefit of this expense needs to be eliminated from the CFA

Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship?

Interest tax shield

The static theory of capital structure assumes a firm:

Is fixed in terms of its assets and operations

Which one of the following is minimized when the value of a firm is maximized?

WACC

When is a firm insolvent from an accounting perspective?

When the firm has a negative net worth

A share repurchase will:

increase the earnings per share and decrease the PE ratio.

In an efficient market, the cost of equity for a highly risky firm:

increases in direct relation to the stock's systematic risk.

When evaluating a project, the dividend growth model:

is relatively simple to use.