3A - Capital Structure
Which of the following corporate characteristics would favor debt financing versus equity financing?
A high tax rate
Default risk as it relates to accounts receivable includes which of the following? The chance that the principal will not be paid by the due date The chance that the cash received will not be the promised amount The chance that the product may have declined in value if it is necessary to repossess it All of the answer choices are correct.
ALL
Which of the following factors would likely cause a firm to increase its use of debt financing as measured by the debt-to-total-capitalization ratio?
An increase in the corporate income tax rate
Which of the following has the highest level of liquidity risk? U.S. Treasury bills Stock in major corporations Bonds issued by major firms Bonds issued by smaller, more obscure firms
Bonds issued by smaller, more obscure firms
Which of the following factors is inherent in a firm's operations if it utilizes only equity financing?
Business risk
When calculating a company's cost of common stock, an analyst evaluates the following four components: risk-free rate, stock's beta coefficient, rate of return on the market portfolio, and required rate of return on the company's stock. Which of the following measurement models is being used?
Capital asset pricing
Which of the following items represents a business risk in capital structure decisions?
Cash flow
Bander Co. is determining how to finance some long-term projects. Bander has decided it prefers the benefits of no fixed charges, no fixed maturity date, and an increase in the creditworthiness of the company. Which of the following would best meet Bander's financing requirements?
Common stock Common stock increases the equity position of a company and can provide a basis for increasing debt—or in other words, the issuance of common stock increases the creditworthiness of a company.
Which of the following quantitative factors, when compared to its industry average, could be an indicator of potential corporate failure?
High fixed cost to total cost structure
The benefits of debt financing over equity financing are likely to be highest in which of the following situations?
High marginal tax rates and few noninterest tax benefits
A company uses its company-wide cost of capital to evaluate new capital investments. What is the implication of this policy when the company has multiple operating divisions, each having unique risk attributes and capital costs?
High-risk divisions will over-invest in new projects and low-risk divisions will under-invest in new projects.
Which of the following is not part of the Modigliani and Miller theorem? In a world with no taxes, no bankruptcy costs and no agency costs, the value of a company would be indifferent to its capital structure. In a world with taxes and no bankruptcy costs, the value of a company would be highest with 100% debt. In a world with taxes and bankruptcy costs, the maximum value of a firm would be the point where the marginal cost of debt is equal to the marginal cost of bankruptcy. In a world with taxes, bankruptcy costs, and agency costs, the value of a company would be indifferent to its capital structure.
In a world with taxes, bankruptcy costs, and agency costs, the value of a company would be indifferent to its capital structure.
If Brewer Corporation's bonds are currently yielding 8% in the marketplace, why would the firm's cost of debt be lower?
Interest is deductible for tax purposes.
According to the pecking order theory, which of the following will companies prefer to use first?
Internal financing
Which of the following is not a source of funds used to finance a company?
Investment in bonds
Why would a firm generally choose to finance temporary assets with short-term debt?
Matching the maturities of assets and liabilities reduces risk.
Which of the following is not a way to optimize capital structure? Minimize the weighted-average cost of capital Provide a tax shield for debt Maximize the weighted-average cost of capital Issue debt to the point of increasing financial distress
Maximize the weighted-average cost of capital
A firm's target or optimal capital structure is consistent with which one of the following?
Minimum weighted average cost of capital
Which of the following statements is correct regarding corporate debt and equity securities? Both debt and equity security holders have an ownership interest in the corporation. Both debt and equity securities have an obligation to pay income. I only II only Both I and II Neither I nor II
Neither I nor II
Larson Corp. issued $20 million of long-term debt in the current year. What is a major advantage to Larson with the debt issuance?
The relatively low after-tax cost due to the interest deduction
The cost of debt most frequently is measured as:
actual interest rate minus tax savings.
Market risk or systemic risk includes all the following except: company risk. congressional tax reform. inflation or recession. world energy situation(s).
company risk.
A rational approach to capital budgeting requires that the return on investment of a project equal or exceed the firm's:
cost of capital.
Valecito Company is a regional food and beverage supplier to a large number of small grocery and convenience stores. Most of these are individually owned and over 90% of Valecito's sales are on credit. As a result, bad debt losses, higher receivable balances and collection costs often present problem for Valecito's management. These specific problem areas fall under the category of ________ risk.
credit Credit risk is related directly to the risk that receivables will not be collected in full on a timely basis. This appears to be a potentially significant problem area for Valecito.
Credit risk is a problem faced by many companies. All of the following are possible components of credit risk except: bad debts. collection costs. diversification. higher receivable balances.
diversification.
A firm's dividend policy may treat dividends either as the residual part of a financing decision or as an active policy strategy. Treating dividends as an active policy strategy assumes that:
dividends provide information to the market.
As the cost of capital increases and all other factors remaining constant:
fewer capital projects will probably meet the company's investment criteria.
Sylvan Corporation has the following capital structure. Debenture bonds $10,000,000 Preferred equity 1,000,000 Common equity 39,000,000 The financial leverage of Sylvan Corporation would increase as a result of: issuing common stock and using the proceeds to retire preferred stock. issuing common stock and using the proceeds to retire debenture bonds. financing its future investments with a higher percentage of bonds. financing its future investments with a higher percentage of equity funds.
financing its future investments with a higher percentage of bonds.
The purchase of treasury stock with a firm's surplus cash:
increases a firm's financial leverage.
In general, it is more expensive for a company to finance with equity capital than with debt capital because:
investors are exposed to greater risk with equity capital.
The optimal capitalization for an organization usually can be determined by the:
lowest total weighted-average cost of capital (WACC).
Capital budgeting is generally most accurate when the method used considers the cost of capital, as in the net present value method. The cost of capital used in this analysis should be ________ weighted average cost of capital.
marginal
Inflation and recession, energy market fluctuations and changing interest rates are all components of ________ risk.
market
The business environment includes several types of business risk. One type of business risk is systemic risk. Systemic risk is also called ________ risk.
market
A firm has just received the proceeds from a $5 million bond issue that is earmarked for plant expansion. Work on the project is not expected to begin for several weeks. The firm will invest the funds in marketable securities. The firm is primarily concerned with ensuring they will receive all the funds they have invested in a timely manner. Thus, they are primarily concerned with the ________ of the securities they purchase.
marketability and default risk
The working capital financing policy that subjects the firm to the greatest risk of being unable to meet the firm's maturing obligations is the policy that finances:
permanent current assets with short-term debt.
The overall cost of capital is the:
rate of return on assets that covers the costs associated with the funds employed.
According to the hedging approach to financing, seasonal variations in current assets should be financed with:
short-term debt.
All of the following describe short-term debt except: secured bank loans. unsecured bank loans. commercial paper. spontaneous financing created through accounts receivable.
spontaneous financing created through accounts receivable.
A ratio that examines the percentage change in earnings available to common stockholders that is associated with a given percentage change in earnings before interest and taxes is a measure of:
the degree of financial leverage.
A firm with a higher degree of operating leverage when compared to the industry average implies that:
the firm's profits are more sensitive to changes in sales volume.