Chapter 16 MC

The value of the company depends on: A) the debt-to-equity ratio of that company B) the market share of that company C) the opportunity cost of its project D) the overall cash flows of that company

D) the overall cash flows of that company

If a company has the optimal amount of debt in its capital structure, then the: A) value of the levered company will exceed the value of the unlevered firm B) company has no financial distress costs C) Value of the firm is equal to VL + TDc D) debt-equity ratio is equal to 1

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Westover Mills reduced its taxes last year by $210 by increasing its interest expense by $1,000. Which one of the following terms is used to describe this tax savings? A) Interest tax shield B) Interest credit C) Homemade leverage shield D) Current tax yield E) Tax-loss interest

A) Interest tax shield

The concept of homemade leverage is most associated with: A) M&M Proposition I with no tax. B) M&M Proposition II with no tax. C) M&M Proposition I with tax. D) M&M Proposition II with tax. E) the static theory proposition.

A) M&M Proposition I with no tax.

Referring to the Modligliani and Miller Proposition II without taxes, the cost of equity capital is increasing as the percentage of debt in the capital structure increase A) True B) False

A) True

You have computed the break-even point between a levered and un levered capital structure. Ignore taxes. At the break-even level, the: A) company is earning just enough to pay for the cost of the debt B) company's earnings before interest and taxes are equal to zero. C) earnings per share for the levered option are exactly double those of the unlevered option. D) advantages of leverage exceed the disadvantages of leverage. E) company has a debt-equity ratio of .50.

A) company is earning just enough to pay fro the cost of the debt

M&M Proposition II with taxes: A) has the same general implications as M&M Proposition II without taxes. B) states that capital structure is irrelevant to shareholders. C) supports the argument that business risk is determined by the capital structure decision. D) supports the argument that the cost of equity decreases as the debt-equity ratio increases. E) concludes that the capital structure decision is irrelevant to the value of a firm.

A) has the same general implications as M&M Proposition II without taxes

Referring to the Modligliani and Miller Proposition I with taxes, optimal structure does not exist A) True B) False

B) False

Which of the following states that the value of a company is unrelated to the company's capital structure? A) Homemade leverage B) M&M Proposition I, no tax C) M&M Proposition II, no tax D) Pecking-order theory E) Static theory of capital structure

B) M&M Proposition I, no tax

A firm should select the capital structure that: A) Produces the highest cost of capital B) Maximizes the value of the firm C) Minimizes Taxes D) is fully unlevered E) Equates the value of debt with the value of equity

B) Maximizes the value of the firm

Which of the following four sources of capital has the lowest cost for a typical corporation? A) Preferred Equity B) Subordinated debt C) Mortgage-backed security D) Convertible debt

B) Subordinated debt

The basic lesson of M&M theory is that the value of a company is dependent upon: A) the company's capital structure. B) the total cash flows of that company. C) minimizing the marketed claims. D) the amount of the company's marketed claims. E) size of the stockholders' claims.

B) the total cash flows of that company

If a company has the optimal amount of debt, then the: A) direct financial distress costs must equal the present value of the interest tax shield. B) value of the levered company will exceed the value of the unlevered company. C) company has no financial distress costs. D) Value of the firm is equal to VL + TCD. E) debt-equity ratio is equal to 1.

B) value of the levered company will exceed the value of the unlevered company

According to the Pecking Order Theory, what source of capital do companies prefer to use last when they need funds to pursue a new project? A) Senior Debt B) Preferred Equity C) Common Equity D) Internal Funds

C) Common Equity

Which one of the following statements is correct in relation to M&M Proposition II, without taxes? A) The cost of equity remains constant as the debt-equity ratio increases. B) The cost of equity is inversely related to the debt-equity ratio. C) The required return on assets is equal to the weighted average cost of capital. D) Financial risk determines the return on assets. E) Financial risk is unaffected by the debt-equity ratio.

C) The required return on assets is equal to the weighted average cost on capital

The company ____ the leverage when it issues new debt and uses the proceeds to buy back some of its outstanding stock. The company ____ the leverage when it issues new equity and uses the proceeds to retire some of its outstanding debt A) increases; increases B) decreases; decreases C) increases; decreases D) decreases; increases

C) increases; decreases

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs. A) flotation B) direct bankruptcy C) indirect bankruptcy D) financial solvency E) capital structure

C) indirect bankruptcy

M&M Proposition I with taxes is based on the concept that: A) the optimal capital structure is the one that is totally financed with equity. B) capital structure is irrelevant because investors and companies have differing tax rates. C) WACC is unaffected by a change in the company's capital structure. D) the value of a taxable company increases as the level of debt increases. E) the cost of equity increases as the debt-equity ratio increases.

D) the value of a taxable company increases as the level of debt increases (the optimal capital structure is the one that is totally financed with equity)

The optimal capital structure has been achieved when: A) D/E ratio is equal to 1 B) weight of equity is equal to weight of debt C) cost of equity is maximized given a pretax cost of debt D) D/E ratio is such that the cost of debt exceeds the cost of equity E) D/E ratio results in the lowest possible weighted average cost of capital (WACC)

E) D/E ratio results in the lowest possible weighted average cost of capital

Which of the following makes the capital structure of a company irrelevant? A) Taxes B) Interest tax shield C) 100 percent dividend payout ratio D) Debt-equity ratio that is greater than 0 but less than 1 E) Homemade leverage

E) Homemade leverage

The present value of the interest tax shield is expressed as: A) TcD/Ra. B) VU + TCD. C) TcDRa. D) [EBIT(TcD)]/Ra. E) TcD.

E) TcD.

Which form of financing do companies prefer to use first according to the pecking-order theory? A) Regular debt B) Convertible debt C) Common stock D) Preferred stock E) Internal funds

E) internal funds