Exam 2 Quizley

Which one of the following states that a firm's cost of equity capital is directly and proportionally related to the firm's capital structure? A.Static Theory of capital structure B. M&M Proposition I C. M&M Proposition II D. Homemade leverage E. Pecking-order theory

( C. )M&M Proposition II

The unlevered cost of capital refers to the cost of capital for: A. A privately owned entity. B. An all-equity firm. C. A governmental entity. D. A private individual. E. A corporate shareholder.

(B. )An all-equity firm.

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

(B. )M&M Proposition I, no tax.

Which one of these will increase a firm's aftertax cost of debt? A. a Decrease in the market value of the firm's outstanding bonds. B. a Decrease in the firm's tax rate. C. An increase in the bond's credit rating. D. An increase in the firm's beta. E. A Decrease in the market rate of interest.

(B.) a Decrease in the firm's tax rate.

The capital structure weights used in computing a firm's weighted average cost of capital: A. are based on the book values of total debt and total equity. B. are based on the market value of the firm's debt and equity securities. C. are computed using the book value of the long-term debt and the book value of equity. D. remain constant over time unless the firm issues new securities. E. are restricted to the firm's debt and common stock.

(B.) are based on the market value of the firm's debt and equity securities.

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called? A. dividend yield B. cost of equity C. capital gains yield D. cost of capital E. income return

(B.) cost of equity

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

The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as _____ costs. A. flotation B. issue C. direct bankruptcy D. indirect bankruptcy E. unlevered

(C.)direct bankruptcy

Flotation costs for a levered firm should: A. be ignored when analyzing a project because they are not an actual project cost. B. be spread over the life of a project thereby reducing the cash flows for each year of the project. C. only be considered when two projects are mutually exclusive. D. be weighted and included in the initial cash flow. E. be totally ignored when internal equity funding is utilized.

(D. )be weighted and included in the initial cash flow.

Which one of the following is the equity risk that is most related to the daily operations of a firm? A. Market risk B. Systematic risk C. Extrinsic risk D. Business risk E. Financial risk

(D.) Business risk

Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70 percent of the firm's overall sales. Division A is also the riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should: A. allocate more funds to Division A since it is the largest of the two divisions. B. fund all of Division B's projects first since they tend to be less risky and then allocate the remaining funds to the Division A projects that have the highest net present values. C. allocate the company's funds to the projects with the highest net present values based on the firm's weighted average cost of capital. D. assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values. E. fund the highest net present value projects from each division based on an allocation of 70 percent of the funds to Division A and 30 percent of the funds to Division B.

(D.) assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.

High Adventure is considering a new project that is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of .55 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity? A. by adding the market risk premium to the aftertax cost of debt B. by multiplying the market risk premium by (1 - 0.55) C. by using the dividend growth model D. by using the capital asset pricing model E. by averaging the costs based on the dividend growth model and the capital asset pricing model

(D.) by using the capital asset pricing model

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. the capital structure of a firm does not matter because investors can use homemade leverage. C. a firm's WACC is unaffected by a change in the firm's capital structure. D. the value of a firm increases as the firm's debt increases because of the interest tax shield. E. the cost of equity increases as the debt-equity ratio of a firm increases

(D.) the value of a firm increases as the firm's debt increases because of the interest tax shield.

The value of a firm is maximized when the: A. cost of equity is maximized. B. tax rate is zero. C. levered cost of capital is maximized. D. weighted average cost of capital is minimized. E. debt-equity ratio is minimized.

(D.) weighted average cost of capital is minimized.

Which one of the following is the primary determinant of a firm's cost of capital? A. debt-equity ratio B. applicable tax rate C. cost of equity D. cost of debt (E). use of the funds

(E). use of the funds

The capital asset pricing model approach to equity valuation: A. Is dependent upon the unsystematic risk of a security. B. Assumes the reward-to-risk ratio increases as beta increases. C. Can only be applied to dividend-paying firms. D. Assumes a firm's future risks will be higher than its current risks. E. Assumes the reward-to-risk ratio is constant

(E. )Assumes the reward-to-risk ratio is constant

The dividend growth model cannot be used to compute the cost of equity for a firm that: A. Pays an increasing dividend. B. Reduces its dividend on a regular basis. C. Has a dividend payout ratio of 100 percent. D. Pays a constant dividend year after year. (E. )Has a retention ratio of 100 percent.

(E. )Has a retention ratio of 100 percent.

Which one of the following is a direct cost of bankruptcy? A. Bypassing a positive NPV project to avoid additional debt. B. Firm investing in cash reserves. C. Maintaining a debt-equity ratio that is lower than the optimal ratio. D. Losing a key company employee. (E. )Paying an outside accountant to prepare bankruptcy reports.

(E. )Paying an outside accountant to prepare bankruptcy reports.

JLK is a partnership that was formed two years ago for the purpose of creating new fad items and distributing them directly to consumers. The firm has been extremely successful thus far and has decided to incorporate and offer shares of stock to the general public. What is this type of an equity offering called? A. venture capital offering B. shelf offering C. private placement D. seasoned equity offering E. initial public offering

(E. )initial public offering

Which one of the following is the equity risk related to a firm's capital structure policy? A. Market B. Systematic C. Static D. Business E. Financial

(E.) Financial

D.L. Jones & Co. recently went public. The firm received $20.80 a share on the entire offer of 25,000 shares. Keeser & Co. served as the underwriter and sold 23,700 shares to the public at an offer price of $22 a share. What type of underwriting was this? A. best efforts B. shelf C. over subscribed D. private placement E. firm commitment

(E.) firm commitment

Jenner's is a multi division firm that uses its overall WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to: A. receive less project funding if its line of business is riskier than that of the other divisions. B. avoid risky projects so it can receive more project funding. C. become less risky over time based on the projects that are accepted. D. have equal probability of receiving funding as compared to the other divisions. E. prefer higher risk projects over lower risk projects.

(E.) prefer higher risk projects over lower risk projects.