Finance Ch 16 Self Quiz

Homemade leverage refers to the: A. ability of an individual investor to set the amount of leverage he or she desires. B. ability of a firm to self-determine the amount of leverage it prefers. C. amount of debt a small firm arranges with its local bank. D. ratio of cash holdings to equity holdings held by an individual investor.

A. ability of an individual investor to set the amount of leverage he or she desires.

Which risk determines the required return on assets? A. business B. total C. financial D. unsystematic

A. business

Which one of the following states that the value of a levered firm is equal to the unlevered value of the firm plus the present value of the interest tax shield? A. M&M Proposition I without taxes B. M&M Proposition I with taxes C. M&M Proposition II without taxes D. M&M Proposition II with taxes

B. M&M Proposition I with taxes

The value of an unlevered firm is equal to: A. EBIT + (1 − TC)] / RU. B. [EBIT × (1 − TC)] / RU. C. VL + TC × D. D. VL × (TC / D).

B. [EBIT × (1 − TC)] / RU.

The order of claims in a bankruptcy is set forth in the: A. Bankruptcy Act of 1987. B. absolute priority rule. C. prepack. D. initial bankruptcy filing.

B. absolute priority rule.

Which one of the following is a direct cost of bankruptcy? A. time spent by company managers on the bankruptcy paperwork B. administrative expenses related to the bankruptcy filing C. cash reserves held by a firm D. cost of actions taken by a firm to avoid a bankruptcy filing

B. administrative expenses related to the bankruptcy filing

All else equal, the financial leverage of a firm will: A. decrease as the amount of debt increases relative to equity. B. decrease as the firm's retained earnings account grows. C. increase by the amount of equity it issues in a given year. D. decrease if the firm has negative net income. E. decrease as the firm uses debt to fund expansion projects.

B. decrease as the firm's retained earnings account grows.

Which one of the following states that a firm's WACC is the same regardless of the firm's debt-equity ratio? A. M&M Proposition I without taxes B. M&M Proposition I with taxes C. M&M Proposition II without taxes D. M&M Proposition II with taxes

C. M&M Proposition II without taxes

The value of a firm is maximized when the: A. debt-equity ratio is set equal to zero. B. debt-equity ratio equals 1.0. C. WACC is minimized. D. WACC is maximized.

C. WACC is minimized.

Which one of the following will generally receive the highest priority in a bankruptcy? A. consumer claims B. employee wages C. administrative expenses associated with the bankruptcy filing D. federal taxes

C. administrative expenses associated with the bankruptcy filing

M&M Proposition I with taxes implies that a firm's weighted average cost of capital: A. remains constant regardless of a firm's debt-equity ratio. B. increases as the debt-equity ratio increases. C. decreases as the debt-equity ratio increases. D. varies independently of a firm's debt-equity ratio.

C. decreases as the debt-equity ratio increases.

Which one of the following is indicative of an optimal capital structure? A. maximum tax shield B. maximum debt-equity ratio C. maximum value of marketed claims D. minimum value of unmarketed claims

C. maximum value of marketed claims

The static theory advocates borrowing to the point where: A. the pre-tax cost of debt is equal to the cost of equity. B. the cost of equity is equal to the interest tax shield. C. the tax benefit from debt is equal to the cost of the increased probability of financial distress. D. the debt-equity ratio equals 1.0.

C. the tax benefit from debt is equal to the cost of the increased probability of financial distress.

Which one of the following statements is correct? A. The higher the tax rate, the less incentive a firm has to borrow money. B. M&M Proposition I without taxes states that the value of a firm depends on the firm's capital structure. C. Financial risk determines the required return on assets. D. M&M Proposition II without taxes states that the cost of equity rises as the debt-equity ratio increases.

D. M&M Proposition II without taxes states that the cost of equity rises as the debt-equity ratio increases.

Which one of the following is the preferred source of funding according to the pecking-order theory? A. common stock B. preferred stock C. external debt D. internal financing

D. internal financing

Which of the following is (are) true regarding observed capital structures? I. Drug companies appear to use less debt than electric utility companies do. II. It appears that many firms choose to pay substantial taxes rather than increase debt to further benefit from the interest tax shield. III. It appears that, for whatever reason, capital structures vary quite a bit across industry groups.

I, II, and III

Business risk is a positive function of the systematic risk of a firm's assets. True/False?

True

Direct bankruptcy costs are those costs that are directly associated with bankruptcy, such as legal and administrative expenses. True/False?

True

If the static theory of capital structure is true, then the optimal level of debt for a given firm increases as its marginal tax rate increases and decreases as the costs of financial distress increase. True/False?

True