Finance Chapter 13

According to M&M Proposition II, without taxes, the cost of equity depends on the firm's:

-Cost of Debt -Debt-equity Ratio -Required rate of return on its assets

The bankruptcy process has been utilized in the past by firms to:

-Renegotiate labor contracts -Reduce their labor costs -Avoid paying a legal judgement -Improve their competitive position

Which one of the following statements is true concerning a bankruptcy?

A federal judge has the authority to deny a chapter 11 bankruptcy petition field by a firm.

Which one of the following will generally recieve the highest priority in a bankruptcy liquidation , assuming that the absolute priority rule applies?

Bankruptcy administrative expenses

The maximum firm value, as defined by the static theory of capital structure, demonstrates that a firm:

Benefits from leverage, net of financial distress costs.

Business Risk is defined as the:

Equity risk that comes from the nature of a firm's operating activities

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

Re rises as a firm increases its use of financial leverage.

Taylor & Taylor has positive earnings before interest and taxes (EBIT). Given this, which one of the following statements related to the interest tax shield is correct?

The present value of the tax shield is equal to Tc X D.

Which of the following are correct assumptions based on the static theory of capital structure?

-There is an inverse relationship between the amount that a firm should borrow and the volatility of its earnings before interest and taxes (EBIT) -The higher a firm's tax rate, the greater the firm's incentive to borrow

Which one of the following is an example of a direct bankruptcy cost?

A firm engages an attorney to draft a prepack

Bankruptcy is best defined as:

A legal proceeding for liquidating or reorganizing a business.

Less Debt INC. just revised its capital structure such that the firm's debt-equity ratio decreased from .80 to .40. Those individual investors who prefer the old capital structure:

Can replicate that structure by increasing their use of homemade leverage.

Which of the following statements correctly relate to M&M Proposition I, with taxes?

DEBT financing is advantageous to a firm

The legal and administrative costs of bankruptcy are called____ bankruptcy costs.

DIRECT

Assume that you are comparing two firms which are identical with one excpetion. Firm A is an all-equity firm and firm B has a debt-equity ratio of .6. All else equal firm A will:

Earn less than firm B when the level of earnings before interest and taxes (EBIT) is relatively high

Financial risk is defined as :

Equity risk that comes from the capital structure of a firm.

The direct and indirect costs of bankruptcy are also called____ costs.

FINANCIAL DISTRESS

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

Financial leverage magnifies both profits and losses

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

HOMEMADE LEVERAGE

U.S firms, in general:

Have debt-equity ratios that vary by industry

The costs incurred by a firm in an effort to avoid bankruptcy are called_____bankruptcy costs:

INDIRECT

You are comparing two financial policies. The first is all equity. The second involves the use of $2 million of debt. The break-even point between these two policies occurs when the earnings before interest and taxes (EBIT) is $450,000. Given this, it is accurate to say that leverage____ beneficial to the firm when EBIT is $325,000 and _____beneficial when EBIT is $625,000.

IS NOT, IS

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

If a firm employs financial leverage, the shareholders will be exposed to greater risk.

Financial Risk:

Increases as a firm's debt-equity ratio increases

The tax savings attained by a firm because of the tax deductibility of the interest expense is called the:

Interest Tax Shield

M&M Proposition I, without taxes, states that:

It is completely irrelevant how a firm arranges its finances.

The term which best describes the termination of a firm as a going concern is:

LIQUIDATION

The theory that the value of a firm is independent of its capital structure is referred to as:

M&M Proposition I

Which one of the following suggests that a firm should be indifferent between a debt-equity ratio of .40 and a ratio of .75 if the firm's goal is to maximize firm value?

M&M Proposition I, without taxes

The theory that a firm's cost of equity capital is a positive linear function of its capital structure is referred to as:

M&M Proposition II

The financial restructuring of a firm in an attempt to create a situation in which the firm can continue its operations as a going concern is best described as :

REORGANIZATION

Which one of the following relates to a bankruptcy liquidation, but not to a reorganization?

Termination of the firm as a going concern

A firm's optimal capital structure:

The Debt-Equity ratio that results in the lowest possible weighted average cost of capital

The list which establishes the order of claims in a liquidation is referred to as:

The absolute priority rule

The argument that a firm borrows up to the point where the tax benefit of an extra dollar of debt is exactly offset by the increased probability of financial distress is called:

The static theory of capital structure

The assumption that a firm is fixed in terms of its operations and assets is most related to:

The static theory of capital structure

A secured creditor in a bankruptcy liquidation is entitled to the proceeds from the underlying security:

Up to the amount they are due.

The maximum firm value, according to the static theory of capital structure, occurs at a point where the:

Value of the firm equalizes the costs of financial distress with the present value of the tax shield on debt.

M&M Proposition I, with taxes, states that the value of a levered (Vl) firm is equal to:

Vu+(Tc X D)

A firm is technically insolvent:

When it is unable to meet its financial obligations

A prepackaged bankruptcy:

has been approved by a firm's creditors prior to the bankruptcy petition being filed with the court