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Question 1 5 / 5 pts Financial leverage: I

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Question 1

5 / 5 pts

Financial leverage:

I. increases expected ROE 
II. increases the variablility to earnings
III. is a fundamental financial variable affecting sustainable growth.
IV. increases expected return and risk to owners.

  

II, III, and IV only

   

I, II, III, and IV

   

I and III only

   

I and II only

  

II and IV only

 

None of the above.

 

Question 2

5 / 5 pts

The interest tax shield has no value when a firm has:

I. no taxable income.
II. debt-equity ratio of 1.
III. zero debt.
IV. no leverage.

  

II and IV only

  

I, II, and IV only

  

II, III, and IV only

  

I, III, and IV only

  

I and III only

  

None of the above.

 

Correct.

 

Question 3

5 / 5 pts

The term "financial distress costs" includes which of the following?

I. Direct bankruptcy costs
II. Indirect bankruptcy costs
III. Direct costs related to being financially distressed, but not bankrupt
IV. Indirect costs related to being financially distressed, but not bankrupt

  

I, II, III, and IV

   

III and IV only

  

I and II only

  

I only

  

III only

 

None of the above.

 

Question 4

5 / 5 pts

When considering the impact of distress costs on capital structure, which of the following facts should lead ABC Corporation to set a higher target debt ratio than XYZ Corporation (all else equal)?

  

ABC operates in a more competitive industry than XYZ.

  

ABC's cash flows from operations are less volatile than XYZ's.

  

ABC's assets have lower resale values than XYZ's assets.

  

ABC is a computer software firm, and XYZ is an electric utility.

 

 

Question 5

5 / 5 pts

Which of the following factors favor the issuance of debt in the financing decision?

I. Market signaling
II. Distress costs
III. Management incentives 
IV. Financial flexibility

  

I and III only

   

II and IV only

  

I and II only

  

I, II, and III only

  

I, II, and IV only

 

None of the above.

 

 

Question 6

10 / 10 pts

Which of the following factors favor the issuance of equity in the financing decision?

I. Market signaling
II. Distress costs
III. Management incentives
IV. Financial flexibility  

I and II only

  

I and III only

  

II, III, and IV only

  

I, II, and IV only

  

II and IV only

  

None of the above.

 

 

Question 7

5 / 5 pts

 MM’s propositions assume perfect financial markets and ignore taxes and other market imperfections.

  

True

 

False

 

Question 8

5 / 5 pts

MM’s proposition 2 says that the cost of equity increases with borrowing and that the increase is proportional to D/V, the ratio of debt to firm value.

  

True

  

False

 

Question 9

5 / 5 pts

MM’s proposition 2 assumes that increased borrowing affects the interest rate on the firm's debt.

 

True

 

False

 

Question 10

5 / 5 pts

ABC Co. is financed 100% by common stock and has outstanding 20 million shares with a market price of $30 a share. It announces that it intends to issue $150 million of debt and to use the proceeds to buy back common stock.  What does this signal to the market about the value of the stock price?

  

No Signal.

   

Management believe the stock is undervalued (cheap).

   

Management believes the stock is overvalues (expensive).

 

Not enough information.

 

Question 11

5 / 5 pts

ABC Co. is financed 100% by common stock and has outstanding 20 million shares with a market price of $30 a share. It announces that it intends to issue $150 million of debt and to use the proceeds to buy back common stock. 

How many shares can the company buy back with the $150 million of new debt that it issues?

 

5 million shares

  

7.5 million shares

  

20 million shares

  

not enough info

 

Question 12

10 / 10 pts

ABC Co. is financed 100% by common stock and has outstanding 20 million shares with a market price of $30 a share. It announces that it intends to issue $150 million of debt and to use the proceeds to buy back common stock. 

What is the market value of the firm (equity plus debt) after the change in capital structure?

 

Question 13

10 / 10 pts

Succes Inc. has net income of $10 million per year on net sales of $50 million per year. It currently has no long-term debt, but is considering a debt issue of $15 million. The interest rate on the debt would be 8%. Success Inc's. current effective tax rate of 35%. What would be the annual interest tax shield to Succes Inc. if it issues the debt? (round 1 decimal place to millions)

 

Question 14

10 / 10 pts

Happy  Corp. is all-equity-financed. The expected rate of return on the company's shares is 15%.What is the opportunity cost of capital for an average-risk Good Life Co. investment?

  

Lower than 15%

   

Higher than 15%

   

15%

 

Not enough info

 

Question 15

10 / 10 pts

Happy  Corp. is all-equity-financed. The expected rate of return on the company's shares is 15%.  If the company recapitalizes by issuing debt and targets a 30% debt-to-total capital (D/((D+E)=.30), what is Happy Corp.'s new weighted average cost of capital? Assume the borrowing rate is 8% and the tax rate is 40%.