Chapter 16 - Capital Structure: Basic Concepts
17. In an EPS-EBI graphical relationship, the debt ray and equity ray cross. At this point the equity and debt are:
A. equivalent with respect to EPS but above and below this point equity is always superior. B. at breakeven in EPS but above this point debt increases EPS via leverage and decreases EPS below this point.
C. equal but away from breakeven equity is better as fewer shares are outstanding. D. at breakeven and MM Proposition II states that debt is the better choice.
E. at breakeven and debt is the better choice below breakeven because small payments can be made.
18. When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of EBIT because:
A. interest payments on the debt vary with EBIT levels.
B. interest payments on the debt stay fixed, leaving less income to be distributed over less shares.
C. interest payments on the debt stay fixed, leaving more income to be distributed over less shares.
D. interest payments on the debt stay fixed, leaving less income to be distributed over more shares.
E. interest payments on the debt stay fixed, leaving more income to be distributed over more shares.
19. Financial leverage impacts the performance of the firm by: A. maintaining the same level of volatility of the firm's EBIT. B. decreasing the volatility of the firm's EBIT.
C. decreasing the volatility of the firm's net income. D. increasing the volatility of the firm's net income. E. None of the above.
20. The increase in risk to equityholders when financial leverage is introduced is evidenced by: A. higher EPS as EBIT increases.
B. a higher variability of EPS with debt than all equity. C. increased use of homemade leverage.
D. equivalence value between levered and unlevered firms in the presence of taxes. E. None of the above.
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Chapter 16 - Capital Structure: Basic Concepts
21. The reason that MM Proposition I does not hold in the presence of corporate taxation is because:
A. levered firms pay less taxes compared with identical unlevered firms. B. bondholders require higher rates of return compared with stockholders. C. earnings per share are no longer relevant with taxes. D. dividends are no longer relevant with taxes. E. All of the above.
22. MM Proposition I with corporate taxes states that: A. capital structure can affect firm value.
B. by raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value.
C. firm value is maximized at an all debt capital structure. D. All of the above. E. None of the above.
23. The change in firm value in the presence of corporate taxes only is: A. positive as equityholders face a lower effective tax rate.
B. positive as equityholders gain the tax shield on the debt interest.
C. negative because of the increased risk of default and fewer shares outstanding. D. negative because of a reduction of equity outstanding. E. None of the above.
24. A firm should select the capital structure which: A. produces the highest cost of capital. B. maximizes the value of the firm. C. minimizes taxes. D. is fully unlevered. E. has no debt.
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Chapter 16 - Capital Structure: Basic Concepts
25. In a world of no corporate taxes if the use of leverage does not change the value of the levered firm relative to the unlevered firm is known as:
A. MM Proposition III that the cost of stock is less than the cost of debt. B. MM Proposition I that leverage is invariant to market value. C. MM Proposition II that the cost of equity is always constant.
D. MM Proposition I that the market value of the firm is invariant to the capital structure. E. MM Proposition III that there is no risk associated with leverage in a no tax world.
26. Bryan invested in Bryco, Inc. stock when the firm was financed solely with equity. The firm is now utilizing debt in its capital structure. To unlever his position, Bryan needs to: A. borrow some money and purchase additional shares of Bryco stock.
B. maintain his current position as the debt of the firm did not affect his personal leverage position.
C. sell some shares of Bryco stock and hold the proceeds in cash.
D. sell some shares of Bryco stock and loan it out such that he creates a personal debt-equity ratio equal to that of the firm.
E. create a personal debt-equity ratio that is equal to exactly 50% of the debt-equity ratio of the firm.
27. The capital structure chosen by a firm doesn't really matter because of: A. taxes.
B. the interest tax shield.
C. the relationship between dividends and earnings per share. D. the effects of leverage on the cost of equity. E. homemade leverage.
28. MM Proposition I with no tax supports the argument that: A. business risk determines the return on assets. B. the cost of equity rises as leverage rises.
C. it is completely irrelevant how a firm arranges its finances.
D. a firm should borrow money to the point where the tax benefit from debt is equal to the cost of the increased probability of financial distress.
E. financial risk is determined by the debt-equity ratio.
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Chapter 16 - Capital Structure: Basic Concepts
29. The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:
A. MM Proposition I with no tax. B. MM Proposition II with no tax. C. MM Proposition I with tax. D. MM Proposition II with tax. E. static theory proposition.
30. The concept of homemade leverage is most associated with: A. MM Proposition I with no tax. B. MM Proposition II with no tax. C. MM Proposition I with tax. D. MM Proposition II with tax. E. static theory proposition.
31. Which of the following statements are correct in relation to MM Proposition II with no taxes?
I. The required return on assets is equal to the weighted average cost of capital. II. Financial risk is determined by the debt-equity ratio. III. Financial risk determines the return on assets.
IV. The cost of equity declines when the amount of leverage used by a firm rises. A. I and III only B. II and IV only C. I and II only D. III and IV only E. I and IV only
32. MM Proposition I with taxes supports the theory that:
A. there is a positive linear relationship between the amount of debt in a levered firm and its value.
B. the value of a firm is inversely related to the amount of leverage used by the firm.
C. the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield.
D. a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm. E. a firm's weighted average cost of capital increases as the debt-equity ratio of the firm rises.
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