Homemade leverage is:
the borrowing or lending of money by individual shareholders as a means
of adjusting their level of financial leverage.
Which one of the following states that the value of a firm is unrelated to the
firm's capital structure?
M & M Proposition I
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?
M & M Proposition II
Which one of the following is the equity risk that is most related to the daily
operations of a firm?
Business risk
Which one of the following is the equity risk related to a firm's capital
structure policy?
Financial
Butter & Jelly reduced its taxes last year by $350 by increasing its interest
expense by $1,000. Which of the following terms is used to describe this tax
savings?
Interest tax shield
The unlevered cost of capital refers to the cost of capital for a(n):
All-equity firm
The explicit costs, such as legal and administrative expenses, associated
with corporate default are classified as _____ costs.
direct bankruptcy
The costs incurred by a business in an effort to avoid bankruptcy are
classified as _____ costs.
indirect bankruptcy
By definition, which of the following costs are included in the term "financial
distress costs"?
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
The proposition that a firm borrows up to the point where the marginal benefit
of the interest tax shield derived from increased debt is just equal to the
marginal expense of the resulting increase in financial distress costs is
called:
The static theory of capital structure
Which one of the following is the legal proceeding under which an insolvent
firm can be reorganized?
bankruptcy
A business firm ceases to exist as a going concern as a result of which one
of the following?
liquidation
Edwards Farm Products was unable to meet its financial obligations and was
forced into using legal proceedings to restructure itself so that it could
continue as a viable business. The process this firm underwent is known as a...
reorganization
The absolute priority rule determines:
E. which parties receive payment first in a bankruptcy proceeding.
A firm should select the capital structure that:
maximizes the value of the firm.
The value of a firm is maximized when the:
weighted average cost of capital is minimized.
The optimal capital structure has been achieved when the:
debt-equity ratio results in the lowest possible weighted average cost of capital.
AA Tours is comparing two capital structures to determine how to best
finance its operations. The first option consists of all equity financing. The
second option is based on a debt-equity ratio of 0.45. What should AA Tours
do if its expected earnings be
select the unlevered option since the expected EBIT is less than the
break-even level
You have computed the break-even point between a levered and an
unlevered capital structure. Assume there are no taxes. At the break-even
level, the:
firm is just earning enough to pay for the cost of the debt.
Which one of the following statements is correct concerning the relationship
between a levered and an unlevered capital structure? Assume there are no
taxes.
A. At the break-even point, there is no advantage to debt.
Jessica invested in Quantro stock when the firm was unlevered. Since then,
Quantro has changed its capital structure and now has a debt-equity ratio of
0.30. To unlever her position, Jessica needs to:
sell some shares of Quantro stock and loan out the sale proceeds.
Which one of the following makes the capital structure of a firm irrelevant?
homemade leverage
M & M Proposition I with no tax supports the argument that:
the debt-equity ratio of a firm is completely irrelevant.
The concept of homemade leverage is most associated with:
M & M Proposition I with no tax.
Which of the following statements are correct in relation to M & M 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.
M & M Proposition II is the proposition that:
a firm's cost of equity is a linear function with a slope equal to (R A - R D ).
The business risk of a firm:
has a positive relationship with the firm's cost of equity.
Which of the following statements related to financial risk are correct?
I. Financial risk is the risk associated with the use of debt financing.
II. As financial risk increases so too does the cost of equity.
III. Financial risk is wholly dependent upon the financial policy of a firm.
M & M Proposition I with tax supports the theory that:
a firm's weighted average cost of capital decreases as the firm's debt-
equity ratio increases.
M & M Proposition I with taxes is based on the concept that:
the value of a firm increases as the firm's debt increases because of the
interest tax shield.
M & M Proposition II with taxes:
has the same general implications as M & M Proposition II without taxes.
The present value of the interest tax shield is expressed as:
T c � D.
The interest tax shield has no value when a firm has a:
I. tax rate of zero.
III. zero debt.
IV. zero leverage.
The interest tax shield is a key reason why:
C. the net cost of debt to a firm is generally less than the cost of equity.
Based on M & M Proposition II with taxes, the weighted average cost of
capital:
decreases as the debt-equity ratio increases.
Bankruptcy:
transfers value from shareholders to bondholders.
Which one of the following is a direct bankruptcy cost?
paying an outside accountant fees to prepare bankruptcy reports
If a firm has the optimal amount of debt, then the:
value of the levered firm will exceed the value of the firm if it were
unlevered.
Which one of the following has the greatest tendency to increase the
percentage of debt included in the optimal capital structure of a firm?
low probabilities of financial distress
The capital structure that maximizes the value of a firm also:
minimizes the cost of capital.
The optimal capital structure:
will vary over time as taxes and market conditions change.
The static theory of capital structure advocates that the optimal capital
structure for a firm:
equates the tax savings from an additional dollar of debt to the increased
bankruptcy costs related to that additional dollar of debt.
The basic lesson of M & M Theory is that the value of a firm is dependent
upon:
the total cash flow of the firm
Which form of financing do firms prefer to use first according to the pecking-
order theory?
internal funds
Which of the following are correct according to pecking-order theory?
I. Firms stockpile internally-generated cash.
II. There is an inverse relationship between a firm's profit level and its debt
level..
IV. A firm's capital structure is dictated by its need for external financing.
Corporations in the U.S. tend to:
under-utilize debt
In general, the capital structures used by U.S. firms:
vary significantly across industries
A firm is technically insolvent when:
it is unable to meet its financial obligations.
Which one of the following statements related to Chapter 7 bankruptcy is
correct?
Under a Chapter 7 bankruptcy, a trustee will assume control of the firm's
assets until those assets can be liquidated.
Which one of the following will generally have the highest priority when
assets are distributed in a bankruptcy proceeding?
payment of employee wages
A firm may file for Chapter 11 bankruptcy:
in an attempt to gain a competitive advantage.
II. using a prepack.
III. while allowing the current management to continue running the firm.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:
permits key employee retention plans only if an employee has another job
offer.