Exam 14: Capital Structure

A) Generally, debt ratios do not vary much among different industries, although they do vary among firms within a given industry.
B) Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries.
C) Airline companies tend to have very volatile earnings, and as a result they generally have high target debt-to-equity ratios.
D) Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes.
E) Since most stocks sell at or very close to their book values, book value capital structures are typically adequate for use in estimating firms' weighted average costs of capital.

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A) The capital structure that maximizes the stock price is also the capital structure that minimizes the cost of equity from retained earnings (rs) .
B) The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share.
C) The capital structure that maximizes the stock price is also the capital structure that maximizes the firm's times interest earned (TIE) ratio.
D) If a company increases its debt ratio, this will typically increase the marginal costs of both debt and equity, but it still may reduce the company's WACC.
E) If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios.

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A) 0.71
B) 0.75
C) 0.79
D) 0.83
E) 0.87

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A) As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.
B) The optimal capital structure simultaneously maximizes EPS and minimizes the WACC.
C) The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price.
D) The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC.
E) The optimal capital structure simultaneously maximizes the stock price and minimizes the WACC.

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A) 28,880
B) 30,400
C) 32,000
D) 33,600
E) 35,280

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A) If Congress lowered corporate tax rates while other things were held constant, and if the Modigliani-Miller tax-adjusted theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.
B) A change in the personal tax rate should not affect firms' capital structure decisions.
C) "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage.
D) The optimal capital structure is the one that simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS.
E) If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation's debt ratio.

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