Question 1

One advantage of preferred is that it increases a firm's equity without diluting the ownership and control of the common shareholders.

Accepted Answer

A) True 
 B)False

Question 2

As a general rule, the capital structure that:

Accepted Answer

A)  minimizes the cost of equity also maximizes the stock price
B)  maximizes the stock price also minimizes the weighted average cost of capital
C)  minimizes the cost of debt also maximizes the expected earnings per share
D)  none of the above is a true statement

Question 3

The EPS/EBIT indifference level represents the level of EBIT at which the firm would be indifferent between two different capital structures because they both result in the same level of EPS.

Accepted Answer

A) True 
 B)False

Question 4

Which of the following is not potentially used in the weighted average cost of capital equation?

Accepted Answer

A)  cost of retained earnings
B)  weight of debt
C)  average corporate income tax rate
D)  marginal tax rate

Question 5

In calculating the cost of new common stock using the constant dividend growth model, it is important that the __________ are subtracted from the price of the stock.

Accepted Answer

A)  flotation costs
B)  par value
C)  cost of retained earnings
D)  proceeds of the sale

Question 6

A non-optimal capital structure may lead to higher financing costs.

Accepted Answer

A) True 
 B)False

Question 7

All of the following statements are correct except:

Accepted Answer

A)  	Venture capitalists usually are members of partnerships that consist of a few general partners.
B)  	The typical venture capital partnership manages between $50 million and $100 million in assets.
C)  	It is common to organize a venture capital fund as a limited partnership in which the venture capitalist is the general partner and the other investors are limited investors.
D)  	At the end of a fund’s life, cash and securities are distributed to the investors.
E)  	All of the above statements are correct.

Question 8

The weighted average cost of capital represents the maximum required rate of return on a capital-budgeting project and is found by multiplying the cost of each capital structure component by its appropriate weight and summing the terms.

Accepted Answer

A) True 
 B)False

Question 9

A high degree of financial leverage means that a small change in sales will result in:

Accepted Answer

A)  a small change in earnings per share
B)  a large change in earnings per share
C)  no change in earnings per share
D)  none of the above

Question 10

Business risk is measured by the degree of financial leverage.

Accepted Answer

A) True 
 B)False

Question 11

All of the following statements regarding capital structure weights in the WACC equation are correct except:

Accepted Answer

A)  The weights represent a specific intended financing mix.
B)  These target weights represent a mix of debt and equity that the firm will try to achieve or maintain over the planning horizon.
C)  As much as possible, the target weights should reflect the combination of debt and equity that management believes will minimize the firm's weighted average cost of capital.
D)  The firm should make an effort over time to move toward and maintain its target capital structure mix of debt and equity.
E)  All of the above statements are correct.

Question 12

All of the following statements regarding capital structure weights in the WACC equation are correct except:

Accepted Answer

A)  The weights represent a firm's most recent financing mix.
B)  These target weights represent a mix of debt and equity that the firm will try to achieve or maintain for a period of at least 5 years.
C)  As much as possible, the target weights should reflect the combination of debt and equity that management believes will maximize the firm's weighted average cost of capital.
D)  The firm should make an effort over time to move toward and maintain its target capital structure mix of current liabilities, debt and equity.
E)  All of the above statements are correct.Clone of 2 prior items

Question 13

Finance theory favors the use of ____________ value weights in the calculation of the weighted average cost of capital.

Accepted Answer

A)  book
B)  future
C)  market
D)  none of the above

Question 14

The degree of combined leverage is the percentage change in earnings per share that results from a one percent change in EBIT.

Accepted Answer

A) True 
 B)False

Question 15

The ratio of long-term debt to GDP for non-financial U.S.corporations declined drastically during the late 1990s.

Accepted Answer

A) True 
 B)False

Question 16

When the interest expense is zero, the percentage change in earnings per share will be the same as the percentage change in EBIT.

Accepted Answer

A) True 
 B)False

Question 17

The firm's unadjusted cost of debt financing equals the yield to maturity on new debt issues.

Accepted Answer

A) True 
 B)False

Question 18

All of the following statements are correct except:

Accepted Answer

A)  Relevant cash flows are incremental before-tax cash flows, which must be discounted using an incremental after-tax cost of capital.
B)  The firm's relevant cost of capital is computed from before-tax financing costs.
C)  A project's incremental cash flows must be discounted at a cost of capital that represents the historical cost to the firm of financing the project.
D)  In estimating the cost of capital, the firm's analysts need to evaluate investors' historical returns under past market conditions and then use these past returns to compute the firm's cost of raising funds.
E)  None of the above statements are correct.Clone of 2 prior items

Question 19

If a firm has current earnings per share of $2 and a degree of operating leverage of 4, a 10% increase in sales would result in earnings per share of:

Accepted Answer

A)  $2.80
B)  $8
C)  $2.20
D)  cannot tell from this information

Question 20

All of the following components are needed to calculate the internal growth rate except:

Accepted Answer

A)  return on assets
B)  retention rate
C)  return on equity
D)  all are needed

Exam 18: Capital Structure and the Cost of Capital

A non-optimal capital structure may lead to higher financing costs.

Correct AnswerverifiedShow Answer

The degree of combined leverage is the percentage change in earnings per share that results from a one percent change in EBIT.

Correct AnswerverifiedShow Answer

Finance theory favors the use of ____________ value weights in the calculation of the weighted average cost of capital.

Correct AnswerverifiedShow Answer

If a firm has current earnings per share of $2 and a degree of operating leverage of 4, a 10% increase in sales would result in earnings per share of:

Correct AnswerverifiedShow Answer

In calculating the cost of new common stock using the constant dividend growth model, it is important that the __________ are subtracted from the price of the stock.

Correct AnswerverifiedShow Answer

All of the following statements regarding capital structure weights in the WACC equation are correct except:

Correct AnswerverifiedShow Answer

All of the following statements regarding capital structure weights in the WACC equation are correct except:

Correct AnswerverifiedShow Answer

One advantage of preferred is that it increases a firm's equity without diluting the ownership and control of the common shareholders.

Correct AnswerverifiedShow Answer

Which of the following is not potentially used in the weighted average cost of capital equation?

Correct AnswerverifiedShow Answer

The firm's unadjusted cost of debt financing equals the yield to maturity on new debt issues.

Correct AnswerverifiedShow Answer

All of the following statements are correct except:

Correct AnswerverifiedShow Answer

The ratio of long-term debt to GDP for non-financial U.S.corporations declined drastically during the late 1990s.

Correct AnswerverifiedShow Answer

When the interest expense is zero, the percentage change in earnings per share will be the same as the percentage change in EBIT.

Correct AnswerverifiedShow Answer

All of the following statements are correct except:

Correct AnswerverifiedShow Answer

The weighted average cost of capital represents the maximum required rate of return on a capital-budgeting project and is found by multiplying the cost of each capital structure component by its appropriate weight and summing the terms.

Correct AnswerverifiedShow Answer

All of the following components are needed to calculate the internal growth rate except:

Correct AnswerverifiedShow Answer

A high degree of financial leverage means that a small change in sales will result in:

Correct AnswerverifiedShow Answer

Business risk is measured by the degree of financial leverage.

Correct AnswerverifiedShow Answer

As a general rule, the capital structure that:

Correct AnswerverifiedShow Answer

The EPS/EBIT indifference level represents the level of EBIT at which the firm would be indifferent between two different capital structures because they both result in the same level of EPS.

Correct AnswerverifiedShow Answer

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