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Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant?


A) An increase in the corporate tax rate.
B) An increase in the personal tax rate.
C) An increase in the company's operating leverage.
D) The Federal Reserve tightens interest rates in an effort to fight inflation.
E) The company's stock price hits a new high.

F) A) and B)
G) A) and C)

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Which of the following statements is CORRECT?


A) If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff 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 make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation.

F) A) and B)
G) A) and C)

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Companies HD and LD have identical amounts of assets, operating income Which of the following statements is CORRECT?


A) Company HD has a higher return on assets (ROA) than Company LD.
B) Company HD has a higher times interest earned (TIE) ratio than Company LD.
C) Company HD has a higher return on equity (ROE) than Company LD, and its risk, as measured by the standard deviation of ROE, is also higher than LD's.
D) The two companies have the same ROE.
E) Company HD's ROE would be higher if it had no debt.

F) B) and E)
G) B) and D)

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Lauterbach Corporation uses no debt, its beta is 1.10, and its tax rate is 40%.However, the CFO is considering moving to a capital structure with 30% debt and 70% equity.If the risk-free rate is 5.0% and the market risk premium is 6.0%, by how much would the capital structure shift change the firm's cost of equity?


A) 1.53%
B) 1.70%
C) 1.87%
D) 2.05%
E) 2.26%

F) A) and E)
G) A) and D)

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Blemker Corporation has $500 million of total assets, its basic earning power is 15%, and it currently has no debt in its capital structure.The CFO is contemplating a recapitalization where it will issue debt at a cost of 10% and use the proceeds to buy back shares of the company's common stock, paying book value.If the company proceeds with the recapitalization, its operating income, total assets, and tax rate will remain unchanged.Which of the following is most likely to occur as a result of the recapitalization?


A) The ROA would increase.
B) The ROA would remain unchanged.
C) The basic earning power ratio would decline.
D) The basic earning power ratio would increase.
E) The ROE would increase.

F) C) and E)
G) A) and E)

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Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant?


A) An increase in costs incurred when filing for bankruptcy.
B) An increase in the corporate tax rate.
C) An increase in the personal tax rate.
D) The Federal Reserve tightens interest rates in an effort to fight inflation.
E) The company's stock price hits a new low.

F) A) and B)
G) C) and D)

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Which of the following statements is CORRECT? As a firm increases the operating leverage used to produce a given quantity of output, this will


A) normally lead to an increase in its fixed assets turnover ratio.
B) normally lead to a decrease in its business risk.
C) normally lead to a decrease in the standard deviation of its expected EBIT.
D) normally lead to a decrease in the variability of its expected EPS.
E) normally lead to a reduction in its fixed assets turnover ratio.

F) A) and E)
G) A) and B)

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assume that PP is considering changing from its original capital structure to a new capital structure with 35% debt and 65% equity.This results in a weighted average cost of capital equal to 9.4% and a new value of operations of $510,638.Assume PP raises $178,723 in new debt and purchases T-bills to hold until it makes the stock repurchase.What is the stock price per share immediately after issuing the debt but prior to the repurchase?


A) $45.90
B) $48.12
C) $51.06
D) $53.33
E) $58.75

F) A) and B)
G) C) and D)

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Provided a firm does not use an extreme amount of debt, financial leverage typically affects both EPS and EBIT, while operating leverage only affects EBIT.

A) True
B) False

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Which of the following statements is CORRECT?


A) Increasing financial leverage is one way to increase a firm's basic earning power (BEP) .
B) If a firm lowered its fixed costs while increasing its variable costs, holding total costs at the present level of sales constant, this would decrease its operating leverage.
C) The debt ratio that maximizes EPS generally exceeds the debt ratio that maximizes share price.
D) If a company were to issue debt and use the money to repurchase common stock, this action would have no impact on its basic earning power ratio.(Assume that the repurchase has no impact on the company's operating income.)
E) If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation's debt ratio.

F) C) and D)
G) B) and D)

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Assume that PP is considering changing from its original capital structure to a new capital structure with 35% debt and 65% equity.This results in a weighted average cost of capital equal to 9.4% and a new value of operations of $510,638.Assume PP raises $178,723 in new debt and purchases T-bills to hold until it makes the stock repurchase.PP then sells the T-bills and uses the proceeds to repurchase stock.How many shares remain after the repurchase, and what is the stock price per share immediately after the repurchase?


A) 7,500; $71.49
B) 7,000; $59.57
C) 6,500; $51.06
D) 6,649; $53.33
E) 6,959; $58.78

F) C) and E)
G) None of the above

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Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal.

A) True
B) False

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Volga Publishing is considering a proposed increase in its debt ratio, which would also increase the company's interest expense.The plan would involve issuing new bonds and using the proceeds to buy back shares of its common stock.The company's CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share Assuming the CFO's estimates are correct, which of the following statements is CORRECT?


A) Since the proposed plan increases Volga's financial risk, the company's stock price still might fall even if EPS increases.
B) If the plan reduces the WACC, the stock price is also likely to decline.
C) Since the plan is expected to increase EPS, this implies that net income is also expected to increase.
D) If the plan does increase the EPS, the stock price will automatically increase at the same rate.
E) Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds.

F) C) and D)
G) All of the above

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consultant has collected the following information regarding Young Publishing: The company has no growth opportunities The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values) that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%.If the company makes this change, what would be the total market value (in millions) of the firm?


A) $3,200
B) $3,600
C) $4,000
D) $4,200
E) $4,800

F) A) and D)
G) All of the above

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Based on the data in the previous two problems, what would the stock price be if VF issued the new debt and immediately used the proceeds to repurchase stock?


A) $49.43
B) $50.70
C) $52.00
D) $53.33
E) $56.00

F) C) and E)
G) B) and C)

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graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant.

A) True
B) False

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firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

A) True
B) False

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Firms U and L each have the same amount of assets, and both have a basic earning power ratio of 20%.Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity.Firm L's debt has a before-tax cost of 8%.Both firms have positive net income.Which of the following statements is CORRECT?


A) The two companies have the same times interest earned (TIE) ratio.
B) Firm L has a lower ROA than Firm U.
C) Firm L has a lower ROE than Firm U.
D) Firm L has the higher times interest earned (TIE) ratio.
E) Firm L has a higher EBIT than Firm U.

F) A) and B)
G) C) and E)

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firm is considering moving to a capital structure that is comprised of 40% debt and 60% equity, based on market values.The new funds would be used to replace the old debt and to repurchase stock.It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on debt to rise to 7%, while the required rate of return on equity would rise to 9.5%.If this plan were carried out, what would be AJC's new WACC and total value?


A) 7.38%; $800,008
B) 7.38%; $813,008
C) 7.50%; $813,008
D) 7.50%; $790,008
E) 7.80%; $790,008

F) A) and B)
G) A) and E)

Correct Answer

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is AJC's current total market value and weighted average cost of capital?


A) $600,000; 7.5%
B) $600,000; 8.0%
C) $800,000; 7.0%
D) $800,000; 7.5%
E) $800,000; 8.0%

F) B) and E)
G) C) and E)

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