Q&A Hero

Q: In a large, widely-held corporation, the financial manager should consider all of the following in establishing a dividend policy except a. individual shareholder preferences b. cash flow needs c. informational content of dividends d. investment opportunities

Q: Which phrase below bestsummarizes the arguments supporting a stable dollar dividend policy? a. earnings stability b. beta c. capital structure d. informational content

Q: A passive residual dividend policy suggests that the firm will: a. pay the same dollar amount of dividends every year b. pay the same percentage of earnings in dividends every year c. pay a dividend only after all viable investment projects have been exhausted d. omit a dividend in the next period

Q: The record datein the normal dividend payment procedure is a. the same day as the declaration date b. the same day as the ex-dividend date c. the date when the firm makes a list from its stock transfer books of shareholders eligible to receive the dividend d. one day prior to the payment date

Q: Many firms try to maintain a stable dividend policy a. because of the informational content of dividend changes b. in order to satisfy investors who rely on dividends as a primary source of income c. in order to remain as eligible investments for many financial institutions d. All of these answers are correct.

Q: The passive residual dividend policy seemsto be inconsistent with a. a world having significant transactions costs associated with new stock issues b. a stable dividend policy c. a policy of paying only stock dividends d. a share-repurchase policy

Q: The passive residual dividend policy asserts that a. dividends should be paid out only if the firm does not have enough acceptable investment projects to utilize all earnings internally. b. dividends should be paid only when the firm has ready access to new equity markets c. retained earnings, being the residual earnings of the firm, should always be paid out to existing stockholders d. investment policy and dividend policy decisions should always be made independently

Q: Finance researcher Myron Gordon argues that a. risk-averse shareholders may prefer some dividends over the promise of future capital gains if the interest rate is expected to decline b. dividends reduce uncertainty, and thus the payment of dividends will increase the firm's value c. the clientele effect has no influence on share value d. the existence of transaction costs has no impact on the dividend decision

Q: In the theoretical world of Miller and Modigliani a. a firm should pay out 100 percent of earnings as dividends, to maximize shareholder wealth b. the marginal tax rates facing investors are the most important single determinant of dividend policy c. dividends are important only for their informational content d. dividends should not be paid at all

Q: The following factors influence a firm's ability and/or willingness to pay dividends: a. liquidity b. borrowing capacity and access to capital markets c. earnings stability d. All of these answers are correct.

Q: Most states limit dividend policy by requiring a. that dividends may not be paid unless the firm generates net earnings during the most recent year b. that dividends may only be paid out of retained earnings c. that dividends may not be paid when the firm is insolvent d. that dividends may be paid when the firm is insolvent

Q: Dividend reinvestment plans involve the purchase of a. newly issued stock b. existing stock c. letter stock d. newly issued and existing stock

Q: The dividend "clientele effect" concept was originally developed by a. Myron Gordon b. Merton Miller and Franco Modigliani c. Milton Friedman d. Paul Samuelson

Q: Explain the pecking order theory.

Q: Crown Data(CD) has a current capital structure that consists of $120 million in common equity (15 million shares) and $80 million in long-term debt with an average interest rate of 11 percent. CD is considering an expansion project that will cost $22 million. The project will be financed either by issuing long-term debt at a cost of 12.5 percent, or the sale of new common stock at $35 per share. The firm's marginal tax rate is 40%. What is the EBIT indifference point between the two financing options?a. $71.5 millionb. $77.2 millionc. $68.3 milliond. $ 1.0 million

Q: Twin City Printing is considering two financial alternatives for financing a major expansion program. Under either alternative EBIT is expected to be $15.6 million. Currently the firm's capital structure consists of 4 million shares of common stock and $35 million in 11% long-term bonds. Under the debt financing alternative $10 million in 12% long-term bonds will be sold and under the equity financing alternative the firm would sell 500,000 shares of common stock. The P/E under the debt alternative would be 15 and the P/E under the equity alternative would be 16. The firm's marginal tax rate is 40%. Which alternative would produce the higher stock price?a. debt--stock price of $23.75b. debt--stock price of $32.29c. equity--stock price of $25.07d. equity--stock price of $33.28

Q: Jocko Inc. has a capital structure that consists of 60% common equity (2.0 million shares), 30% long-term debt ($10 million with 12% coupon), and 10% preferred stock ($50 par value with $4.75 dividend). The company is planning a major plant expansion and is undecided between the following two financing plans:1. Equity financing: Sale of 400,000 shares of common at $10 each.2. Debt financing: Sale of $4 million of 12.5 percent long-term bonds.Calculate the EBIT-EPS indifference point. Assume the marginal tax rate is 40%.a.$4.253 millionb.$3.051 millionc.$3.654 milliond.$4.728 million

Q: Midwest Can Company is considering opening a new plant in St. Louis that is expected to produce an average EBIT of $3 million per year. To finance this new plant, Midwest is considering two financing plans. The first plan is to sell 600,000 shares of common stock at $15 each. The second plan is to sell 200,000 shares of common stock at $15 each and $6 million of 13 percent long-term debt. If Midwest has a marginal tax rate of 40 percent, what is the EBIT-EPS indifference point for this plant? a. $702,000 b. $234,000 c. $2,234,000 d. $1,170,000

Q: Higgins currently has 2 million shares of common stock outstanding that are selling for $32 per share. Higgins also has a $20 million mortgage bond outstanding that has an 11 percent coupon rate. Higgins is considering two alternatives to financing a major expansion. Plan A is to sell $10 million of additional long-term debt with a 12.5 percent coupon. Plan B is to sell 200,000 shares of common stock at $30 per share and $4 million in long-term debt with a 11.25 percent coupon. What is the EBIT indifference level between these two alternatives? Assume the marginal tax rate is 40 percent. a. $1,374,000 b. $11,450,000 c. $4,554,000 d. $9,409,000

Q: Sulzar's capital structure consists only of common stock (20 million shares), but the firm is planning a major expansion which will require $100 million of new capital. Sulzar has a choice of obtaining the needed capital through the sale of 5 million shares of common stock at $20 per share or the sale of $100 million of first mortgage bonds that would have a coupon rate of 9%. If Sulzar has a marginal tax rate of 40%, calculate the EBIT-EPS indifference point. a. $45 million b. $36 million c. $5 million d. $9 million

Q: Dagger Company has a current capital structure consisting of $60 million in long-term debt with an interest rate of 9% and $60 million in common equity (12 million shares). The firm is considering an expansion plan costing $23 million. The expansion plan can be financed with additional long-term debt at a 12% interest rate or the sale of new common stock at $8 per share. The firm's marginal tax rate is 40%. Determine the indifference level of EBIT for the two financing plans.a. -$30.24 millionb. $18.36 millionc. $30.24 milliond. $19.68 million

Q: Triad Labs has total assets of $120 million and $40 million of debt in its capital structure. Its current cost of equity is 13% and its cost of debt is 8.5%. Triad is considering increasing its debt to $70 million and purchasing its own stock with proceeds from the sale of $30 million in debt with a cost of 9.5%, reducing equity to $50 million. The cost of equity will increase to 14.5%. Net operating income (EBIT) will remain at $12 million. If Triad has a marginal tax rate of 40%, should the firm increase its debt? Assume that both debt and EBIT are perpetual. a. No, the value of the firm decreases $15.9 million b. No, the value of the firm decreases $30.0 million c. Yes, the value of the firm increases $14.1 million d. Yes, the value of the firm increases $30.0 million

Q: Biotec has estimated the costs of debt and equity capital for various proportions of debt in its capital structure: % of Debt Cost of Debt Cost of Equity 35 5.4% 13.8% 40 5.6 14.0 45 5.9 14.3 50 6.4 14.7 If Biotec pays a current dividend of $1.00 and expects dividends to grow at a constant rate of 7%, what is Biotec's stock price if it obtains its optimal capital structure? a. $14.66 b. $30.40 c. $30.14 d. $29.40

Q: Biotec has estimated the costs of debt and equity capital for various proportions of debt in its capital structure: % of Debt Cost of Debt Cost of Equity 35 5.4% 13.8% 40 5.6 14.0 45 5.9 14.3 50 6.4 14.7 Based on these estimates, determine Biotec's optimal capital structure. a. 35% debt b. 40% debt c. 45% debt d. 50% debt

Q: Technico has determined that its optimal capital structure is 40% debt, at which point its weighted cost of capital, ka, is 13.7%. Due to financial problems, the firm has decided to raise the proportion of debt to 50%, which will increase its weighted cost of capital to 14.4%. What is the effect on the stock price of Technico? The current dividend is $1.60 and the long-term growth rate of dividends is expected to be 8.5%. a. Decrease $3.65 b. Decrease $3.96 c. Increase $3.65 d. Increase $3.96

Q: Seduak has estimated the costs of debt and equity capital for various proportions of debt in its capital structure: % of Debt Cost of Debt Cost of Equity 0% - 13.0% 10 5.4% 13.3 20 5.4 13.8 30 5.8 14.4 40 6.3 15.2 50 7.0 16.0 60 8.2 17.0 Based on these estimates, determine Seduak's optimal capital structure. a. 30% debt b. 40% debt c. 50% debt d. 60 % debt

Q: Feldspar Inc. is considering the capital structure for a new division. Management has been given the following cost information:Debt/assetskdke.30.10.125.40.105.13.50.11.135.60.117.142.70.13.155Based on this information, what capital structure (debt/asset ratio) should management accept? Assume the marginal tax rate is 40%.a. 40% has lowest cost of capitalb. 50% has lowest cost of capitalc. 60% has lowest cost of capitald. 70% has lowest cost of capital

Q: RoTek has a capital structure of $300,000 in equity and $300,000 in perpetual debt. The firm's cost of equity is 14 percent and its cost of debt is 9 percent. If the firm has an expected, perpetual net operating income of $120,000 and a marginal tax rate of 40 percent, what is the market value of RoTek? Assume all net income is paid out as dividends. a. $698,571 b. $814,286 c. $818,571 d. $489,000

Q: Calculate the market value of a firm with total assets of $105 million and $50 million of 10% perpetual debt in the capital structure. The firm's cost of equity is 14% on the $55 million in equity in the capital structure. The perpetual EBIT is expected to be $9 million and the marginal tax rate is 40%. a. $88.6 million b. $67.1 million c. $114.3 million d. $78.6 million

Q: What is the market value of Barings, a firm with total assets of $100 million and $30 million in perpetual debt in its capital structure? Barings' cost of equity is 15% and its cost of debt is 10%. Expected perpetual net operating income (EBIT) will be $17 million and the marginal tax rate is 40%. a. $86.0 million b. $104.0 million c. $98.0 million d. $92.7 million

Q: Knight Moves is considering two alternative financing plans. The firm is expected to operate at the $75 million EBIT level. Under Plan D (debt financing) EPS is expected to be $2.25, and under Plan E (equity financing) EPS is expected to be $1.82. If the market is expected to assign a P/E ratio of 12 to the debt plan and 15 to the equity plan, which plan should Knight pursue? a. debt b. equity c. indifferent between the two alternatives d. neither is satisfactory

Q: Alace is an all equity firm with 10 million shares outstanding that is evaluating two alternative financing plans. With the first plan, Alace will sell 1 million shares of common stock at $15 each. Under the second plan, the firm would sell $15 million of 12 percent long-term debt. If Alace has a marginal tax rate of 35 percent, what is the EBIT-EPS indifference point? a. $12.9 million b. $19.8 million c. $11.7 million d. $8.4 million

Q: Two companies, Jefferson and Jackson, are virtually identical in all aspects of their operations except that the two companies differ in their capital structures, as shown below: Jefferson Jackson Debt (10%) $200 million $100 million Common equity $300 million $400 million No. shares outstanding 15 million 20 million Both companies have $500 million in total assets and both have a 40% marginal tax rate. What is the EPS for Jackson at an EBIT level of $50 million? a. $1.50 b. $1.20 c. $2.00 d. $2.50

Q: Two companies, Jefferson and Jackson, are virtually identical in all aspects of their operations except that the two companies differ in their capital structures, as shown below: Jefferson Jackson Debt (10%) $200 million $100 million Common equity $300 million $400 million No. shares outstanding 15 million 20 million Both companies have $500 million in total assets and both have a 40% marginal tax rate. What is the EPS for Jefferson at an EBIT level of $50 million? a. $-1.20 b. $ 1.20 c. $ 2.20 d. $ 3.33

Q: The Albany Corporation has a present capital structure consisting of common stock ($200 million, 10 million shares) and debt ($150 million, 8%). The company is planning a major expansion and is undecided between two financing plans. Plan A: Equity financing. Under this plan, an additional 2.5 million shares of common stock will be sold at $15 each. Plan B: Debt financing. Under this plan, $37.5 million of 10% long-term debt will be sold. What happens to the EBIT indifference point if the interest rate on the new debt decreases and the common stock price remains constant? a. the indifference point increases b. the indifference point decreases c. the indifference point does not change d. cannot be determined

Q: The Albany Corporation has a present capital structure consisting of common stock ($200 million, 10 million shares) and debt ($150 million, 8%). The company is planning a major expansion and is undecided between two financing plans. Plan A: Equity financing. Under this plan, an additional 2.5 million shares of common stock will be sold at $15 each. Plan B: Debt financing. Under this plan, $37.5 million of 10% long-term debt will be sold. What is the EBIT-EPS indifference point? Assume a 40 percent marginal tax rate. a. $33.9 million b. $30.75 million c. $37.0 million d. $70.9 million

Q: Calculate the market value of a firm with total assets of $60 million and a net worth of $35 million. The firm's cost of equity is 15% and the cost of perpetual debt is 8%. The firm has a perpetual net operating income (EBIT) of $4.5 million and a marginal tax rate of 35%. a. $41.67 million b. $30.00 million c. $35.83 million d. $30.83 million

Q: What is the present value of the tax shield to a firm that has total assets of $80 million and a net worth of $55 million, if the average interest rate on perpetual debt is 8.5%, the average return on equity is 14%, and the marginal tax rate is 35%? a. $8.75 million b. $12.25 million c. $0.85 million d. $0.744 million

Q: What is the annual tax shield to a firm that has total assets of $80 million and a net worth of $55 million, if the average interest rate on debt is 8.5%, the average return on equity is 14%, and the marginal tax rate is 35%? a. $2.125 million b. $1.87 million c. $0.85 million d. $0.744 million

Q: Calculate the market value of Lotle Group, a firm with total assets of $80 million and $30 million of perpetual debt in its capital structure. The firm's cost of equity is 14% and the cost of debt is 9%. Lotle expects annual, perpetual net operating income (EBIT) of $9 million and a marginal tax rate of 40%. a. $30 million b. $61.3 million c. $57 million d. $64.3 million

Q: What is the present value of the tax shield to a firm that has a capital structure consisting of $100 million of perpetual debt and $180 million of equity, if the average interest rate on debt is 9%, the return on equity is 13%, and the marginal tax rate is 40%? a. $72 million b. $40 million c. $60 million d. $3.6 million

Q: What is the annual tax shield to a firm that has a capital structure consisting of $100 million of debt and $180 million of equity, if the average interest rate on debt is 9%, the return on equity is 13%, and the marginal tax rate is 40%? a. $9.0 million b. $5.4 million c. $9.36 million d. $3.6 million

Q: The management of Graphicopy is trying to determine how much debt they should have in their capital structure. If they sell $500,000 in perpetual bonds with a 9 percent coupon, what would be the present value of the tax shield? Assume the marginal tax rate is 35%. a. $15,750 b. $29,250 c. $175,000 d. $45,000

Q: A firm with highly liquid assets plus unused debt capacity is said to have ____. a. arbitrage structural capacity b. the optimal capital structure c. financial slack d. optimal financial structure

Q: A survey of Fortune 500 firms indicate that they prefer internal financing (retained earnings) to external financing. This preference is known as ____. a. financial slack b. the pecking order theory c. capital structure theory d. asymmetric capital

Q: ____ refers to the argument that officers and managers have access to information about the expected future earnings of the firm that is not available to outside investors. a. Insider trading b. Asymmetric information c. Signaling effect d. Pecking order theory

Q: According to the "pecking order theory," firms prefer to issue ____ securities first and then issue ____ securities as a last resort. a. equity, debt b. debt, convertible debt c. debt, equity d. equity, convertible debt

Q: The optimal capital structure is a function of ____. a. corporate income taxes b. financial distress costs c. agency costs d. All of these are correct.

Q: The market value of a levered firm can be represented by the following equation: Market value of levered firm = Market value of unlevered firm ____ Present value of tax shield ____ Present value of financial distress costs ____ Present value of agency costs a. minus; plus; plus b. plus; plus; plus c. plus; minus; minus d. minus, minus, plus

Q: The optimal capital structure of a firm is a function of the ____. a. business risk of the firm b. tax structure c. business risk and tax structure of the firm d. bankruptcy costs

Q: The managerial implications of capital structure theory include all of the following except: a. capital structure changes transmit important information to investors b. changes in capital structure result in changes in the market value of the firm's equity c. optimal capital structure is influenced heavily by the business risk facing the firm d. tax shield benefits from equity lead to increased firm value

Q: Studies of capital structure changes have found that actions that increase leverage have generally been associated with ____ stock returns, and actions that decrease leverage are associated with ____ stock returns. a. negative, positive b. negative, no change in c. positive, negative d. no change in, positive

Q: Investors' required returns and the cost of equity capital ____ as the relative amount of debt used to finance the firm ____. a. increase, increases b. increase, decreases c. remain constant, increases d. remain constant, decreases

Q: As the proportion of debt in the capital structure increases, investors require a ____ return and the value of existing debt will ____. a. higher, increase b. higher, decrease c. lower, increase d. lower, decrease

Q: Protection for debt holders takes the form of protective covenants in the bond indenture. These covenants place restrictions on which of the following activities? a. the sale of assets b. payment of dividends c. the issuance of additional debt d. all of these are typical protective covenants

Q: Agency costs a. increase as the debt/total assets ratio decreases b. affect the present value of the tax shield c. decrease as financial distress increases d. reduce the market value of the levered firm

Q: Due to both financial distress and agency costs, a firm should have a capital structure that a. contains all debt b. contains all equity c. contains both debt and equity d. contains only long-term debt

Q: Modigliani and Miller show that the value of a firm is ____ capital structure given perfect capital markets and no corporate income taxes. a. maximized by having no debt in the b. independent of c. maximized by having an optimal d. dependent on the

Q: Financial leverage benefits shareholders when the a. return on assets is greater than the cost of debt b. return on equity is greater than the cost of debt c. return on investments is less than the weighted cost of capital d. cost of debt is greater than the return on equity

Q: The objective of capital structure management is to find the capital mix that leads to a. maximization of earnings per share b. shareholder wealth maximization c. maximization of net income d. maximization of the current period's dividends

Q: Generally the ____ a firm's business risk, the ____ the amount of financial leverage that will be used in the optimal capital structure. a. greater, greater b. smaller, less c. greater, less d. none of the above is correct

Q: One of the primary assumptions of capital structure analysis is that the level and variability of ____ is not expected to change as changes in capital structure are contemplated. a. net income b. earnings before taxes c. operating income d. debt

Q: The optimal capital structure is determined by several factors including all of the following except: a. corporate capital gains b. business risk c. potential bankruptcy risk d. agency costs

Q: The mix of debt, preferred stock, and common equity that minimizes the weighted cost of capital to the firm is known as the a. optimal corporate structure b. target financial structure c. optimal capital structure d. optimal degree of combined leverage

Q: Which of the following statements is (are) true concerning the relationship between the firm's cost of equity and its capital structure (as measured by the debt ratio)? a. The exact relationship between the cost of equity and the debt ratio is difficult to determine. b. The range of debt ratios where the cost of equity begins to increase rapidly varies by firm and industry depending on the firm's age. c. The relationship is a saucer-shaped curve. d. a and b only

Q: Which of the following statements is (are) true concerning the relationship between the firm's cost of debt and its capital structure (as measured by the debt ratio)? a. The range of debt ratios where the cost of debt begins to increase rapidly varies by firm and industry, depending on the level of business risk. b. The precise relationship between the cost of debt and the debt ratio is simple to determine. c. The relationship is a saucer-shaped curve. d. a and b only

Q: As more debt is added to the capital structure of a firm, the cost of debt capital a. initially rises slowly, then falls beyond some point b. increases at a steady rate throughout the entire range c. beyond some point, becomes greater than the cost of equity d. initially rises slowly, then increases rapidly beyond some point

Q: Holding all other things equal, as the relative amount of debt in the capital structure of the firm increases, the cost of equity capital will a. increase b. decrease c. remain unchanged; there is no relationship between the two d. initially rise rapidly, then increase slowly beyond some point

Q: With an optimal capital structure a. overall capital costs are minimized b. the net present value of new projects is minimized c. financial leverage is minimized d. both overall capital costs and financial leverage are minimized

Q: Perfect capital markets imply the following: a. there are no transactions costs for buying and selling securities b. relevant information is readily available for individuals and is costless to obtain c. all investors can borrow and lend at the same rate d. All of these answers are correct.

Q: Two prominent finance researchers (Modigliani and Miller) showed that a. the firm's optimal capital structure consists of approximately equal proportions of debt and equity b. the value of the firm is independent of its capital structure in perfect capital markets with no income taxes c. the firm's cost of capital is minimized when its capital structure consists of approximately equal proportions of debt and equity d. the value of the firm is independent of its capital structure in perfect capital markets with income taxes

Q: The Modigliani-Miller theory that the value of the firm is independent of its capital structure is based on a(n) ____ process. a. reinvestment b. capital asset pricing model c. arbitraging d. compound interest

Q: In analyzing the value of the firm as a function of capital structure, the present value of the tax shield benefit is offset by the present value of the expected ____, resulting in an interior optimal capital structure. a. financial distress costs b. agency costs c. holding costs d. financial distress and agency costs

Q: Explain Degree of Combined Leverage.

Q: Breakeven analysis is also known as: a. Cost of sales analysis b. Financial leverage analysis c. Cost-volume-profit analysis d. EBIT-EPS analysis

Q: Chirping Charlie Canary Farms has fixed operating costs of $10,000. It is trying to determine its breakeven point in dollars for its special bird seed. The sale price for each bag of bird seed is $25 and its variable cost per bag is $15. The firm's operating breakeven point in dollars is: a. $10,000 b. $16,667 c. $6,250 d. $25,000

Q: Buffalo Bonsai Tree Farms sells small bonsai trees. It has fixed operating costs of $400,000. The firm's sales price is $35 per tree and its variable cost per tree is $22.50. The firm's operating breakeven point in units is: a. 23,330 b. 32,000 c. 42,0000 d. 52,000

Q: Given the following financial data for Cosmos, compute the firm's degree of financial leverage. Sales $780,000 $874,000 Fixed costs 195,000 218,500 Variable costs 460,200 524,400 EBIT 124,800 131,100 Interest 46,800 52,400 EPS $0.42 $0.51 a. 23.81 b. 4.24 c. 0.42 d. 2.18

Q: Given the following financial data for Cosmos, compute the firm's degree of combined leverage. 2004 2005 Sales $780,000 $874,000 Fixed costs 195,000 218,500 Variable costs 460,200 524,400 EBIT 124,800 131,100 Interest 46,800 52,400 EPS $0.42 $0.51 a. $0.42 b. 8.37 c. -2.15 d. 1.78

Q: Given the following financial data for Boston Technology, compute the firm's degree of combined leverage. Assume a marginal tax rate of 40%. 2004 2005 Sales $700,000 $760,000 Fixed costs 175,000 190,000 Variable costs 406,000 448,000 EBIT 119,000 122,000 Interest 42,000 46,000 Shares outstanding 100,000 102,000 a. 0.29 b. -0.38 c. -0.15 d. 0.38