106 CH 16

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1. According to MM, an increase in required return on 17. Firms in which one of the Railroad
expected earnings per share can leave equity increases following industries are most apt
the share price unchanged if the to have the highest debt ratios?
2. According to MM, if individuals cannot capital structure 18. If a firm's expected return on firm has no debt in its
obtain the same borrowing terms as may be relevant equity equals its expected return capital structure
firms, then on assets, then the:
3. According to MM II, as a firm's debt- the required rate of 19. If the present value of the firm is using the optimal
equity ratio decreases return on equity interest tax shield equals the level of debt.
decreases present value of the costs of
financial distress, then the:
4. According to pecking-order theory, debt rather than
managers will often choose to finance new equity, to 20. An implicit cost of adding debt to increases the required
with: avoid reduced the capital structure is that it: return on equity.
share price.
21. In a world with corporate taxes firm uses no equity in
5. According to the trade-off theory, C. tax savings and but no possibility of financial its capital structure
capital structure is a trade-off financial distress distress, the value of the firm is
between costs. maximized when the:
6. Although the value of an increase in firm's asset base is 22. An increase in a corporation's tax a decrease in a levered
the interest tax shield may be positive, largely intangible rate will cause firm's WACC
firms are most apt to restrict
23. An increase in a firm's financial increase the variability
borrowing if the
leverage will: in earnings per share.
7. Any financial benefit derived from the shareholders
24. The interest tax shield is equal to product of the interest
interest tax shield accrues to the:
the: expense and the tax
8. As a firm's debt-equity ratio the expected return rate.
approaches zero, the firm's expected on assets.
25. Leverage will _____ shareholders' increase; increase
return on equity approaches:
expected return and ______ their
9. As the debt-equity ratio decreases debtholders risk.
when debt is not risk free demand a lower
26. MM proposition I states that a mixture of debt and
expected return
firm's value is unaffected by its equity
10. Costs of financial distress are greater intangible assets
27. MM Proposition I without taxes shareholders are
when a firm increases its: as a percentage of
states that: unaffected by the debt
total assets.
policy of the firm
11. Debt may be the preferred form of equity issuance is
28. MM's proposition II without taxes expected return on
external financing for many firms considered by
states that the: equity increases as
because: investors to be a
financial leverage
negative sign.
increases
12. Debt usage will have an effect on: financial risk.
29. One advantage of debt financing tax-deductible interest
13. Financial risk refers to the risk faced by over equity financing is the:
equityholders of
30. The optimal capital structure the tax savings from
firms with debt.
occurs when additional leverage are
14. A firm's business risk depends upon the risk of the firm's offset by the increased
assets and costs of distress.
operations
31. The pecking-order theory they have insufficient
15. A firm's capital structure is liabilities and suggests that less profitable firms internal funds
represented by its mix of: equity. borrow more because:
16. Firms facing financial distress may the benefits may 32. The possibility of bankruptcy will reduce the interest rate
pass up positive NPV projects rather be shared with the do all of the following except: on debt
than commit new equity because: bondholders
33. The present value of a perpetual tax shield increases; 46. When taxes are considered, the value of unlevered firm
increases as the firm's tax rate _____ and the increases a levered firm equals the value of the: plus the present
amount of principal _____. value of the tax
shield
34. The present value of the costs of financial probability of
distress increases with increases in the default and/or 47. Which one of the following is a safe The firm has
debt ratio because the: bankruptcy is assumption for a firm in which the PV of reached its
greater the tax shield is approximately equal to optimal debt
the PV of the financial distress costs? level.
35. The reason that financial leverage less equity to
increases shareholder risk is that there is: absorb the 48. Which one of the following lists Internally
operating risk. presents the order of financing from generated funds,
most preferred to least preferred debt issue, stock
36. Restructuring a firm involves changing the mix of
according to the pecking-order theory? issue
liabilities and
equity. 49. Which one of the following statements Shareholders
is false regarding MM's proposition I? should care
37. The stability of a firm's operating income is business risk.
about the firm's
the focus of:
debt policy
38. The trade-off theory of capital structure equates the
50. Which one of the following statements Less risky firms
describes the optimal capital structure for present values
is true regarding the trade-off theory? ought to have a
any firm as being the level of debt that of the interest
greater amount
tax shield and
of debt financing
the financial
distress costs. 51. Which one of the following would not Expected return
be expected to change with changes in on assets
39. The trade-off theory of capital structure with higher
the firm's capital structure?
suggests that firms: risk should
use less debt. 52. Which one of these is a disadvantage to Receiving
tax-paying individual investors? interest income
40. WACC = expected return on assets thats it
rather than
41. When a corporation issues permanent increases by dividends
debt, the value of all its securities the present
53. Which one of these is not an underlying Taxes remain at
value of the
assumption of MM Proposition I? their current non-
tax shield
zero levels.
42. When corporate taxes and the cost of plus; minus
54. Which one of these statements The return on
financial distress are taken into
correctly applies to an unlevered firm assets equals the
consideration, the market value of a firm is
that pays no taxes? return on equity
equal to the value of the all-equity firm
and also equals
_____ the PV of the tax shield _____ the costs
WACC
of financial distress
55. Which one of these statements Debt interest
43. When corporate taxes are considered, Increased
corresponds to MM proposition I without reduces equity
how does leverage affect the WACC? leverage will
taxes? income but does
decrease the
not affect firm
WACC.
value
44. When debt is risky under MM II: equityholders
56. Those who benefit from the interest tax equityholders
shift more risk
shield are
to
bondholders. 57. With risky debt and MM II, the expected remains constant;
return on assets _____ as the debt-equity increases
45. When financial disaster is looming, the lender
ratio _____.
management may borrow to invest in bears all the
projects having a negative expected NPV risk 58. With the inclusion of taxes, MM I is lower tax
because: incorrect and the capital structure of liability due to
the firm can be important due to the: interest
deductibility