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Management Consultancy CHAPTER 18 LONG TERM FINANCING DECISIONS Quiz NAME: _______________________________________________ DATE:_______________ I. TRUE OR FALSE _______ 1.

. Capital Structure pertains to the mix of the long term sources of funds. _______ 2. Financial executives treat the optimal capital structure as a range rather as a precise point. _______ 3. The lower the optimal debt ratio, the greater the need for reserve borrowing capacity. _______ 4. The discount rate is influenced both by the shape of the MCC curve and by the set of available projects. _______ 5. The Marginal Cost of Capital schedule to be prepared in establishing the optimal capital budget shows the weighted average cost of capital. _______ 6. If the actual debt ratio is below the target level, expansion capital will probably be raised by issuing debt. _______ 7. Managerial aggressiveness does not affect the optimal or value-maximizing capital structure. _______ 8. There are 6 basic procedures involved in establishing the optimal capital budget; one of those is to determine each projects net present value using the riskadjusted cost of capital. _______9. The extent to which costs are fixed is one of the factors to consider in determining the overall uncertainty inherent in projections of future returns of assets. ______10. The higher the firms tax rate, the less debt it should include in its capital structure. II. MULTIPLE CHOICE THEORIES 1. It aims to mix the permanent sources of funds used by the firm in a manner that will maximize the companys ordinary share price. a. Capital-structure management b. Capital Budgeting c. Optimal Budget Determination d. Financing Decisions 2. This factor does not affect the optimal, or value maximizing capital structure, but it does influence the target capital structure. a. Managerial Aggressiveness b. Financial flexibility c. The firms tax position d. Business Risk 3. It is the added risk borne by shareholders as a result of financial leverage. a. Financial Risk b. Business Risk c. Either A or B d. Neither A or B 4. What influences the discount rate? a. set of available projects b. shape of the IOS curve c. weighted average cost of capital d. both a and c


5. The following are basic procedures involved in establishing the optimal capital budget, except a. Prepare a graph that combines the IOS and MCC schedules and the intersection defines the projects Marginal Cost of Capital used in capital budgeting. b. Prepare the IOS showing the firms investment opportunities in order of the projects IRR. c. Divide the Retained Earnings by Equity Fraction or %. d. None of the above 6. Retained earnings breakpoint is the point where a. marginal cost of capital increases b. internal rate of return increases c. the IOS and MCC intersects d. all of the above 7. Risk depends on the following factors, except a. Input price validity b. Demand or sales c. operating leverage c. Ability to change sales prices for changes in input prices 8. Which of the following is incorrect about financial leverage? a. Financial leverage will cause the earnings per share to rise if the return on assets is greater than the cost of capital. b. The degree of risk associated with the firm will also increase as financial leverage increases. c. By using the firms financial leverage the firm concentrates its business risk on the ordinary stockholders. d. Cost of debt will rise due to the increased risk of not being able to meet fixed charges. 9. A reduction in operating leverage would normally lead to a. Increase in the optimal amount of financial leverage. b. Increase in the optimal amount of debt. c. Return on Assets will increase d. Both B and C 10. The steps in determining the optimal capital structure include I. Calculate EBIT II. Calculate the Stock Price at each debt/assets ratio III. Calculate the Earnings per Share at each ratio The order in which the above mentioned steps are generally applied are a. I, III, II b. I, II, III c. II, I, III d. III, I, II

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III. MULTIPLE CHOICE PROBLEMS (2 pts each) DM Company uses a process of capital rationing in its decision making. The firms cost of capital is 13%. It will only invest P60 million this year. It has determined that the internal rate of return for each of the following projects: Project A B C D E F G 11. Determine the projects that the firm should accept. a. E, D, C and G c. A, C, E and G Project Size P10M 30M 25M 10M 10M 20M 15M Internal Rate of Return 15.0% 14.0 16.5 17.0 23.0 11.0 16.0 b. A, B, C and D d. D, E, F and G

The following tabulation gives earnings per share (EPS) figure for the UNO Company during the preceding 5 years. The firms ordinary shares, 7.8M outstanding is now selling for P65 and the expected dividend at the end of the current year (2010) is 55% of the 2005 EPS. Because investors expect past trends to continue, g may be based on the earnings growth rate: Year 2005 2006 2007 2008 2009 EPS 5.73 6.19 6.68 7.22 7.80

The current interest rate on new debt is 9%. The firms marginal tax rate is 32%. Its capital structure, considered to be optimal, is as follows: Debt P104M Ordinary equity 156M Total Liabilities and equity P260M 12. Compute for the cost of debt and the cost of equity a. 6.12% and 14.6% respectively c. 9% and 8% respectively

b. 14.6% and 6.12% respectively d. 12.6% and 6.14% respectively

13. VM products is a new firm just starting operations. The firm will produce backpacks which will sell for P22.00 a piece. Fixed costs are P500,000 per year and variable costs are P2.00 per unit of production. The company expects to sell 50,000 backpacks per year, and its effective tax rate is 40%. What is VMs Earnings before interest and taxes? a. 500,000 b. 300,000 c. 600,000 d. 700,000 14. ROMMEL and Co. needs to raise money for an addition to its plant. It will issue 300,000 new shares. The new shares will be priced at P60 per share with an 8.5% spread on the offer price. Registration costs will be P150,000. Presently Rommel and Co. has earnings of P3,000,000 and 750,000m shares outstanding. The net proceeds to Rommel and Co. will be a. P16,320,000 c. P18,000,000

b. P16,470,000 d. P16,620,000

15. PPG Corporation needs to net P7,800,000 from the sale of ordinary shares. Its investment banker has informed the firm that the retail price will be P22 per share, and that the firm will receive P19 per share. Out-of-pocket costs are P100,000. How many must be sold? a. 415,790 b. 359,091 c. 354,545 d. 410,526

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