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ch 13
| Question | Answer |
|---|---|
| 1. The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called: | d. homemade leverage. |
| 2. The theory that the value of a firm is independent of its capital structure is referred to as: | b. M&M Proposition I. |
| 3. The theory that a firm’s cost of equity capital is a positive linear function of its capital structure is referred to as: | c. M&M Proposition II. |
| 4. Business risk is defined as the: | a. equity risk that comes from the nature of a firm’s operating activities. |
| 5. Financial risk is defined as the: | e. equity risk that comes from the capital structure of a firm. |
| 6. The tax savings attained by a firm because of the tax deductibility of the interest expense is called the: | d. interest tax shield. |
| 7. The legal and administrative costs of bankruptcy are called _____ bankruptcy costs. | c. direct |
| 8. The costs incurred by a firm in an effort to avoid bankruptcy are called _____ bankruptcy costs. | e. indirect |
| 9. The direct and indirect costs of bankruptcy are also called _____ costs. | a. financial distress |
| 10. The argument that a firm borrows up to the point where the tax benefit of an extra dollar of debt is exactly offset by the increased probability of financial distress is called: | e. the static theory of capital structure. |
| 11. Bankruptcy is best defined as: | c. a legal proceeding for liquidating or reorganizing a business. |
| 12. The term which best describes the termination of a firm as a going concern is: | d. liquidation. |
| 13. The financial restructuring of a firm in an attempt to create a situation in which the firm can continue its operations as a going concern is best described as a(n): | b. reorganization. |
| 14. The list which establishes the order of claims in a liquidation is referred to as: | a. the absolute priority rule. |
| 15. A firm’s optimal capital structure: | d. is the debt-equity ratio that results in the lowest possible weighted average cost of capital. |
| 16. Assume that you are comparing two firms which are identical, with one exception. Firm A is an all-equity firm and firm B has a debt-equity ratio of .6. All else equal, firm A will: | b. earn less than firm B when the level of earnings before interest and taxes (EBIT) is relatively high. |
| 17. Which one of the following statements concerning financial leverage is correct? | d. Financial leverage magnifies both profits and losses. |
| 18. You are comparing two financial policies. The first is all equity. The second involves the use of $2 million of debt. The break-even point between these two policies occurs when the earnings before interest and taxes (EBIT) is $450,000. Given | c. is not; is |
| 19. Which one of the following statements concerning financial leverage is correct? | c. If a firm employs financial leverage, the shareholders will be exposed to greater risk. |
| 20. Less Debt, Inc., just revised its capital structure such that the firm’s debt-equity ratio decreased from .80 to .40. Those individual investors who prefer the old capital structure: | d. can replicate that structure by increasing their use of homemade leverage. |
| 21. M&M Proposition I, without taxes, states that: | d. it is completely irrelevant how a firm arranges its finances. |
| 22. Which one of the following suggests that a firm should be indifferent between a debt- equity ratio of .40 and a ratio of .75 if the firm’s goal is to maximize firm value? | a. M&M Proposition I, without taxes |
| 23. According to M&M Proposition II, without taxes, the cost of equity depends on the firm’s: I. earnings before interest and taxes. II. cost of debt. III. debt-equity ratio. IV. required rate of return on its assets. | b. II, III, and IV only |
| 24. M&M Proposition II, without taxes, states that: | c. RE rises as a firm increases its use of financial leverage. |
| 25. Financial risk: | d. increases as a firm’s debt-equity ratio increases. |
| 26. Taylor & Taylor has positive earnings before interest and taxes (EBIT). Given this, which one of the following statements related to the interest tax shield is correct? | e. The present value of the tax shield is equal to TC × D |
| 27. M&M Proposition I, with taxes, states that the value of a levered (VL) firm is equal to: | a. VU + (TC × D) |
| 28. Which of the following statements correctly relate to M&M Proposition I, with taxes? I. Debt financing is advantageous to a firm. II. The value of a firm unlevered is greater than the value levered. III. The weighted average cost of capital (WAC | a. I only |
| 29. Which one of the following is an example of a direct bankruptcy cost? | d. A firm engages an attorney to draft a prepack. |
| 30. The assumption that a firm is fixed in terms of its operations and assets is most related to: | d. the static theory of capital structure. |
| 31. The maximum firm value, according to the static theory of capital structure, occurs at a point where the: | e. value of the firm equalizes the costs of financial distress with the present value of the tax shield on debt. |
| 32. The maximum firm value, as defined by the static theory of capital structure, demonstrates that a firm: | c. benefits from leverage, net of financial distress costs. |
| 33. Which of the following are correct assumptions based on the static theory of capital structure? I. There is a direct relationship between the amount of benefit a firm realizes from leverage and the amount of the annual depreciation expense. | d. II and IV only |
| 34. U.S. firms, in general: | b. have debt-equity ratios that vary by industry. |
| 35. A firm is technically insolvent: | a. when it is unable to meet its financial obligations. |
| 36. Which one of the following relates to a bankruptcy liquidation, but not to a reorganization? | e. termination of the firm as a going concern |
| 37. Which one of the following will generally receive the highest priority in a bankruptcy liquidation, assuming that the absolute priority rule applies? | e. bankruptcy administrative expenses |
| 38. A secured creditor in a bankruptcy liquidation is entitled to the proceeds from the underlying security: | a. up to the amount they are due |
| 39. Which one of the following statements is true concerning a bankruptcy? | b. A federal judge has the authority to deny a Chapter 11 bankruptcy petition filed by a firm. |
| 40. A prepackaged bankruptcy: | b. has been approved by a firm’s creditors prior to the bankruptcy petition being filed with the court. |
| 41. The bankruptcy process has been utilized in the past by firms to: I. renegotiate labor contracts. II. reduce their labor costs. III. avoid paying a legal judgment. IV. improve their competitive position. | e. I, II, III, and IV |
Created by:
martin.2021