Reference no: EM132828335

Question 1: Which of the following statements does NOT correctly explain the effect of additional debt on the weighted average cost of capital (WACC)?

A) Debtholders' prior and "fixed" claim increases the risk of stockholders' "residual" claim, so the cost of stock (rs) goes up.

B) Additional debt also increases the pre-tax of cost of debt (rd) because the increased risk of bankruptcy.

C) The net effect of additional debt on WACC is to increase WACC.

D) The net effect of additional debt on WACC is uncertain.

Question 2: Financial risk refers to the extra risk that stockholders bear as a result of the use of debt compared with the risk they would bear if no debt were used.

True

False

Question 3: How does debt financing help reduce agency problems which arise when managers and shareholders have different objectives?

A) Debt financing can help prevent managers from using excess cash on perquisites.

B) Debt financing may make managers too risk-averse, therefore causing "underinvestment" in some risky but positive NPV projects.

C) Debt financing can help prevent managers from using excess cash on non-value adding acquisitions.

D) Both A and C are correct.

Question 4: Elephant Books sells paperback books for $5 each. The variable cost per book is $3. The fixed costs are $40,000. What's the publisher's breaking- even sales volume?

A) 8,000 books.

B) 10,000 books.

C) 20,000 books.

D) 40,000 books.

Question 5: Investors often perceive an additional issuance of stock as a negative signal and push the stock price to fall because the information asymmetry problem exists between inside managers and outside investors.

True

False

Question 6: Which of following variable can be used to measure total risk, including both business risk and financial risk, for a leveraged firm?

A) Standard deviation of the earnings before interest and tax (σEBIT).

B) Standard deviation of the return on equity (σROE).

C) Standard deviation of the return on invested capital (σROIC).

Question 7: The trade-off theory tells us that the capital structure decision involves a tradeoff between the costs of debt financing and the benefits of debt financing.

True

False

Question 8: The MM irrelevance capital structure theory proved that a firm's value is unaffected by its capital structure. But their study was based on some strong assumptions that: _____

A) There are no brokerage costs.

B) There are no corporate taxes and personal taxes.

C) There are no bankruptcy costs and agency costs.

D) There is no asymmetric information problem, and all investors can borrow at the same rate as corporations.

E) All of the above.

Question 9: The MM model with corporate taxes is a special case of the Miller model with personal taxes. If the personal tax rate on debt income (Td) and the personal tax rate on stock income (Ts) are the same, the Miller model becomes to the MM model with corporate taxes.

True

False

Question 10: Project selection ambiguity can arise if you rely on the internal rate of return (IRR) instead of the net present value (NPV) when _____.

A) A project's cash flows are normal.

B) There are multiple IRRs.

C) Projects are independent from each other.

D) All of the statements above are correct.