Deck 12: Capital Structure

Question 1

Fixed cost sources of financing include both debt and common stock.

Answer 1

False

Question 2

The many factors influencing business risk can be placed in one of two categories. What are these two categories?

A)factors affecting sales revenue and those affecting assets
B)factors affecting assets and those effecting costs
C)factors affecting operating costs and those affecting financial costs
D)factors affecting sales revenue and those affecting costs

Answer 2

D

Question 3

What is financial risk?

A)the risk arising from a firms over reliance on short-term sources of financing
B)the ordinary business risk arising from a firm's basic operations
C)the risk arising from a firm's use of variable cost sources of financing
D)the risk arising from a firm's use of fixed cost sources of financing

Answer 3

D

Question 4

Financial risk is the risk arising from the use of fixed cost sources of financing.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

Question 5

What is a firm doing if it is using financial leverage?

A)Marketable securities is part of its assets structure.
B)It is using common stock as part of its capital structure.
C)It is using debt or preferred stock as part of its capital structure.
D)Accounts receivable is part of its asset structure.

Question 6

What is a firm's capital structure?

A)a firm's proportion of short-term financing provided by accounts payable, notes payable and other short-term sources
B)a firm's composition of current assets broken up into cash, accounts receivable, and inventory
C)a firm's proportion of long-term financing provided by debt, preferred stock, and common equity
D)a firm's composition of debt broken up into short-term debt and long-term debt

Question 7

Which of the following is most likely to cause a firm to use more financial leverage?

A)the current owners concern for maintaining control of a healthy firm
B)concern for the firm's Moodys and S & P bond ratings
C)concern for maintaining excess borrowing capacity
D)management's concern for their own risk

Question 8

Which of the following is most likely to cause a firm to use less financial leverage?

A)currently low profits, but a large need for new funds
B)concern for the firm's Moodys and S & P bond ratings
C)low business risk
D)avoidance of a corporate takeover

Question 9

How does financial leverage affect firm risk?

A)Financial leverage increases the volatility of a firm's sales revenue.
B)Financial leverage increases the volatility of a firm's return on equity.
C)Financial leverage increases the volatility of a firm's EBIT.
D)Financial leverage increases the volatility of a firm's operating costs.

Question 10

As a firm increases its use of debt financing, what is the impact upon the cost of equity?

A)The cost of equity decreases.
B)The cost of equity remains the same.
C)The cost of equity increases.
D)None of the above.

Question 11

The desire to maintain excess borrowing capacity will tend to increase the use of debt financing in a firm's capital structure.

Question 12

Increasing financial leverage decreases the volatility of owners' returns.

Question 13

Which of the following is true at a firm's optimal capital structure?

A)The firm's cost of capital is minimized.
B)The firm is financed 100% with equity.
C)The firm's cost of equity is minimized.
D)The firm's cost of debt is minimized.

Question 14

An optimal capital structure minimizes a firm's cost of capital.

Question 15

How does high business risk affect firm risk?

A)Higher business risk increases the volatility of capital structure.
B)Higher business risk increases the volatility of EBIT.
C)Higher business risk increases the volatility of financial costs.
D)Higher business risk increases the volatility of the firm's asset structure.

Question 16

Bankruptcy costs are one type of financial distress cost.

Question 17

A firm's capital structure is its proportion of short-term assets composed of cash, accounts receivables, and inventory.

Question 18

A firm's use of more debt financing creates more risk to owners and thus increases the cost of equity.

Question 19

Financial risk is the basic risk inherent in the operations of a firm. It can be viewed as the volatility of a firm's EBIT.

Question 20

The desire to maintain high bond ratings will tend to increase the use of debt financing in a firm's capital structure.

Question 21

An investment banking firm has estimated the following after-tax cost of debt and cost of equity for Marquez Luxury Travel Tours. Proportion of Debt After-tax Cost of Debt Cost of Equity
30% 3.5% 10.5%
40% 3.8% 11.3%
50% 5.0% 12.9%
60% 7.2% 14.5%
What is the cost of capital at Marquez' optimal capital structure given the above information?

A)8.95%
B)8.40%
C)8.30%
D)8.15%

Question 22

An investment banking firm has estimated the following after-tax cost of debt and cost of equity for Odarti's Finest Vegas Resorts. Proportion of Debt After-tax Cost of Debt Cost of Equity
30% 6.8% 13.8%
40% 7.7% 14.1%
50% 8.9% 14.6%
What is the cost of capital at Odarti's optimal capital structure given the above information?

A)11.70%
B)11.54%
C)11.75%
D)11.65%

Question 23

Takeoka's Sushi To Go has estimated the following cost of debt before-tax)and cost of equity. Proportion of Debt Before-tax Cost of Debt Cost of Equity
30% 9.5% 14.4%
40% 9.7% 15.2%
50% 10.1% 16.2%
60% 11.8% 18.5%
What is the cost of capital at Takeoka's optimal capital structure given the above information and a 40% effective tax rate?

A)10.78%
B)11.02%
C)11.13%
D)11.45%

Question 24

Luther's Famous Barbeque has estimated the following cost of debt before-tax)and cost of equity. Proportion of Debt Before-tax Cost of Debt Cost of Equity
30% 7.0% 11.1%
40% 7.3% 11.9%
50% 8.4% 13.7%
What is the cost of capital at Luther's optimal capital structure given the above information and a 40% effective tax rate?

A)8.71%
B)8.89%
C)9.03%
D)9.37%