Question 1

Revenue stability affects ________.
A) dividend risk
B) maturity risk
C) business risk
D) interest rate risk

Accepted Answer

Revenue stability refers to how consistent a company's income is. A company with unstable revenue is more vulnerable to business risk, which is the risk of not being able to generate enough revenue to cover expenses. This can lead to decreased profitability or even bankruptcy. The other options, dividend risk, maturity risk, and interest rate risk are not directly affected by revenue stability.

Question 2

Which of the following is the correct order in which corporations generally raise funds to enhance the wealth of stockholders and to send positive signals to the market?
A) retained earnings, equity, debt
B) retained earnings, debt, equity
C) debt, retained earnings, equity
D) equity, retained earnings, debt

Accepted Answer

Retained earnings are the profits that a company keeps for itself instead of distributing them as dividends to shareholders. Using retained earnings to finance growth projects can send a positive signal to the market that the company is financially healthy and expects continued growth. Debt financing comes second because it is a cheaper source of funding than equity, and issuing debt securities can also signal that the company is confident about its future prospects. Equity financing comes last because issuing new shares dilutes the ownership stakes of existing shareholders and can signal that the company is struggling to generate profits internally.

Question 3

A firm's ________ is the mix of long-term debt and equity utilized by the firm, which may significantly affect its value by affecting return and risk.
A) dividend policy
B) capital budget
C) capital structure
D) working capital

Accepted Answer

Capital structure refers to the mix of long-term debt and equity utilized by a firm. It affects the return and risk of a firm, therefore affecting its value. Dividend policy refers to the distribution of earnings to shareholders. Capital budget refers to the firm's decisions regarding investments in long-term assets. Working capital refers to the short-term assets and liabilities a company has in order to fund its day-to-day operations.

Question 4

Which of the following affects business risk?
A) operating leverage
B) interest rate stability
C) preferred stock
D) financial lease

Accepted Answer

The answer of Which of the following affects business risk?
A)...

Question 5

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ less financial leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

Accepted Answer

This is because a firm with more business risk is more likely to experience fluctuations in its earnings, making it harder to meet debt obligations. Therefore, to reduce the risk of bankruptcy or default, the firm should rely less on debt financing and instead use more equity financing.

Question 6

________ is the risk of being unable to cover operating costs of a firm.
A) Systematic risk
B) Business risk
C) Financial risk
D) Diversifiable risk

Accepted Answer

Business risk refers to the risk of a firm not being able to cover its operating costs due to various factors such as declining sales, increasing competition, and changes in consumer preferences. This type of risk is specific to the individual company and cannot be diversified away.

Question 7

The lower risk nature of long-term debt in a firm's capital structure is due to the fact that ________.
A) the debt holders are the true owners of the firm
B) equity capital has a fixed return
C) creditors have a higher position in the priority of claims
D) dividend payments are tax-deductible

Accepted Answer

Creditors have a higher position in the priority of claims, which means they have the right to be paid before equity holders in case of bankruptcy or liquidation. This gives long-term debt a lower risk nature as compared to equity capital. Option A is incorrect because debt holders are not the true owners of the firm; they are lenders who have a claim on the firm's assets. Option B is incorrect as equity capital does not have a fixed return. Option D is incorrect as dividend payments are not tax-deductible.

Question 8

As debt is substituted for equity in the capital structure and the debt ratio increases, the behavior of the overall cost of capital is partially explained by ________.
A) the tax-deductibility of interest payments
B) the increase in the number of common shares outstanding
C) the reduction in risk as perceived by the common shareholders
D) the decrease in the cost of equity

Accepted Answer

The tax-deductibility of interest payments reduces the overall cost of capital as it lowers the effective cost of debt. This, in turn, raises the debt ratio, shifting the capital structure towards debt.

Question 9

The inexpensive nature of long-term debt in a firm's capital structure is due to the fact that ________.
A) the equity holders are the true owners of the firm
B) equity capital has a fixed return
C) interest payments are tax-deductible
D) equity holders have a higher position in the priority of claims

Accepted Answer

Interest payments on long-term debt are tax-deductible, making the cost of debt lower than the cost of equity. This is because the company's taxable income is reduced by the interest paid on the debt, resulting in a lower tax liability for the company.

Question 10

The inexpensive nature of long-term debt in a firm's capital structure is due to the fact that ________.
A) the equity holders are the true owners of the firm
B) equity capital has a fixed return
C) creditors have a higher position in the priority of claims
D) dividend payments are tax-deductible

Accepted Answer

Creditors have a higher position in the priority of claims compared to equity holders, which makes long-term debt less risky and thus less expensive for the firm. Equity holders are paid after all debts have been satisfied, making debt financing cheaper due to its lower risk.

Question 11

The inexpensive nature of long-term debt in a firm's capital structure is due to the fact that ________.
A) the debt holders are the true owners of the firm
B) equity capital has a fixed return
C) long-term debt has a fixed return and a maturity date
D) dividend payments are tax-deductible

Accepted Answer

Long-term debt typically has a lower cost of capital compared to equity because it has a fixed rate of return and a maturity date. This makes it less risky for investors, and therefore, less expensive for the firm. Option A is incorrect because debt holders are not the true owners of the firm. Option B is incorrect because equity capital is not fixed, and its return varies based on the company's performance. Option D is incorrect because dividend payments are not tax-deductible.

Question 12

Which of the following is a basic source of capital for a firm ?
A) short-term debt
B) discounts from suppliers
C) current liabilities
D) common stock

Accepted Answer

Common stock represents ownership in a company and is a primary source of capital. Short-term debt, discounts from suppliers, and current liabilities are sources of financing, but not capital.

Question 13

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ less operating leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

Accepted Answer

This is because a firm with greater business risk is more likely to experience fluctuations in sales and profits, and a higher level of operating leverage would amplify these fluctuations, leading to greater financial risk. By employing less operating leverage, the firm can reduce the impact of these fluctuations on its financial performance.

Question 14

Which of the following affects business risk?
A) revenue stability
B) financial leases
C) operating leverage
D) preferred stock

Accepted Answer

The answer of Which of the following affects business risk?
A)...

Question 15

Which of the following is a reason why equity capital is considered riskier than debt capital?
A) Equity capital has a higher priority claim against assets and earnings.
B) Equity capital requires regular periodic payments in the form of dividends.
C) Equity capital expects dividend payments which are not tax-deductible.
D) Equity capital remains invested in a firm indefinitely.

Accepted Answer

Equity capital does not have a fixed maturity date like debt capital and therefore remains invested in a firm indefinitely. This makes it riskier than debt capital, which has a fixed repayment schedule and is usually secured by specific assets.

Question 16

A decrease in fixed financial costs will result in a(n)________.
A) increase in financial risk
B) decrease in financial risk
C) increase in operating leverage
D) decrease in operating leverage

Accepted Answer

Fixed financial costs refer to expenses that remain constant regardless of the amount of sales or revenue generated. These costs include expenses such as interest on loans or lease payments for equipment. A decrease in fixed financial costs would result in a decrease in the overall financial risk for a company, as there would be less pressure to meet these expenses. This reduction in financial risk could lead to greater flexibility and stability for the company.

Question 17

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ more operating leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

Accepted Answer

A firm with greater business risk should employ less operating leverage to avoid amplifying the risk through fixed costs, as operating leverage increases the volatility of earnings.

Question 18

________ is the risk of being unable to cover financial obligations of a firm.
A) Systematic risk
B) Business risk
C) Financial risk
D) Diversifiable risk

Accepted Answer

Financial risk refers to the risk of a firm being unable to meet its financial obligations. This can occur due to factors such as high levels of debt or insufficient cash flow. It is a type of risk that is specific to the financial structure of a company and can be affected by factors such as interest rates, credit ratings, and market conditions.

Question 19

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ less total leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

Accepted Answer

This is because a firm with greater business risk is already exposed to more uncertainty and variability in its earnings, and adding more financial leverage (i.e. debt) can magnify the negative effects of that risk on the firm's profitability and financial stability. On the other hand, a firm with lower business risk may be able to tolerate more leverage because its earnings are more predictable and stable, reducing the potential downside of financial leverage.

Question 20

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ more financial leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

Accepted Answer

A firm with a greater level of business risk should generally employ less financial leverage to avoid compounding risk, as higher leverage increases the firm's financial risk on top of its existing business risk.

Quiz 13: Leverage and Capital Structure

Revenue stability affects ________.

Which of the following is the correct order in which corporations generally raise funds to enhance the wealth of stockholders and to send positive signals to the market?

A firm's ________ is the mix of long-term debt and equity utilized by the firm, which may significantly affect its value by affecting return and risk.

Which of the following affects business risk?

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ less financial leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

________ is the risk of being unable to cover operating costs of a firm.

The lower risk nature of long-term debt in a firm's capital structure is due to the fact that ________.

As debt is substituted for equity in the capital structure and the debt ratio increases, the behavior of the overall cost of capital is partially explained by ________.

The inexpensive nature of long-term debt in a firm's capital structure is due to the fact that ________.

The inexpensive nature of long-term debt in a firm's capital structure is due to the fact that ________.

The inexpensive nature of long-term debt in a firm's capital structure is due to the fact that ________.

Which of the following is a basic source of capital for a firm ?

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ less operating leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

Which of the following affects business risk?

Which of the following is a reason why equity capital is considered riskier than debt capital?

A decrease in fixed financial costs will result in a(n) ________.

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ more operating leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

________ is the risk of being unable to cover financial obligations of a firm.

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ less total leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ more financial leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.