Question 1

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

The answer of Holding all other factors constant, a firm...

Question 2

All of the following affect business risk EXCEPT
A) operating leverage.
B) interest rate stability.
C) cost stability.
D) revenue stability.

Accepted Answer

Interest rate stability does not directly affect business risk because it is an external factor that businesses cannot control. Operating leverage, cost stability, and revenue stability all directly impact business risk.

Question 3

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, meaning that firms can lower their taxable income by deducting these payments from their revenues. This reduces the overall cost of debt for the firm, making it an inexpensive option for raising capital.

Question 4

Probability of bankruptcy is determined by
A) financial risk.
B) total risk.
C) business risk.
D) interest rate risk.

Accepted Answer

The answer of Probability of bankruptcy is determined by
A) financial...

Question 5

In theory, the firm should maintain financial leverage consistent with a capital structure that
A) meets the industry standard.
B) maximizes the earnings per share.
C) maximizes the owner's wealth.
D) maximizes dividends.

Accepted Answer

The objective of maximizing shareholder wealth is the ultimate goal of any financial decision-making, and this includes the capital structure decision. Financial leverage, or the use of debt financing, can amplify returns to equity holders, but it also increases the risk of financial distress or bankruptcy. Therefore, the firm should balance the benefits and costs of financial leverage and maintain a capital structure that maximizes shareholder wealth, which is a long-term goal that incorporates both risk and return considerations. Maximizing earnings per share, industry standards, or dividends may not necessarily be consistent with the goal of shareholder wealth maximization, and thus, they should not be the primary drivers of capital structure decisions.

Question 6

The 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 financing mix of a company which includes long-term debt and equity. It affects the company's value by influencing the return and risk of investing in the company. Dividend policy refers to the decision of how much profit a company should distribute to its shareholders in the form of dividends. Capital budget refers to the plan of how a company will allocate its financial resources to various projects. Working capital refers to the resources required to fund day-to-day operations of a company. Therefore, the only choice that fits the given description is C) capital structure.

Question 7

________ risk is the risk of being unable to cover financial costs.
A) Business
B) Financial
C) Total
D) Leverage

Accepted Answer

Financial risk specifically refers to the risk of not being able to meet financial obligations, such as debt payments or operating expenses. Business risk relates to the overall viability of a business and its ability to generate profits, while total risk encompasses all potential risks faced by a business. Leverage risk is the risk of a business being unable to meet its financial obligations due to high levels of debt.

Question 8

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 higher level of business risk increases the chances of financial distress or bankruptcy, and using excessive financial leverage can amplify this risk. Therefore, it is advisable for such a firm to use less financial leverage to reduce its overall risk.

Question 9

The asymmetric information explanation of capital structure suggests that firms will issue new debt only when the managers believe the firm's stock is overvalued; as a result, issuing new debt is considered a negative signal that will result in a decline in share price.

Accepted Answer

The asymmetric information explanation of capital structure suggests that firms will issue new equity only when the managers believe the firm's stock is overvalued, not debt. Issuing new equity is considered a negative signal that will result in a decline in share price, not issuing new debt.

Question 10

The key differences between debt and equity capital include all of the following EXCEPT
A) voice in management.
B) maturity.
C) tax treatment.
D) effect on operating leverage.

Accepted Answer

The key differences between debt and equity capital include maturity, tax treatment, and voice in management. Operating leverage is not directly affected by the type of capital raised, but it can be influenced by the cost of capital and the level of financial risk assumed.

Question 11

Which of the following is NOT a reason why debt capital is considered to be the least risky source of capital?
A) It has a high priority claim against assets and earnings.
B) It has a strong legal position.
C) It is a low cost source of capital because interest payments are tax deductible.
D) It does not normally have to be repaid at a specific future date.

Accepted Answer

Debt capital does have to be repaid at a specific future date, typically with interest. This is actually one reason why it is considered less risky than equity financing, where investors do not have a guaranteed return on their investment.

Question 12

The lower risk 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

The lower risk nature of long-term debt in a firm's capital structure is due to the fact that creditors have a higher position in the priority of claims. This means that in the case of bankruptcy or liquidation, creditors will be paid before equity holders. Therefore, the risk associated with long-term debt is lower compared to equity as the chances of losing invested capital are lower.

Question 13

________ risk is the risk of being unable to cover operating costs.
A) Business
B) Financial
C) Leverage
D) Total

Accepted Answer

Business risk refers to the risk of operational failure that may result in an inability to cover operating costs. This can be caused by a variety of factors, such as changes in market conditions, competition, or internal management issues. It is a separate risk from financial risk or leverage risk.

Question 14

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.

Question 15

After satisfying obligations to creditors, the government, and preferred stockholders, any remaining earnings will most likely be allocated to any of the following EXCEPT
A) common shareholders as cash dividends.
B) common shareholders as stock dividends.
C) retained by the firm for future investment.
D) a combination of retained earnings and cash dividends.

Accepted Answer

Any remaining earnings after satisfying obligations to creditors, government, and preferred stockholders can be allocated to common shareholders as cash dividends or retained by the firm for future investment. Additionally, a combination of retained earnings and cash dividends can also be utilized. However, stock dividends are not typically used as a means of distributing remaining earnings to common shareholders.

Question 16

Business risk is affected by all of the following EXCEPT
A) revenue stability.
B) cost stability.
C) operating leverage.
D) earnings per share.

Accepted Answer

Earnings per share is a measure of a company's profitability and is not directly related to the level of business risk. Factors that can affect business risk include revenue stability, cost stability, operating leverage, competition, regulatory changes, and economic conditions.

Question 17

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 higher level of business risk increases the likelihood of default, and therefore, a firm may have difficulty meeting the contractual obligations of their debts. Therefore, a firm subject to greater business risk should use less leverage to reduce the risk of defaulting on their debt payments.

Question 18

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

The inexpensive nature of long-term debt in a firm's capital structure is due to the fact that creditors have a higher position in the priority of claims. This means that in the case of bankruptcy, creditors are paid off before equity holders, making it less risky for them to invest in the firm's debt. As a result, the cost of borrowing through long-term debt is lower than the cost of issuing equity.

Question 19

The basic sources of capital for a firm include all of the following EXCEPT
A) long-term debt.
B) preferred stock.
C) current liabilities.
D) common stock.

Accepted Answer

Current liabilities are not a source of capital for a firm, but rather a form of short-term funding that must be repaid within one year. Long-term debt, preferred stock, and common stock are all sources of capital for a firm.

Question 20

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 higher business risk increases the variability of a firm's earnings and cash flow, making it more difficult for the firm to cover fixed costs associated with operating leverage. As such, a firm with higher business risk would face greater financial distress if it were to use a high level of operating leverage.

Quiz 13: Leverage and Capital Structure

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.

All of the following affect business risk EXCEPT

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

Probability of bankruptcy is determined by

In theory, the firm should maintain financial leverage consistent with a capital structure that

The 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.

________ risk is the risk of being unable to cover financial costs.

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.

The asymmetric information explanation of capital structure suggests that firms will issue new debt only when the managers believe the firm's stock is overvalued; as a result, issuing new debt is considered a negative signal that will result in a decline in share price.

The key differences between debt and equity capital include all of the following EXCEPT

Which of the following is NOT a reason why debt capital is considered to be the least risky source of capital?

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

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

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.

After satisfying obligations to creditors, the government, and preferred stockholders, any remaining earnings will most likely be allocated to any of the following EXCEPT

Business risk is affected by all of the following EXCEPT

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.

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

The basic sources of capital for a firm include all of the following EXCEPT

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.