Question 1

Which of the following factors does not affect a firm's business risk?

Accepted Answer

Interest cost variability is related to financial risk, not business risk. Business risk is affected by factors such as demand variability, input price variability, operating leverage, and sales price variability.

Question 2

The most commonly held view of capital structure, according to the text, is that the weighted average cost of capital

Accepted Answer

The commonly held view is that the weighted average cost of capital (WACC) first falls with moderate levels of leverage, as the benefits of debt (tax shield) offset the costs (increased risk of financial distress). However, beyond a certain point, the cost of debt (in terms of higher interest rates due to increased risk) and risk of financial distress become too high, causing WACC to increase.

Question 3

Which of the following statements is correct?

Accepted Answer

The firm's financial risk may have both market risk (the risk of changes in interest rates, exchange rates, etc.) and diversifiable risk (the risk of events that are specific to the company, such as a major lawsuit or a product recall). The other statements are either partially or completely false. A is false because a firm's business risk is also affected by factors such as competition and market conditions, not just industry characteristics. B is partially true, but managerial decisions can still have an impact on a firm's business risk. C is false because financial flexibility remains important even at the target capital structure.

Question 4

Which of the following statements is most correct?

Accepted Answer

Option A is correct as the optimal capital structure minimizes the weighted average cost of capital (WACC). 
Option B is incorrect as even when the after-tax cost of equity exceeds the after-tax cost of debt, increasing the amount of debt in a firm's capital structure may not always lead to a reduction in WACC. 
Option C is also correct as increasing the amount of debt in a firm's capital structure is likely to increase the cost of both debt and equity financing. 
Therefore, options A and C are both correct, making option D the correct answer. Option E is incorrect as option B is not correct.

Question 5

If debt financing is used, which of the following is correct?

Accepted Answer

When debt financing is used, interest expense must be subtracted from operating income before arriving at net income. Therefore, the percentage change in net income will be more than the percentage change in net operating income. This means the percentage change in net operating income is less than the percentage change in net income.

Question 6

Which of the following types of dividends is (are) never paid out in the form of cash?

Accepted Answer

Stock dividends are paid out in the form of additional shares of stock, rather than cash. Regular, extra, and liquidating dividends can be paid out in cash.

Question 7

Which of the following statements is correct?

Accepted Answer

Maintaining financial flexibility means having enough reserve borrowing capacity to meet unexpected needs. This is important operationally because it ensures that the company has access to necessary funds when needed.

Question 8

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
...

Question 9

The "Pure Modigliani and Miller Result" establishes, under restrictive assumptions, that the firm's stock price will be maximized if it uses virtually 100 percent debt.Which of the following real world conditions does the most to limit real world corporate debt-to-assets ratios to far less than 100 percent?

Accepted Answer

The "Pure Modigliani and Miller Result" assumes no taxes, bankruptcy costs, or effects on business risk as debt increases. However, in the real world, as a firm increases its debt-to-assets ratio, lenders perceive higher risk of default and thus demand higher interest rates to compensate for this risk. This increased cost of debt at higher levels of leverage limits the practicality of firms financing themselves with close to 100 percent debt.

Question 10

Business risk is concerned with the operations of the firm.Which of the following is not associated with (or not a part of) business risk?

Accepted Answer

Business risk is focused on the operations of the firm, such as demand variability, sales price variability, the extent to which operating costs are fixed, and the ability to change prices as costs change. Changes in required returns due to financing decisions are a part of financial risk.

Question 11

The firm's target capital structure is consistent with which of the following?

Accepted Answer

The target capital structure is the mix of debt and equity that minimizes the weighted average cost of capital (WACC). Therefore, the best choice is E, as it aims to minimize the WACC. The other options may not align with the overall goal of maximizing shareholder wealth.

Question 12

If you know that your firm is facing relatively poor prospects but needs new capital, and you know that investors do not have this information, signaling theory would predict that you would

Accepted Answer

Signaling theory suggests that a firm will choose a financing method that signals to investors the value of the company or its prospects. In this scenario, issuing equity would signal to investors that the firm is confident in its ability to generate future profits and is willing to share the burden of decreased equity returns with new shareholders. Issuing debt may signal the opposite, as the firm would be taking on additional debt burden without a clear path to generating profits. Option A is not a good choice because it would increase the debt burden on the firm, making it difficult for the firm to generate profits in the future. Option C might be true in some situations, but in this scenario, issuing equity is likely the better choice. Option D is not a good choice because the firm needs new capital. Option E is not ethical and could be illegal, as insiders are prohibited from conveying inside information to investors.

Question 13

A decrease in the debt-to-assets ratio will generally have no effect on ____ risk.

Accepted Answer

A decrease in the debt-to-assets ratio primarily affects the financial structure of a company, reducing its financial risk by lowering the leverage. However, it does not directly impact the company's operational or business risk, which is more influenced by factors such as market demand, competition, and operational efficiency. Systematic or market risk is influenced by broader market or economic changes and is also not directly affected by a company's debt-to-assets ratio.

Question 14

From the information below, select the optimal capital structure for Minnow Entertainment Company.

Accepted Answer

The optimal capital structure for a company is the one that maximizes the value of the firm and minimizes the cost of capital. Based on the given information, option C with a debt ratio of 60% and an equity ratio of 40% gives the highest EPS of $3.18 and the highest stock price of $31.20. This implies that the company is being profitable with its debt levels and its investors have confidence in the company's financial health. Therefore, option C is the best choice.

Question 15

As a general rule, the capital structure that

Accepted Answer

The capital structure that maximizes the price per share of common stock is the one that minimizes the weighted average cost of capital (WACC). This is because a lower WACC reduces the discount rate applied to future cash flows, increasing the present value of those cash flows and thus the stock price.

Question 16

Empirical testing has confirmed the validity of which of the following attitudes concerning dividends?

Accepted Answer

Empirical testing has produced some evidence in support of each of the theories above. While there is some evidence to support each theory, no single theory has been definitively proven.

Question 17

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
...

Question 18

A decrease in a firm's willingness to pay dividends might result from an increase in its

Accepted Answer

If the firm has profitable investment opportunities, management may decide to reinvest earnings into the firm rather than paying dividends. This would result in a decrease in willingness to pay dividends. The other options are not closely related to a decrease in willingness to pay dividends.

Question 19

In the real world, we find that dividends

Accepted Answer

The answer of In the real world, we find that...

Question 20

Which of the following would not have an influence on the optimal dividend policy?

Accepted Answer

All of the factors listed can potentially affect a company's optimal dividend policy. The possibility of accelerating or delaying investment projects can affect the cash flow available for dividends, shareholder preferences can impact the demand for dividends, bond indenture constraints may require a certain level of dividend payments, and the cost of selling new stock can affect the decision to issue dividends instead of raising capital through equity financing.

Quiz 14: Capital Structure and Dividend Policy Decisions

Which of the following factors does not affect a firm's business risk?

The most commonly held view of capital structure, according to the text, is that the weighted average cost of capital

Which of the following statements is correct?

Which of the following statements is most correct?

If debt financing is used, which of the following is correct?

Which of the following types of dividends is (are) never paid out in the form of cash?

Which of the following statements is correct?

Which of the following statements is correct?

Business risk is concerned with the operations of the firm.Which of the following is not associated with (or not a part of) business risk?

The firm's target capital structure is consistent with which of the following?

If you know that your firm is facing relatively poor prospects but needs new capital, and you know that investors do not have this information, signaling theory would predict that you would

A decrease in the debt-to-assets ratio will generally have no effect on ____ risk.

From the information below, select the optimal capital structure for Minnow Entertainment Company.

As a general rule, the capital structure that

Empirical testing has confirmed the validity of which of the following attitudes concerning dividends?

Which of the following statements is correct?

A decrease in a firm's willingness to pay dividends might result from an increase in its

In the real world, we find that dividends

Which of the following would not have an influence on the optimal dividend policy?