Question 1

A firm's capital structure consists of which of the following?

Accepted Answer

A firm's capital structure typically includes debt, preferred stock, and common stock. Debt represents the funds borrowed by the firm, while preferred stock represents an ownership stake that typically pays a fixed dividend before common stockholders receive any dividends. Common stock represents ownership in the company and generates returns through price appreciation and dividend payments. Therefore, the capital structure of a firm typically includes all three components - debt, preferred stock, and common stock.

Question 2

A company whose rate of return on investments is higher than the interest rate on its debt is said to have:

Accepted Answer

When a company's rate of return on investments is higher than the interest rate on its debt, it means that the company is earning more on its investments than what it needs to pay in interest on its debt. This situation is referred to as favorable financial leverage, as it allows the company to increase its return on equity.

Question 3

Which of the following should be excluded from a firm's capital structure?

Accepted Answer

Non-interest bearing debt is typically not considered part of a firm's capital structure because capital structure focuses on the mix of different types of financing used by a firm to fund its operations and growth, specifically highlighting interest-bearing debt and equity. Non-interest bearing debt, such as trade credit, does not incur interest and is often short-term, thus not fitting the typical definition of capital structure components.

Question 4

The primary objective of capital structure management is to find the combination of funding sources that will minimize the

Accepted Answer

The primary objective of capital structure management is to find the combination of funding sources that will minimize the Weighted Average Cost of Capital (WACC). WACC is a weighted average of the cost of debt and equity, which represents the minimum return that a company must earn on all of its investments to satisfy its investors. By minimizing the WACC, a company can maximize the value of its investments and achieve a higher return on its capital. The other options, such as interest rate, probability of financial distress, and cost of equity, are important considerations in capital structure management, but they are not the primary objective.

Question 5

How does the text distinguish between firm's financial structure and its capital structure?

Accepted Answer

The answer of How does the text distinguish between firm's...

Question 6

Which of the following is NOT a component of a firm's capital structure?

Accepted Answer

Accounts payable are not a component of a firm's capital structure. They are considered a liability on the balance sheet and represent the amount owed to suppliers and vendors for goods and services purchased on credit. Capital structure refers to the mix of debt and equity financing a company uses to fund its operations and growth. The components of a firm's capital structure typically include debt (such as bonds), preferred stock, common stock, and retained earnings.

Question 7

Cornucopia's liabilities and equity are shown below:

Cornucopia's debt ratio is ________.

Accepted Answer

The answer of Cornucopia's liabilities and equity are shown below:

Cornucopia's...

Question 8

What is meant by the terms "favorable" and "unfavorable" leverage?

Accepted Answer

The answer of What is meant by the terms "favorable"...

Question 9

The Times Interest Earned Ratio measures a firm's ability to meet both interest payments and scheduled principal repayments.

Accepted Answer

The Times Interest Earned Ratio specifically measures a firm's ability to cover its interest expenses with its earnings before interest and taxes (EBIT), not principal repayments.

Question 10

The firm's optimal capital structure is the mix of financing sources that:

Accepted Answer

The optimal capital structure is the one that maximizes the total value of the firm's debt and equity, as it reflects the best trade-off between risk and return, considering the cost of capital and financial distress.

Question 11

Cornucopia's liabilities and equity are shown below:

Cornucopia's debt to value ratio is ________.

Accepted Answer

The answer of Cornucopia's liabilities and equity are shown below:

Cornucopia's...

Question 12

Financial structure includes long-term and short-term sources of funds.

Accepted Answer

Financial structure refers to the combination of long-term and short-term sources of funds that a company uses to finance its operations and investments. Therefore, the statement is true.

Question 13

A company that earns a rate of return on its investments lower than the interest rate on its debt is said to have:

Accepted Answer

If a company earns a rate of return on its investments that is lower than the interest rate on its debt, it is not generating enough income to cover its debt obligations. This means the company has to use its own funds to pay off its debt, which reduces its profitability and could lead to financial distress. This situation is known as unfavorable financial leverage.

Question 14

Merrimac Brewing company's total assets equal $18 million.The book value of Merrimac's equity is $6 million.The market value of Merrimac's equity is $10 million.It's Debt to Value ratio is .5.What is the book value of Merrimac's interest- bearing debt?

Accepted Answer

The Debt to Value ratio is 0.5, which means the debt is half the size of the total value of the company.

Therefore, the total value of the company can be divided into debt and equity as follows:

Debt + Equity = Total Value
Debt + $6 million = $18 million
Debt = $12 million

The book value of equity is $6 million, so the book value of debt can be calculated as follows:

Book value of debt = Total assets - Book value of equity
Book value of debt = $18 million - $6 million
Book value of debt = $12 million

Therefore, the book value of Merrimac's interest-bearing debt is $12 million, which is option B.

Question 15

A firm's financial structure is defined by the Debt Ratio,while it's capital structure is defined by the Debt to Value ratio.

Accepted Answer

The answer of A firm's financial structure is defined by...

Question 16

Fibonacci Property Management's balance sheet shows total liabilities of $5 million and total assets of $13 million.Interest bearing liabilities total $3 million (book value).The market value of Fibonnacci's equity is $21 million.Fibonacci's Debt to Value ratio is ________.

Accepted Answer

The answer of Fibonacci Property Management's balance sheet shows total...

Question 17

Fibonacci Property Management's balance sheet shows total liabilities of $5 million and total assets of $13 million.Interest bearing liabilities total $3 million (book value).The market value of Fibonnacci's equity is $21 million.Fibonacci's debt ratio is ________.

Accepted Answer

Total liabilities = $5 million

Total assets = $13 million

Interest bearing liabilities = $3 million

Book value of equity = Total assets - Total liabilities - Interest bearing liabilities 
= $13 million - $5 million - $3 million 
= $5 million

Market value of equity = $21 million

Debt ratio = (Total liabilities / Total assets) x 100% 
= ($5 million / $13 million) x 100% 
= 38.46%

Rounding to the nearest whole number, the debt ratio is 38%. Therefore, the correct answer is A) 38.

Question 18

Suppose we calculate a times interest earned ratio of 29 for Colgate-Palmolive.We can conclude:

Accepted Answer

A times interest earned ratio of 29 indicates that Colgate-Palmolive is very unlikely to have difficulty meeting its interest payments. The higher the ratio, the more capable the company is of covering its interest expenses with its operating income. A ratio of 29 shows that Colgate-Palmolive generates 29 times more operating income than its interest expenses, indicating a strong financial position.

Question 19

Merrimac Brewing company's total assets equal $18 million.The book value of Merrimac's equity is $6 million.The market value of Merrimac's equity is $10 million.It's Debt to Value ratio is .5.What is Merrimac's Debt Ratio?

Accepted Answer

First, let's find the total debt of Merrimac Brewing company:

Debt to Value ratio = Total Debt / Total Assets - Equity

0.5 = Total Debt / (18 - 6)

0.5 = Total Debt / 12

Total Debt = 0.5 x 12 = 6

Now, we can find the Debt Ratio:

Debt Ratio = Total Debt / Total Assets

Debt Ratio = 6 / 18

Debt Ratio = 0.33

Therefore, the answer is B (0.33).

Question 20

Tremont Inc.'s Total Assets =$25 million.The balance sheet shows Accounts payable and accruals totaling $7 million,common stock and retained earnings total $10 million.There is no preferred stock.What is the book value of interest bearing debt?

Accepted Answer

Book value of interest bearing debt = Total Assets - (Accounts payable and accruals + Common stock and retained earnings)
= $25 million - ($7 million + $10 million)
= $8 million

Quiz 15: Capital Structure Policy