Question 1

When there is information asymmetry between managers and investors,the announcement of a new share issue is likely to cause the company's:&#10;A)share price to rise.&#10;B)share price to fall.&#10;C)share price to rise by at least 10 per cent.&#10;D)price to remain unchanged.

Accepted Answer

When there is information asymmetry between managers and investors, the announcement of a new share issue is likely to result in a negative signal for investors. This is because the new share issue will dilute the ownership of existing shareholders and reduce the value of their shares. This negative signal is likely to cause investors to sell their shares, leading to a fall in the share price. Therefore, option B is the most appropriate choice. Options A and C are unlikely because it is rare for a new share issue to cause a rise in share price, especially in the presence of information asymmetry. Option D is also unlikely because the announcement of a new share issue is likely to have an impact on the share price, either positive or negative, and is unlikely to leave the price unchanged.

Question 2

Non-debt tax shields can be best defined as:&#10;A)tax deductions for interest costs.&#10;B)tax deductions for items such as investment tax credits and tax losses carried forward.&#10;C)the relationship between leverage and taxes.&#10;D)none of the given options.

Accepted Answer

Non-debt tax shields refer to tax deductions that are not related to interest costs, such as investment tax credits and tax losses carried forward. Option A refers specifically to debt tax shields, while option C refers to the impact of leverage on taxes rather than tax deductions themselves. Option D is incorrect as there must be an answer.

Question 3

Mehrotra,Mikkelson and Partch (2003)found that:&#10;A)higher leverage is related to higher profitability,lower variability of industry operating income and a greater proportion of tangible assets.&#10;B)higher leverage is related to lower profitability.&#10;C)higher leverage is related to negative profitability.&#10;D)higher leverage is related to higher profitability and higher variability of industry operating income.

Accepted Answer

Mehrotra, Mikkelson, and Partch (2003) found that firms with higher leverage tend to have higher profitability, lower variability of industry operating income, and a greater proportion of tangible assets. This suggests that firms with more stable income and tangible assets are more likely to use debt financing.

Question 4

Graham (1996)found that changes in long-term debt are positively related to the company's:&#10;A)tax rate.&#10;B)average tax rate.&#10;C)marginal tax rate.&#10;D)effective marginal tax rate.

Accepted Answer

Changes in long-term debt are positively related to the company's effective marginal tax rate. This is because the effective marginal tax rate is the rate at which the company's taxes increase as its income increases. As a company's long-term debt increases, its income also increases, which leads to an increase in its effective marginal tax rate.

Question 5

Similarities in capital structure can be expected between companies in the same industry since:&#10;A)they tend to face the same variability in cash flows.&#10;B)they tend to replicate each other's policies.&#10;C)they are faced with the same industry legislation.&#10;D)management is often on each other's boards of directors.

Accepted Answer

Companies in the same industry are likely to face similar market conditions, risks, and growth opportunities. As a result, they tend to have similar cash flow variability, which affects their financing decisions and capital structure. They may need to raise funds for similar purposes, such as research and development, expansion, or acquisitions. Therefore, they may choose similar sources of financing, such as debt or equity, and adjust their capital structure accordingly. On the other hand, choices B, C, and D are not necessarily true for all companies in the same industry. Companies may have different strategies, goals, and management styles that affect their financing decisions, regardless of their industry affiliation. They may also face different legal, regulatory, and tax environments that influence their debt-to-equity ratios, interest rates, and capital costs. Therefore, while industry comparables can provide some insights into a company's capital structure, they should be used with caution and context.

Question 6

Which of the following statements is consistent with the pecking order theory?&#10;A)A positive relationship exists between leverage and profitability.&#10;B)For any given level of investment,less profitable firms will borrow more than highly profitable firms.&#10;C)For any given level of investment,less profitable firms will borrow less than highly profitable firms.&#10;D)The level of debt in a firm's capital structure is dependent upon the number of tax shield substitutes.

Accepted Answer

The pecking order theory suggests that firms will first use internal funds (retained earnings) to finance investments, followed by debt, and lastly by external equity. Within this framework, less profitable firms are more likely to rely on debt financing (as opposed to internal funds or equity) due to their limited access to internal funds and external equity. Therefore, for any given level of investment, less profitable firms will borrow more than highly profitable firms.

Question 7

The trade-off theory of capital structure implies that:&#10;A)companies increase the amount of debt to achieve an optimal capital structure.&#10;B)companies move toward an optimal capital structure whether debt is increased or decreased.&#10;C)companies decrease the amount of debt to achieve an optimal capital structure.&#10;D)companies decrease the amount of debt in their capital structure in response to legislation that will decrease liquidation costs.

Accepted Answer

The trade-off theory of capital structure suggests that firms balance the benefits of debt (such as tax advantages) against the costs (such as financial distress costs) to determine their optimal capital structure. This implies that companies adjust their debt levels, either increasing or decreasing, to move toward this optimal structure.

Question 8

Studies that seek to provide evidence of the determinants of capital structure may be criticised on the grounds that:&#10;A)statistical significance has not been found in these studies.&#10;B)the determinants are not consistent with the theory.&#10;C)they provide direct tests of capital structure theory.&#10;D)they do not necessarily imply that leverage affects company value.

Accepted Answer

The criticism of studies on determinants of capital structure is that they do not necessarily imply that leverage affects company value. Thus, while these studies may provide valuable insights into the factors that influence a firm's choice of capital structure, they may not provide direct tests of capital structure theory. However, this does not mean that the determinants identified in these studies are inconsistent with theory or lack statistical significance.

Question 9

Which of the following statements is consistent with the trade-off theory?&#10;A)Costs of financial distress are likely to be most serious for companies with significant intangible assets.&#10;B)A negative relationship exists between leverage and profitability.&#10;C)Companies with mostly intangible assets are likely to borrow more.&#10;D)A positive relationship exists between leverage and non-debt tax shields.

Accepted Answer

The trade-off theory suggests that firms balance the tax benefits of debt financing against the costs of financial distress. Companies with significant intangible assets, which are harder to value and sell in distress, face higher costs of financial distress, making this statement consistent with the trade-off theory.

Question 10

Evidence suggests that the introduction of the imputation tax system has resulted in which of the following changes to capital structure:&#10;A)no change in the capital structure of companies.&#10;B)an increase in corporate financial leverage than is typical under the classical system.&#10;C)a decrease in corporate financial leverage than is typical under the classical system.&#10;D)a decrease in the proportion of profits paid out as dividends.

Accepted Answer

The imputation tax system encourages companies to issue more dividend payments, as the corporate tax paid on profits becomes a credit for shareholders. As a result, companies are likely to decrease their reliance on debt financing and therefore reduce their financial leverage compared to what is typical under the classical tax system. The evidence suggests that the capital structure of companies has changed as a result of the introduction of this tax system. There is no indication that there has been an increase in financial leverage, so option B is not correct. Option A is also incorrect because evidence suggests that there has been a change in the capital structure of companies. Option D is partially correct, as the imputation tax system incentivizes paying dividends and therefore may decrease the proportion of profits paid out as dividends, but the question specifically asks about changes to capital structure, not payout policy.

Question 11

In a survey on managers' perceptions of capital structure,it was found that their reluctance to issue new ordinary shares appeared to vary over time,depending on the recent price behaviour of the company's shares.This evidence is consistent with:

A)the tax deductibility of interest.
B)the pecking order theory.
C)the financial distress theory.
D)any theory of capital structure.

Accepted Answer

The answer of In a survey on managers' perceptions of...

Question 12

A company may raise funds at a lower cost than otherwise would be the case if:&#10;A)it can design a security that focuses on the disequilibrium that exists between investor demands and the supply of securities.&#10;B)it issues securities that have been in short supply in the market indefinitely.&#10;C)it issues a particular security at a discount.&#10;D)it issues a particular security at a premium.

Accepted Answer

The answer of A company may raise funds at a...

Question 13

An important prediction of the pecking order theory is that an announcement of a new share issue will cause the company's:&#10;A)share price to fall.&#10;B)share price to rise.&#10;C)share price to fall by a minimum of 10%.&#10;D)share price to rise by a minimum of 10%.

Accepted Answer

The answer of An important prediction of the pecking order...

Question 14

The problem of being forced to choose between foregoing a positive NPV project and seeing the share price fall because of a share issue can be overcome by maintaining:&#10;A)stable dividends.&#10;B)target leverage levels.&#10;C)reserve borrowing capacity.&#10;D)a company's debt-equity ratio to less than 50 per cent.

Accepted Answer

The answer of The problem of being forced to choose...

Question 15

Which of the following is an implication drawn from the pecking order theory:&#10;A)Internal financing is a last resort due to shareholders' desire for current income.&#10;B)Debt financing is a last resort due to the large direct and indirect bankruptcy costs associated with this form of financing.&#10;C)Due to high information costs associated with riskier securities,companies will only issue equity as a last resort.&#10;D)Managers have no preference about the form of financing they employ.

Accepted Answer

The answer of Which of the following is an implication...

Question 16

According to the tax shield hypothesis,we should expect to find:&#10;A)a negative relationship between companies with high non-debt tax shields and companies with low debt/equity ratios.&#10;B)a positive relationship between companies with high non-debt tax shields and companies with high debt/equity ratios.&#10;C)a positive relationship between companies with high non-debt tax shields and companies with low debt/equity ratios.&#10;D)a positive relationship between companies with low non-debt tax shields and companies with low debt/equity ratios.

Accepted Answer

The answer of According to the tax shield hypothesis,we should...

Question 17

Which of the following provides evidence that is consistent with the pecking order theory?&#10;A)An unusually profitable firm in an industry with relatively slow growth will end up with an unusually high debt/equity ratio.&#10;B)An unusually profitable firm in an industry with relatively high growth will end up with an unusually low debt/equity ratio.&#10;C)An unprofitable firm in an industry with relatively slow growth will end up with a low debt/equity ratio.&#10;D)Companies' past needs for external finance,rather than a target capital structure,determine capital structures.

Accepted Answer

The answer of Which of the following provides evidence that...

Question 18

Companies with high ratios of market value to book value tend to use:&#10;A)debt of longer maturity and higher priority than mature companies.&#10;B)debt of longer maturity and lower priority than mature companies.&#10;C)debt of shorter maturity and lower priority than mature companies.&#10;D)debt of shorter maturity and higher priority than mature companies.

Accepted Answer

The answer of Companies with high ratios of market value...

Question 19

The trade-off theory implies that the actual debt ratios will be described by:&#10;A)a target model where companies have a leverage target.&#10;B)an adjustment model where companies adjust their leverage.&#10;C)a target model where companies have a leverage target but make no adjustments.&#10;D)a target-adjustment model where companies have a leverage target and make gradual adjustments to it.

Accepted Answer

The answer of The trade-off theory implies that the actual...

Question 20

Which of the following approaches appears to be ideal for studying the relationship between capital structure and company value?&#10;A)An examination of bankruptcy costs incurred by failed companies.&#10;B)An examination of companies with tax losses carried forward.&#10;C)An examination of transactions in which one type of security is exchanged for another.&#10;D)An examination of capital-raising transactions by companies from different industries.

Accepted Answer

The answer of Which of the following approaches appears to...

Question 21

Studies,which show that taxes affect marginal financing decisions,show that:&#10;A)the present value of interest tax savings is positive and influences the choice of company debt ratios.&#10;B)taxes have a predictable effect on financing strategy.&#10;C)taxes are important for tactical financing decisions.&#10;D)all of the given options.

Accepted Answer

The answer of Studies,which show that taxes affect marginal financing...

Question 22

Maintaining reserve borrowing capacity allows companies the benefit of:&#10;A)financing projects,particularly for those that operate in low-growth industries.&#10;B)maintaining a constant dividend payout policy.&#10;C)overcoming the need to raise funds to finance projects from a new share issue.&#10;D)not rejecting negative NPV projects.

Accepted Answer

The answer of Maintaining reserve borrowing capacity allows companies the...

Question 23

Schulman et al.(1996)examined the effects of imputation on corporate leverage in Canada.Which of the following statements is true of their results?&#10;A)The tax changes provide significant benefit for low-dividend companies.&#10;B)High-dividend companies experience a significant increase in leverage.&#10;C)There is only a small effect on the leverage of companies that experienced an operating loss during the study period.&#10;D)None of the given options.

Accepted Answer

The answer of Schulman et al.(1996)examined the effects of imputation...

Question 24

'Tax exhaustion':&#10;A)refers to non-debt tax shields lowering a company's expected marginal tax rate only if they are large enough to reduce its taxable income to zero.&#10;B)refers to non-debt tax shields lowering a company's actual marginal tax rate,thus reducing the expected tax savings on additional debt.&#10;C)may indicate low tangible assets.&#10;D)none of the given options.

Accepted Answer

The answer of 'Tax exhaustion':&#10;A)refers to non-debt tax shields lowering...

Question 25

The pecking order theory:&#10;A)predicts that announcement of a new share issue will cause the company's share price to fall.&#10;B)implies that a company's leverage will depend on the difference between its operating cash flow and its investment needs over time.&#10;C)predicts that,other things being equal,a company's leverage will be negatively related to its profitability.&#10;D)All of the given options.

Accepted Answer

The answer of The pecking order theory:&#10;A)predicts that announcement of...

Question 26

For companies that are unable to make immediate use of interest deductions,borrowing is likely to have:&#10;A)a positive net tax advantage.&#10;B)a net tax disadvantage.&#10;C)a positive impact on financial distress because of the tax deductibility of interest on debt.&#10;D)a benefit of achieving an optimal capital structure.

Accepted Answer

The answer of For companies that are unable to make...

Question 27

Which of the following companies is likely to find that debt is very costly?&#10;A)A company with a lack of intangible assets.&#10;B)A company with considerable growth opportunities.&#10;C)A company with less growth opportunities.&#10;D)None of the given options.

Accepted Answer

The answer of Which of the following companies is likely...

Question 28

Assume that LoPine Ltd,a US-based company (which has a classical taxation system),borrows $10 million at an interest rate of 15 per cent and uses the funds to repurchase shares worth $10 million.Further,assume that the company tax rate is 35 per cent,the marginal income tax rate is 30 per cent and the average tax rate on equity income is 12 per cent.Calculate the net tax savings per year.

A)$192 000
B)$182 000
C)$188 000
D)$172 000

Accepted Answer

The answer of Assume that LoPine Ltd,a US-based company (which...

Question 29

Barclay,Smith and Watts (1995)found that:&#10;A)the relationship between leverage and the market-book value ratio was highly significant in a statistical sense but was not 'economically' significant.&#10;B)taxes do not have an important effect on corporate leverage decisions.&#10;C)their findings are consistent with the pecking order theory because they show that leverage is negatively related to profitability.&#10;D)leverage was positively related to the tangibility of assets and negatively related to the market-book value ratio in seven countries.

Accepted Answer

The answer of Barclay,Smith and Watts (1995)found that:&#10;A)the relationship between...

Question 30

The principle that should guide the financial manager in determining a financing strategy is that:&#10;A)it is not as easy to add value by making good investment decisions as it is by making good financing decisions.&#10;B)while it is not easy to add value by making good investment decisions,it is certainly possible to reduce value by making poor investment decisions.&#10;C)it is not as easy to add value by making good investment decisions as it is by making good financing decisions but it is certainly possible to reduce value by making poor investment decisions.&#10;D)None of the given options.

Accepted Answer

The answer of The principle that should guide the financial...

Question 31

The trade-off theory cannot explain:&#10;A)why companies are generally expansive in using debt finance.&#10;B)why evidence suggests that leverage is positively related to profitability.&#10;C)why financial leverage is similar,on average,across many countries despite differences in their tax systems.&#10;D)all of the given options.

Accepted Answer

The answer of The trade-off theory cannot explain:&#10;A)why companies are...

Question 32

Jensen (1986)argued that:&#10;A)the announcement of a new share issue by a mature company will cause its share price to fall.&#10;B)the announcement of a new share issue by a high-growth company will cause its share price to fall.&#10;C)when debt or hybrid security issues are announced,the fall in share price should be smaller than if it is an announcement of a new share issue.&#10;D)the announcement of a new share issue by a mature company will cause its share price to increase.

Accepted Answer

The answer of Jensen (1986)argued that:&#10;A)the announcement of a new...

Question 33

Interest on debt:&#10;A)is taxed more heavily than dividends and capital gains received by shareholders.&#10;B)is deducted from the company's taxable income.&#10;C)is taxed as the corporate tax rate.&#10;D)none of the given options.

Accepted Answer

The answer of Interest on debt:&#10;A)is taxed more heavily than...

Question 34

Which of the following statements is true?&#10;A)Lenders will charge a higher interest rate if the company has a high proportion of company-specific assets.&#10;B)The variability of the net cash flows from a company's assets is taken as a measure of its financial risk.&#10;C)The optimal capital structure will not be affected by its business risk.&#10;D)Lenders will charge a higher interest rate if the company has a high proportion of company-specific assets and the optimal capital structure will be affected by its business risk.

Accepted Answer

The answer of Which of the following statements is true?&#10;A)Lenders...

Question 35

A survey of financial managers by Allen (1991)found that:&#10;A)the vast majority of Australian companies,as opposed to US companies,do not have a policy of maintaining a substantial 'cushion' of reserve borrowing capacity.&#10;B)financial slack is valuable for all companies.&#10;C)Australian companies,on average,have considerably more financial slack than the expansive US companies.&#10;D)None of the given options is applicable.

Accepted Answer

The answer of A survey of financial managers by Allen...

Question 36

Companies that rely heavily on share issues tend to be:&#10;A)small,risky and value-based.&#10;B)large,risky and growing rapidly.&#10;C)small,relatively less risky and growing rapidly.&#10;D)none of the given options.

Accepted Answer

The answer of Companies that rely heavily on share issues...

Question 37

Maintaining reserve borrowing capacity:&#10;A)can help overcome the problem of choosing between seeing the share price fall because of a share issue and forgoing a positive NPV project.&#10;B)can help raise additional finance to take advantage of profitable investments.&#10;C)provides the greatest value for companies that operate in industries where there are significant investment opportunities.&#10;D)All of the given options.

Accepted Answer

The answer of Maintaining reserve borrowing capacity:&#10;A)can help overcome the...

Question 38

Barclay and Smith (1996)investigated the significance of two features of debt--maturity and priority--and found that:&#10;A)companies with low ratios of market value to book value tend to use debt of shorter maturity and lower priority.&#10;B)companies with high ratios of market value to book value tend to use debt of longer maturity and higher priority.&#10;C)companies with low ratios of market value to book value tend to use debt of longer maturity and higher priority.&#10;D)companies with high ratios of market value to book value tend to use debt of shorter maturity and higher priority.

Accepted Answer

The answer of Barclay and Smith (1996)investigated the significance of...

Question 39

Which of the following statements with regard to tax is true?&#10;A)Under a full imputation tax system,the effects of corporate and personal taxes can offset each other exactly.&#10;B)Under a classical tax system,any advantage from reducing company tax would be due only to differences in the timing of tax payments.&#10;C)Under a classical tax system,any net tax advantage of corporate borrowing is likely to go only to companies with high and stable earnings.&#10;D)In order for residential shareholders to benefit under a full imputation tax system,the wastage of tax credits must be reduced.

Accepted Answer

The answer of Which of the following statements with regard...

Question 40

Which of the following statements is true?&#10;A)A company's financial leverage can't affect investment decisions and its operating efficiency.&#10;B)Banks and finance companies have much higher debt/equity ratios than those of retailers and manufacturers.&#10;C)Banks and finance companies have much lower debt/equity ratios than those of retailers and manufacturers.&#10;D)None of the given options.

Accepted Answer

The answer of Which of the following statements is true?&#10;A)A...

Question 41

Which of the following statements is false?&#10;A)Most of the investment by non-financial companies is generally financed from internal cash flow.&#10;B)Some companies effectively have negative debt/equity ratios because their holdings of cash and marketable securities are greater than their debt.&#10;C)Wald (1999)found that differences in leverage between major industrial countries are moderate.&#10;D)Many studies of capital structure include measures of non-debt tax shields with the expectation that they will be positively related to leverage.

Accepted Answer

The answer of Which of the following statements is false?&#10;A)Most...

Question 42

Secure companies with a high proportion of 'assets in place' are expected to have __________ leverage than growth companies.

Accepted Answer

The answer of Secure companies with a high proportion of...

Question 43

The trade-off theory cannot explain why financial leverage is similar,on average,across many countries despite different tax systems.

Accepted Answer

The answer of The trade-off theory cannot explain why financial...

Question 44

Company financing can be considered as a _____________ problem by using the fact that different investors have different tastes,preferences and levels of wealth to explain the coexistence of securities which differ in terms of characteristics such as risk,return,tax treatment and voting rights.

Accepted Answer

The answer of Company financing can be considered as a...

Question 45

Leverage is found to be _________ related to investment opportunities,as measured by the ratio of market to book value.

Accepted Answer

The answer of Leverage is found to be _________ related...

Question 46

Barclay and Smith (1996)suggest that flexibility is an important factor in determining the type of debt a company uses.

Accepted Answer

The answer of Barclay and Smith (1996)suggest that flexibility is...

Question 47

Direct costs of financial distress are small,relative to company value,however the indirect costs are considered to be significantly larger.

Accepted Answer

The answer of Direct costs of financial distress are small,relative...

Question 48

The pecking order theory identifies a target debt-equity ratio.

Accepted Answer

The answer of The pecking order theory identifies a target...

Question 49

___________ risk includes the possibility that a sudden change of government may be followed by expropriation of foreign-owned assets or a difficulty to transfer dividends out of the country.

Accepted Answer

The answer of ___________ risk includes the possibility that a...

Question 50

Evidence from surveys of CFOs provides support to the _____________ theory.

Accepted Answer

The answer of Evidence from surveys of CFOs provides support...

Question 51

Evidence from companies that make 'dual issues' of debt and equity is inconsistent with the predictions of trade-off theory.

Accepted Answer

The answer of Evidence from companies that make 'dual issues'...

Deck 13: Capital Structure Decisions