Question 1

________ refers to how a firm behaves when it feels it is protected from risk compared with how it would behave if it was fully exposed to risk.

Accepted Answer

Moral hazard refers to a situation where there is an increased likelihood of risk-taking behavior when one party is protected from the consequences of its actions. In this context, if a firm feels it is protected from risk, it may behave differently than if it was fully exposed to risk, as it feels that it will not suffer the negative consequences of any risks taken.

Question 2

Plastic Products Inc.has a levered beta of 1.30,a debt-equity ratio of 0.50,and a tax rate of 40%.What is the value of the firm's unlevered beta?

Accepted Answer

The unlevered beta (βu) can be calculated using the formula: βu = βl / [1 + ((1 - Tax Rate) * (Debt/Equity))], where βl is the levered beta. Substituting the given values: βu = 1.30 / [1 + ((1 - 0.40) * 0.50)] = 1.00.

Question 3

Cranston Cranks Inc.is a manufacturer of high quality bicycle components.The firm's levered beta is equal to 1.20.When added to a well-diversified portfolio that matches the market beta,the firm would ________ the portfolio beta.

Accepted Answer

A levered beta greater than 1.0 means that the stock is more volatile than the market. Thus, adding the stock to a well-diversified portfolio would increase the portfolio's beta.

Question 4

White's World Wide Delivery Inc.has an unlevered beta = 1.25,a debt-equity ratio of 0.30,a tax rate of 0.20,and a levered beta = 1.55.If the firm increased the debt-equity ratio to 50%,what would be the impact on the levered beta?

Accepted Answer

The levered beta is calculated as follows: 
Levered beta = Unlevered beta * (1 + (1 - tax rate) * debt/equity)
Substituting the current values, we get,
1.55 = 1.25 * (1 + (1 - 0.20) * 0.30)
If the debt-equity ratio is increased to 50%, the new levered beta can be calculated as follows:
Levered beta = 1.25 * (1 + (1 - 0.20) * 0.50) = 1.75
Therefore, the answer is A.

Question 5

Optimal capital structure "first" criteria suggests that the impact on EPS should be ________ and that the best way to obtain that is with ________ levels of debt and ________ levels of equity.

Accepted Answer

The answer of Optimal capital structure "first" criteria suggests that...

Question 6

Which of the following does your author suggest is NOT a lesson learned from the the Great Recession of 2007 -2009?

Accepted Answer

The author does not suggest that the crisis was limited to the collapse of the U.S. housing market. In fact, the author notes that the crisis started in the housing market but quickly spread to other sectors of the economy. Therefore, the correct answer is C.

Question 7

In a recent comprehensive survey,corporate CFOs were asked why they did NOT use more equity in their capital structure.Which of the following choices was NOT cited by 50% or more of the CFOs responding to the survey?

Accepted Answer

The question specifies that all the given reasons (EPS dilution, concerns about cost, and concerns about share price decline) were not cited by 50% or more of the CFOs, indicating that each reason was significant enough to be mentioned by at least half of the respondents.

Question 8

According to an international survey of CFOs of publicly traded firms,which of the following was NOT considered to be an important factor in determining the optimal amounts of debt in a firm's capital structure?

Accepted Answer

All of the options listed (credit ratings, the tax shield, and the ability to maintain dividends) are considered important factors in determining the optimal amounts of debt in a firm's capital structure according to surveys of CFOs. These factors influence the cost of capital, risk, and financial flexibility, which are crucial in capital structure decisions.

Question 9

Managers need to take into account a number of perspectives when assessing the "first" criteria.The ________ focuses primarily on balancing the tax shield benefits with financial distress costs.

Accepted Answer

The investor perspective focuses on balancing the tax shield benefits with financial distress costs, as investors are concerned with the overall value and risk of the firm, which includes these financial considerations.

Question 10

Big City Lumber Inc.has a levered beta of 1.70,a debt-equity ratio of 0.40,and a tax rate of 25%.What is the value of the firm's unlevered beta?

Accepted Answer

To find the unlevered beta, we need to remove the effects of financial leverage from the firm's levered beta. This can be done using the following formula:

Unlevered beta = Levered beta / (1 + (1 - tax rate) x Debt/Equity)

Plugging in the given values:

Unlevered beta = 1.70 / (1 + (1 - 0.25) x 0.40)
Unlevered beta = 1.31

Therefore, the value of the firm's unlevered beta is 1.31. Option C is the correct choice.

Question 11

It is typically easy to determine a precise mix of optimal debt and equity.

Accepted Answer

It is not always easy to determine a precise mix of optimal debt and equity, as it depends on various factors such as company's financial goals, industry, market conditions, risk appetite, and cost of capital, among others. Finding the right balance between debt and equity financing requires careful analysis and evaluation.

Question 12

The benefit of the ________ approach to firm valuation is that it allows us to segregate the value of a firm if it is all-equity,and the value of the tax benefits of debt.

Accepted Answer

The adjusted present value (APV) approach is specifically designed to separate the value of a firm's assets from the value of the tax benefits of debt. This is important when valuing a firm with an all-equity capital structure because it allows us to determine the value of a potential debt financing option separately from the firm's asset value. This approach starts with the unlevered value of the firm and adds the present value of tax shields that result from introducing debt.

Question 13

Which of the following lessons from the Great Recession is NOT true?

Accepted Answer

Capital markets are not almost perfect. The Great Recession highlighted many flaws and weaknesses in the financial system, including inadequate regulation and oversight, conflicts of interest, and the need for more transparency and accountability. Therefore, option C is not a valid lesson learned from the Great Recession.

Question 14

Managers need to take into account a number of perspectives when assessing the "first" criteria.The ________ focuses on the vision and strategic direction of the firm and how the nature and timing of projected cash outflows influence that strategy and vision.

Accepted Answer

The answer of Managers need to take into account a...

Question 15

________ took place in financial markets during the Great Recession because large financial institutions took excess risks to realize abnormal positive returns in the housing market while they were simultaneously protected from abnormal losses by being "too-big-to-fail."

Accepted Answer

The situation described in the question is a classic example of moral hazard, which refers to the incentive for an individual or institution to take excessive risks because they know they will be protected from the negative consequences of those risks. In this case, the large financial institutions took on excessive risk in the housing market because they knew they would be bailed out by the government if they suffered large losses, due to their status as "too-big-to-fail."

Question 16

Which of the following did NOT contribute to the Great Recession of 2007-2009?

Accepted Answer

All three options- A, B, and C- contributed to the Great Recession of 2007-2009. The collapse of the U.S. housing market resulted in a significant decrease in home prices and a surge in foreclosures, which further led to the downfall of the banking system. The tremendously growth of subprime lending market intensified the risks associated with the housing market. Finally, the liquidity crisis resulted when banks became unwilling to lend into a collapsing market, leading to the failure of many financial institutions, which ultimately led to the Great Recession.

Question 17

If a firm has a positive debt-equity ratio,and a positive tax rate,then then levered beta for the firm must be ________ the unlevered beta for the firm.

Accepted Answer

A positive debt-equity ratio indicates that the firm has taken on debt, which increases the financial risk of the firm. This increased financial risk will lead to a higher levered beta compared to the unlevered beta. Therefore, the levered beta for the firm must be greater than the unlevered beta for the firm if it has a positive debt-equity ratio and a positive tax rate.

Question 18

Optimal capital structure "first" criteria suggests that risk should be ________ and that the best way to obtain that is with ________ levels of debt and ________ levels of equity.

Accepted Answer

The optimal capital structure first criteria suggests that risk should be low, and the best way to achieve that is with low levels of debt and high levels of equity.

Question 19

Managers need to take into account a number of perspectives when assessing the "first" criteria.The ________ focuses on comparing the firms capital structure with those of industry competitors.

Accepted Answer

The competitive perspective focuses on comparing the firm's capital structure with those of industry competitors, which fits with the given description of the "first" criteria. The internal perspective focuses on the firm's own financial goals and strategies, the investor perspective focuses on maximizing shareholder value, and the creditor perspective focuses on the firm's ability to make payments on debt obligations. While all of these perspectives may be relevant in assessing capital structure, the description given specifically points towards the competitive perspective.

Question 20

If a firm has an unlevered beta equal to 1.0 a debt-equity ratio of .50 and a tax rate of .30,calculate the value of the firm's levered beta.

Accepted Answer

The formula for calculating the levered beta is:

Levered beta = Unlevered beta [1 + (1 - Tax rate) * (Debt/Equity)]

Substituting the given values,

Levered beta = 1.0 [1 + (1 - 0.30) * (0.5)]

Levered beta = 1.35

Therefore, the correct choice is C)1.35.

Quiz 12: Designing an Optimal Capital Structure