Question 1

Which of the following is not a factor that influences capital structure decisions for firms?

Accepted Answer

Rational investors are not a factor influencing capital structure decisions as the decisions are made by the management of the firm based on various factors such as financial flexibility, business risk and tax position. However, rational investors may analyze a firm's capital structure decisions and invest accordingly.

Question 2

According to the signaling theory of capital structure, a firm with favorable prospects should raise new capital by issuing ____ and a firm with unfavorable prospects raise new capital by issuing ____.

Accepted Answer

The signaling theory of capital structure suggests that firms with favorable prospects (i.e., those that are performing well or expect to perform well) are more likely to issue debt to finance their operations, as they can comfortably service the debt with their future earnings. On the other hand, firms with less favorable prospects are more likely to issue equity, as they may not be able to commit to regular debt payments and prefer not to increase their financial risk.

Question 3

Once a target capital structure for a firm is determined the firm ____.

Accepted Answer

Once a target capital structure is determined, the firm uses it as a guide for raising capital. This means that the firm will aim to maintain the target capital structure as closely as possible when issuing new debt or equity. While the target capital structure may change over time due to changes in the business environment, the firm will still aim to maintain the appropriate mix of debt and equity as determined by the target. The firm may also use the target capital structure as a basis for making other financial decisions, such as whether to pay dividends, repurchase shares, or invest in new projects.

Question 4

Growth Rate
Copybold Corporation
Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive.The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75.Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine.The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000.Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent.The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share.
-Refer to Copybold Corporation.What is the coefficient of variation of expected EPS under the conservative capital structure plan?

Accepted Answer

To find the coefficient of variation of expected EPS under the conservative capital structure plan, we need to first find the expected EPS under both Feast and Famine scenarios.

With conservative capital structure, D/A = 0.25 and cost of debt = 10%.

Under Feast scenario:
EBIT = $60,000
Interest expense = $400,000 * 0.25 * 0.10 = $10,000
Net income before tax = $60,000 - $10,000 = $50,000
Net income after tax = $50,000 * 0.6 * (1-0.4) = $18,000
EPS = $18,000/10,000 shares = $1.80

Under Famine scenario:
EBIT = $20,000
Interest expense = $400,000 * 0.25 * 0.10 = $10,000
Net income before tax = $20,000 - $10,000 = $10,000
Net income after tax = $10,000 * 0.4 * (1-0.4) = $2,400
EPS = $2,400/10,000 shares = $0.24

Now we can find the expected EPS and standard deviation of EPS under the conservative capital structure plan:

Expected EPS = (0.6 * $1.80) + (0.4 * $0.24) = $1.20
Standard deviation of EPS = sqrt((0.6 * ($1.80 - $1.20)^2) + (0.4 * ($0.24 - $1.20)^2)) = 0.696

Finally, we can find the coefficient of variation:

Coefficient of variation = (0.696/1.20) = 0.58

Therefore, the answer is A.

As for the best choice, it depends on Copybold Corporation's risk preference. If the firm is risk-averse, it should choose the conservative capital structure plan as it offers a lower debt-to-asset ratio with lower cost of debt. If the firm is risk-seeking, it should choose the aggressive capital structure plan as it offers a higher debt-to-asset ratio with higher cost of debt.

Question 5

It has been shown that a firm's beta ____ an increase in its degree of financial leverage.

Accepted Answer

Beta measures a firm's systematic risk and is affected by the degree of financial leverage. As a firm increases its financial leverage (i.e., increases its debt-to-equity ratio), its beta will also increase. This is because debt is typically more risky than equity and increases the overall level of risk to which the firm is exposed.

Question 6

Which of the following is not one of the four primary factors that influence capital structure?

Accepted Answer

The geographic location of the firm is not considered a primary factor in capital structure. The four primary factors are managerial attitude, financial flexibility, tax position, and business risk.

Question 7

Calculate the current price per share (P₀) for Olson Corporation, given the following information.The data all pertain to the year just ended.

Accepted Answer

The formula to calculate the price per share is:
PS = (Net Income - Preferred Dividends) / Weighted Average Common Shares Outstanding
PS = ($8,721,000 - $210,000) / 297,000
PS = $29.43

Question 8

When a firm conducts a seasoned equity offering and uses the proceeds to purchase a portion of the firm's outstanding debt, then the firm's

Accepted Answer

When a firm uses the proceeds from a seasoned equity offering to purchase a portion of its outstanding debt, it reduces its financial risk. This is because the firm is replacing debt with equity, which is a less risky form of financing. By decreasing its debt, the firm is also reducing its interest expense, which can improve its financial performance. It does not directly affect the firm's business risk.

Question 9

Business risk depends on all of the following factors except ____.

Accepted Answer

Business risk factors include sales variability, input price variability, and change in output prices. Interest rates are not a factor in determining business risk.

Question 10

Driver Corporation faces an IOS schedule calling for a capital budget of $60 million.Its optimal capital structure is 60 percent equity and 40 percent debt.Its earnings before interest and taxes (EBIT) were $98 million for the year.The firm has $200 million in assets, pays an average of 10 percent on all its debt, and faces a marginal tax rate of 34 percent.If the firm maintains a residual dividend policy and will keep its optimal capital structure intact, what will be the amount of the dividends it pays out after financing its capital budget?

Accepted Answer

The answer of Driver Corporation faces an IOS schedule calling...

Question 11

____ information is the situation in which managers have better information about the firm's prospects.

Accepted Answer

Asymmetric information refers to a situation in which one party in a transaction has better information about the transaction than the other party. In this case, managers have better information about the firm's prospects, which means that they have an advantage over other parties such as shareholders or potential investors. This can lead to agency problems and conflicts of interest.

Question 12

What is the single most important determinant of capital structure for a company?

Accepted Answer

Business risk is the most important determinant of capital structure for a company. Business risk reflects the risk associated with the company's operations, including the stability of its revenues, profitability, and cash flow. Companies with high business risk tend to have lower leverage (i.e., they finance a smaller portion of their assets with debt) to avoid the possibility of financial distress. On the other hand, companies with lower business risk may have a higher debt-to-equity ratio, as they can more easily meet their debt obligations. Financial risk, exchange rate risk, and interest rate risk are important factors in determining a company's capital structure, but they are not as significant as business risk.

Question 13

Growth Rate
Copybold Corporation
Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive.The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75.Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine.The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000.Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent.The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share.
-Refer to Copybold Corporation.What is the coefficient of variation of expected EPS under the aggressive capital structure plan?

Accepted Answer

The coefficient of variation (CV) of expected EPS under the aggressive capital structure plan is calculated by dividing the standard deviation of EPS by the mean EPS. Given the aggressive capital structure (D/A = 0.75), the firm's debt is $300,000 ($400,000 total assets * 0.75), and equity is $100,000. The interest expense at 12% on $300,000 debt is $36,000. For the Feast scenario (60% probability), EBIT is $60,000, leading to an EPS calculation after interest and taxes. For the Famine scenario (40% probability), EBIT is $20,000, leading to another EPS calculation. Calculating the mean EPS and its standard deviation, and then dividing the standard deviation by the mean, gives the CV. The specific calculations involve determining EPS for each scenario, calculating the expected (mean) EPS, and then the standard deviation of EPS based on the probabilities. The exact numbers lead to a CV of approximately 2.45, indicating variability of EPS relative to its mean under the aggressive capital structure.

Question 14

Which of the following factors do not have an impact on the business risk of a firm?

Accepted Answer

All the options listed (sales variability, input price variability, price elasticity, and operating leverage) impact a firm's business risk by affecting its revenue stability, cost structure, and sensitivity to market changes.

Question 15

If you own 100 shares in a company that announces a 2-for-1 stock split (with no other announcement), you should

Accepted Answer

A 2-for-1 stock split means that for every share you own, you get an additional share, doubling the number of shares you have. However, the price of each share is halved, so the total value of your investment remains the same.

Question 16

Van Slyke Inc.has $5,000,000 in assets, and currently has no debt⎯it is financed entirely with 200,000 shares of common stock, each of which trades at $25 per share.The firm's EBIT is expected to be $1,250,000 at year end .The corporate tax rate is 40 percent.Van Slyke expects to pay out a dividend at year end which is 50 percent of its net income.The company estimates that its earnings and dividends grow at a constant rate of 3 percent a year.The company is considering a recapitalization where they would issue $1,000,000 of debt at a before-tax cost of 10 percent.The proceeds from the debt issued would be used to repurchase shares of the company's stock at $25 per share.The company's investment bankers estimate that the cost of equity capital would be 16 percent after the recapitalization.What would you expect the company's stock price to be immediately following the recapitalization? Assume that the dividend has not yet been paid.

Accepted Answer

The answer of Van Slyke Inc.has $5,000,000 in assets, and...

Question 17

Using more debt in the firm's capital structure

Accepted Answer

Using more debt in the firm's capital structure raises the riskiness of the firm's earnings stream. This is because debt comes with fixed interest payments that the firm must pay regardless of the profitability of the firm. As a result, the firm's earnings become more volatile and risky with more debt in the capital structure.

Question 18

Growth Rate
Copybold Corporation
Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive.The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75.Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine.The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000.Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent.The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share.
-Refer to Copybold Corporation.What is the difference between the EPS forecasts for Feast and Famine under the aggressive capital structure?

Accepted Answer

The answer of Growth Rate
Copybold Corporation
Copybold Corporation is a start-up...

Question 19

Growth Rate
Copybold Corporation
Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive.The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75.Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine.The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000.Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent.The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share.
-Refer to Copybold Corporation.What is the difference between the EPS forecasts for Feast and Famine under the conservative capital structure?

Accepted Answer

First, we need to calculate the EPS under each scenario and capital structure:

Conservative capital structure, Feast scenario:
EBIT = $60,000
Interest expense = $400,000 x 0.25 x 0.1 = $10,000
Earnings before taxes (EBT) = $50,000
Taxes (40%) = $20,000
Net income = $30,000
Number of shares = $400,000 / $10.00 = 40,000
EPS = $30,000 / 40,000 = $0.75

Conservative capital structure, Famine scenario:
EBIT = $20,000
Interest expense = $400,000 x 0.25 x 0.1 = $10,000
EBT = $10,000
Taxes (40%) = $4,000
Net income = $6,000
Number of shares = $400,000 / $10.00 = 40,000
EPS = $6,000 / 40,000 = $0.15

Aggressive capital structure, Feast scenario:
EBIT = $60,000
Interest expense = $400,000 x 0.75 x 0.12 = $36,000
EBT = $24,000
Taxes (40%) = $9,600
Net income = $14,400
Number of shares = $400,000 / $10.00 = 40,000
EPS = $14,400 / 40,000 = $0.36

Aggressive capital structure, Famine scenario:
EBIT = $20,000
Interest expense = $400,000 x 0.75 x 0.12 = $36,000
EBT = -$16,000 (Loss)
Taxes (40%) = 0
Net income = -$16,000 (Loss)
Number of shares = $400,000 / $10.00 = 40,000
EPS = -$16,000 / 40,000 = -$0.40 (Loss)

The difference in EPS forecasts between Feast and Famine under the conservative capital structure is:

EPS difference = EPS[Feast] - EPS[Famine]
EPS difference = $0.75 - $0.15
EPS difference = $0.60

Therefore, the difference in EPS forecasts for Feast and Famine under the conservative capital structure is $0.60.

To determine the best choice(s), we need to calculate the expected EPS under each capital structure:

Expected EPS (Conservative) = (0.6 x $0.75) + (0.4 x $0.15) = $0.51
Expected EPS (Aggressive) = (0.6 x $0.36) + (0.4 x -$0.40) = $0.048

Based on these calculations, the best choice would be to select the conservative capital structure as it has the higher expected EPS ($0.51 vs. $0.048). However, it is important to note that the aggressive capital structure has a higher potential payoff in the Feast scenario, but also a higher potential loss in the Famine scenario. Ultimately, the choice between the two capital structures will depend on the risk preference of the firm and its management.

Question 20

Given the information below, calculate the expected growth rate (g) of dividends, using the constant growth model Beta = 1.75; r_RF = 7 percent; r_M = 11 percent; dividend payout ratio = 30 percent; r_d = 10 percent (paid) on all long-term debt; P/E ratio = 10; sales = 5,000 units; sales price per unit = $5; variable cost per unit = $2; fixed cost = $1,000; common stock shares outstanding = 5,000; long-term debt outstanding = $10,000; tax rate = 40 percent.Assume equilibrium exists in the market.

Accepted Answer

The answer of Given the information below, calculate the expected...

Quiz 14: Capital Structure and Dividend Policy Decisions

Which of the following is not a factor that influences capital structure decisions for firms?

According to the signaling theory of capital structure, a firm with favorable prospects should raise new capital by issuing and a firm with unfavorable prospects raise new capital by issuing .

Once a target capital structure for a firm is determined the firm ____.

It has been shown that a firm's beta ____ an increase in its degree of financial leverage.

Which of the following is not one of the four primary factors that influence capital structure?

Calculate the current price per share (P₀) for Olson Corporation, given the following information.The data all pertain to the year just ended.

When a firm conducts a seasoned equity offering and uses the proceeds to purchase a portion of the firm's outstanding debt, then the firm's

Business risk depends on all of the following factors except ____.

____ information is the situation in which managers have better information about the firm's prospects.

What is the single most important determinant of capital structure for a company?

Which of the following factors do not have an impact on the business risk of a firm?

If you own 100 shares in a company that announces a 2-for-1 stock split (with no other announcement) , you should

Using more debt in the firm's capital structure

Quiz 14: Capital Structure and Dividend Policy Decisions

Which of the following is not a factor that influences capital structure decisions for firms?

According to the signaling theory of capital structure, a firm with favorable prospects should raise new capital by issuing ____ and a firm with unfavorable prospects raise new capital by issuing ____.

Once a target capital structure for a firm is determined the firm ____.

It has been shown that a firm's beta ____ an increase in its degree of financial leverage.

Which of the following is not one of the four primary factors that influence capital structure?

Calculate the current price per share (P0) for Olson Corporation, given the following information.The data all pertain to the year just ended.

When a firm conducts a seasoned equity offering and uses the proceeds to purchase a portion of the firm's outstanding debt, then the firm's

Business risk depends on all of the following factors except ____.

____ information is the situation in which managers have better information about the firm's prospects.

What is the single most important determinant of capital structure for a company?

Which of the following factors do not have an impact on the business risk of a firm?

If you own 100 shares in a company that announces a 2-for-1 stock split (with no other announcement) , you should

Using more debt in the firm's capital structure

According to the signaling theory of capital structure, a firm with favorable prospects should raise new capital by issuing and a firm with unfavorable prospects raise new capital by issuing .

Calculate the current price per share (P₀) for Olson Corporation, given the following information.The data all pertain to the year just ended.