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Chapter: Chapter 29: Capital Structure, Dividends, and Share Repurchases
Multiple Choice
1. For a given firm, which of the following is most likely to be the result of lower leverage?
a) Corporate overinvestment.
b) Increased investor conflicts.
c) Tax savings for the firm.
d) Shareholders preferring higher-risk projects.
2. Which of the following is the correct order of financing choices according to the pecking-
order theory, starting with the most preferred choice?
a) Internal funds, debt, equity.
b) Debt, equity, internal funds.
c) Internal funds, equity, debt.
d) Equity, internal funds, debt.
3. Based on the observed distribution of credit ratings, which of the following ranges of debt
ratings is an effective rating level, meaning it cannot clearly be improved upon in terms of
creating value for shareholders?
a) From BB+ to BBB.
b) From BBB– to A+.
c) From A to AA–.
d) From AA– to AAA.
4. Which of the following is the most important factor in determining a company’s credit
rating?
a) Size.
b) Coverage.
c) Tax bracket.
d) Use of a complex capital structure.
5. Which of the following is most likely to have a negative effect on share price?
a) Issuing debt.
b) Issuing equity.
c) Dividend increase.
d) Extraordinary dividend.
6. Although academic researchers have investigated the issue for decades, there is still no clear
model for deciding a company’s optimal leverage ratio (i.e., the leverage that would create
most value for shareholders).
7. Business erosion is a result of too little leverage and the resulting stagnation and loss of
customers.
8. For a manager attempting to determine the optimal capital structure of a firm, which of the
following is most accurate?
a) It is a fruitless endeavor and should be discouraged based on the conservation of value
principle.
b) The best place to start is by examining the capital structures of the industry peer group of
the company.
c) Well-defined algorithms exist that high-priced consulting firms use, and their cost is generally
justified in terms of the potential value creation.
d) The best place to start is with a Monte Carlo simulation of possible market movements and
their effects on the capitalization weights and the value of the firm.
9. Leverage and coverage measure the same thing but over different time horizons.
10. Option valuation models that determine default estimates of companies have longer time
horizons and therefore produce “through the cycle” estimates.
11. Describe how leverage can cause business erosion.
