D) likelihood of asset growth.
92) As the level of debt increases the tax benefits of debt increase until
A) interest costs exceed dividend payments.
B) tax shield benefit exceeds distress costs.
C) raw material costs exceed dividend payments.
D) employee costs exceed interest expense.
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
93) What are the issues in determining the present value (PV) of financial distress?
94) What are the issues in determining the optimal leverage for a firm?
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
95) The presence of leverage can influence the behavior of the managers of a firm.
96) Equity–debt holder conflicts are more likely to arise if the risk of financial distress is high.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
97) Agency costs arise when
A) there are high labor costs.
B) input costs are higher than interest costs.
C) interest costs exceed dividend payments.
D) conflicts of interest exist between stakeholders.
98) Managerial entrenchment means that managers ________ and run the firm for their own best interests.
A) may face little threat of being fired
B) are overseen by equity holders
C) are overseen by debt holders
D) are well compensated
99) When a firm’s investment decisions have different consequences for the value of equity and the value of
debt, managers may take actions
A) to increase debt values.
B) to decrease costs of distress.
C) that benefit shareholders at the expense of debt holders.
D) to reduce fixed costs.
100) The presence of a large amount of debt can encourage shareholders to take excessive risk because
A) equity holders are risk seeking by nature.
B) the costs of failure are borne largely by debt holders.
C) debt holders are risk seeking.
D) firm value increases with risk taking.
101) Issuing debt provides incentives for managers to run the firm efficiently because:
A) Debt increases the funds available to managers to run the firm.
B) Ownership may remain more concentrated, improving monitoring of management.
C) Managers may take actions that benefit shareholders but harm creditors and lower the value of the
firm.
D) Shareholders prefer to decline new projects to save cash, even if their NPVs are positive.
102) Under–investment problems refers to the problem that equity holders prefer not to invest in positive–NPV
projects in highly levered firms because
A) future investments are contingent on debt financing.
B) projects are contingent on equity financing.
C) gains are evenly shared between all stakeholders.
D) most of the gains from the investment accrue to debt holders.
103) The use of leverage as a way to signal ________ information to investors is known as the signaling theory of
debt.
A) good
B) bad
C) random
D) none of the above
104) Asymmetric information implies that ________ may have better information about a firm’s cash flows than
other stakeholders.
A) debt holders
B) suppliers
C) managers
D) creditors
105) Market timing means that managers may sell ________ when they believe the stock is over–valued and rely
on ________ when the stock is under–valued.
A) debt, shares
B) debt, preferred stock
C) new shares, debt
D) debt, debt
106) The pecking order hypothesis states that managers will have a preference to fund investment by using
________, followed by ________, and will issue ________ as a last resort.
A) debt, equity, retained earnings
B) retained earnings, equity, debt
C) retained earnings, debt, equity
D) debt, retained earnings, equity
107) Managers should make use of the interest tax shield if the firm has
A) consistent taxable income.
B) volatility in taxable income.
C) consistent dividend payments.
D) low tax rates.
108) Managers should consider ________ for external financing when agency costs are significant.
A) long–term debt
B) retained earnings
C) internal equity
D) short–term debt
109) Managers should not change the capital structure unless it departs significantly from the optimal level
because such a change would
A) reduce dividends.
B) incur transactions costs.
C) increase fixed costs.
D) change incentives of stakeholders.
110) The optimal capital structure depends on ________ such as taxes, distress costs and agency costs.
A) capital market factors
B) market imperfections
C) firm specific risks
D) systematic risks
