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Chapter 16
Financial Leverage and Capital Structure Policy
Multiple Choice Questions
1.
Homemade leverage is:
2.
Which one of the following states that the value of a firm is unrelated to the firm's capital
structure?
3.
Which one of the following states that a firm's cost of equity capital is directly and
proportionally related to the firm's capital structure?
4.
Which one of the following is the equity risk that is most related to the daily operations of
a firm?
5.
Which one of the following is the equity risk related to a firm's capital structure policy?
6.
Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by
$1,000. Which of the following terms is used to describe this tax savings?
7.
The unlevered cost of capital refers to the cost of capital for a(n):
8.
The explicit costs, such as legal and administrative expenses, associated with corporate
default are classified as _____ costs.
9.
The costs incurred by a business in an effort to avoid bankruptcy are classified as _____
costs.
10.
By definition, which of the following costs are included in the term "financial distress
costs"?
I. direct bankruptcy costs
II. indirect bankruptcy costs
III. direct costs related to being financially distressed, but not bankrupt
IV. indirect costs related to being financially distressed, but not bankrupt
11.
The proposition that a firm borrows up to the point where the marginal benefit of the
interest tax shield derived from increased debt is just equal to the marginal expense of the
resulting increase in financial distress costs is called:
12.
Which one of the following is the legal proceeding under which an insolvent firm can be
reorganized?
13.
A business firm ceases to exist as a going concern as a result of which one of the
following?
14.
Edwards Farm Products was unable to meet its financial obligations and was forced into
using legal proceedings to restructure itself so that it could continue as a viable business.
The process this firm underwent is known as a:
15.
The absolute priority rule determines:
16.
A firm should select the capital structure that:
17.
The value of a firm is maximized when the:
18.
The optimal capital structure has been achieved when the:
19.
AA Tours is comparing two capital structures to determine how to best finance its
operations. The first option consists of all equity financing. The second option is based on
a debt-equity ratio of 0.45. What should AA Tours do if its expected earnings before
interest and taxes (EBIT) are less than the break-even level? Assume there are no taxes.
20.
You have computed the break-even point between a levered and an unlevered capital
structure. Assume there are no taxes. At the break-even level, the:
21.
Which one of the following statements is correct concerning the relationship between a
levered and an unlevered capital structure? Assume there are no taxes.
22.
Jessica invested in Quantro stock when the firm was unlevered. Since then, Quantro has
changed its capital structure and now has a debt-equity ratio of 0.30. To unlever her
position, Jessica needs to:
23.
Which one of the following makes the capital structure of a firm irrelevant?
24.
M & M Proposition I with no tax supports the argument that:
25.
The concept of homemade leverage is most associated with:
26.
Which of the following statements are correct in relation to M & M Proposition II with no
taxes?
I. The required return on assets is equal to the weighted average cost of capital.
II. Financial risk is determined by the debt-equity ratio.
III. Financial risk determines the return on assets.
IV. The cost of equity declines when the amount of leverage used by a firm rises.
27.
M & M Proposition II is the proposition that:
28.
The business risk of a firm:
29.
Which of the following statements related to financial risk are correct?
I. Financial risk is the risk associated with the use of debt financing.
II. As financial risk increases so too does the cost of equity.
III. Financial risk is wholly dependent upon the financial policy of a firm.
IV. Financial risk is the risk that is inherent in a firm's operations.
