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Exam 12: Capital Structure Decisions

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Question 21

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Other things held constant,which event is most likely to encourage a firm to increase the amount of debt in its capital structure?

A) Its sales become less stable over time.
B) The costs that would be incurred in the event of bankruptcy increase.
C) Management believes that the firm's stock has become overvalued.
D) The corporate tax rate increases.

E) B) and C)
F) None of the above

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Question 22

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During a recession,companies with a significant portion of their capital structure in the form of debt (i.e.,high leverage) often struggle to meet their legally binding interest obligations.

A) True
B) False

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Question 23

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DeLong Inc.has fixed operating costs of $470,000,variable costs of $2.80 per unit produced,and its products sell for $4.00 per unit.What is the company's break-even point,i.e.,at what unit sales volume would income equal costs?

Vafeas Inc.'s capital structure consists of 80% debt and 20% common equity,it has a beta of 1.60,and its tax rate is 35%.However,the CFO thinks the company has too much debt,and he is considering moving to a capital structure with 40% debt and 60% equity.The risk-free rate is 5.0% and the market risk premium is 6.0%.By how much would the firm's cost of equity change as a result of altering its capital structure?

Elephant Books sells paperback books for $7 each.The variable cost per book is $5.At current annual sales of 200,000 books,the publisher is just breaking even.It is estimated that if the authors' royalties are reduced,the variable cost per book will drop by $1.Assume authors' royalties are reduced and sales remain constant; how much more money can the publisher put into advertising (a fixed cost) and still break even?

Financial distress,agency costs,and direct and indirect bankruptcy costs affect a firm's target capital structure.

Which of the following correctly defined a firm's operating break-even?

Firms HD and LD are identical except for their level of debt and the interest rates they pay on debt-HD has more debt and pays a higher interest rate on that debt.Based on the data given below,what is the difference between the two firms' ROEs? $\begin{array}{lll}\text { Applicable to Both Firms } & \text { Firm HD's Data } & \text { Firm LD's Data } \\\text { Assets } \$ 200 & \text { Debt ratio } 50 \% & \text { Debt ratio } 30 \% \\\text { EBIT } \$ 40 & \text { Interest rate } 12 \% & \text { Interest rate } 10 \% \\\text { Tax rate } 35 \% & &\end{array}$ $\begin{array}{llll}\text { Applicable to Both Firms } & & \text { Firm HD's Data } & \text { Firm LD's Data } \\\hline \text { Assets } \$ 200 & & \text { Debt ratio } 50 \% & \text { Debt ratio 30\% } \\\text { EBTT } \$ 40 && \text { Interest rate } 12 \% & \text { Interest rate } 10 \% \\\text { Tax rate } 35 \% & &\end{array}$

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

Which of the following statements best describes capital structure?

Which of the following statements regarding risk,or the avoidance of risk,is correct?

Business risk is affected by a firm's operations.Which of the following is NOT associated with (or does not contribute to) business risk?

Which statement concerning capital structure theory is NOT true?

The Congress Company has identified two methods for producing playing cards.One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards.The other method would use a less expensive machine (fixed cost = $5,000) ,but with greater variable costs ($1.50 per deck of cards) .If the selling price per deck of cards is the same under each method,at what level of output will the two methods produce the same net operating income (EBIT) ?

Which statement best describes the optimal capital structure?

Although they operate in different industries,two firms have the same expected earnings per share and the same standard deviation of expected EPS.Thus,the two firms must have the same business risk.

The MM model employs the concept of arbitrage to develop its theory.

Suppose that the personal tax rate on income from bonds is 34%,and the personal tax rate on income from stocks is 20%.What is the critical corporate tax rate below which leverage will add no value to the unlevered firm per dollar of debt?

A firm's business risk is largely determined by the financial characteristics of its industry,especially by the amount of debt the average firm in the industry uses.

Assume that the firm's gain from leverage according to the Miller model is $126,667.If the effective personal tax rate on stock income is T_S = 20%,what is the implied personal tax rate on debt income?