Question 1

According to the text DFL stands for

Accepted Answer

A)   Degree of Financial Leverage
B)   Detrimental Financial Liability
C)   Differential Finance Learning
D)   Departmental Finance League
E)   Derivative Finance Law

Question 2

A consistent supply of capital is essential for the long-run success of a firm.Although a firm may have access to capital under all types of economic conditions, the concept of financial flexibility implies that the firm can obtain capital on acceptable, competitive terms.

Accepted Answer

A) True 
 B)False

Question 3

Howell Enterprises is forecasting EPS of R4.00 per share for next year.The firm has 10,000 shares outstanding, it pays 12 percent interest on its debt, and it faces a 40 percent marginal tax rate.Its estimated fixed costs are R80,000 while its variable costs are estimated at 40 percent of revenue.The firm's target capital structure is 40 percent equity and 60 percent debt and it has total assets of r400,000.On what level of sales is Howell basing its EPS forecast?

Accepted Answer

A)   R1,000,000
B)   R480,400
C)   R316,722
D)   R292,445
E)   R105,280

Question 4

The fact that some managers are more aggressive in their use of debt financing in attempting to boost profits does not influence the optimal or value-maximising capital structure.

Accepted Answer

A) True 
 B)False

Question 5

The management of a firm can control the degree of total leverage to some extent.

Accepted Answer

A) True 
 B)False

Question 6

The announcement of a share offering by a mature firm that seems to have financing alternatives is taken as a signal that the firm's prospects are very good.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following are practical difficulties associated with capital structure and degree of leverage analyses?

Accepted Answer

A)   It is nearly impossible to determine exactly how P/E ratios or equity capitalisation rates (rs values)  are affected by different degrees of financial leverage.
B)   Managers' attitudes toward risk differ and some managers may set a target capital structure other than the one that would maximise share price.
C)   Managers often have a responsibility to provide continuous service; they must preserve the long-run viability of the enterprise.Thus, the goal of employing leverage to maximise short-run share price and minimise capital cost may conflict with long-run viability.
D)   All of the above.
E)   None of the above represent a serious impediment to the practical application of leverage analysis to capital structure determination.

Question 8

Which of the following statements is correct?

Accepted Answer

A)   Suppose Company A's EPS is expected to experience a larger percentage change in response to a given percentage change in sales than Company B's EPS.Other things held constant, Company A would appear to have more business risk than Company B.
B)   Statement a would be correct if the term "EBIT" were substituted for "EPS."
C)   Statement a would be correct if the term "EBIT" were substituted for "sales."
D)   Statement a would be correct if the words "financial risk" were substituted for "business risk."
E)   The above statements are all false.

Question 9

A firm should raise capital according to its optimal capital structure so as to maximise its

Accepted Answer

A)   earnings per share (EPS) .
B)   share price.
C)   weighted average cost of capital (WAC
C)  .
D)   net income.

Question 10

Firms which maintain an adequate reserve borrowing capacity will be able to borrow money at reasonable cost when good investment opportunities arise.

Accepted Answer

A) True 
 B)False

Question 11

An all equity firm has some risk inherent in its operations.When the firm decides to finance some of its operations with debt, it exposes itself to financial risk and it increases its business risk.

Accepted Answer

A) True 
 B)False

Question 12

One implication of information asymmetry between investors and firm managers is that if a firm raises new capital by issuing debt rather than by selling shares, it signals that the firm has very good prospects.

Accepted Answer

A) True 
 B)False

Question 13

If a change in sales results in a greater relative change in operating income (EBIT) , we know that the firm has

Accepted Answer

A)   a degree of operating leverage greater than one.
B)   a degree of financial leverage greater than one.
C)   a degree of operating leverage less than one.
D)   a degree of financial leverage less than one.
E)   none of the above.

Question 14

The optimal capital structure is the one that maximises __________, and this will always be lower than the debt/equity ratio that maximises __________.

Accepted Answer

A)   expected EPS; the firm's share price
B)   net income, expected EPS
C)   book value of the firm; net income
D)   expected EPS; book value of the firm
E)   the firm's share price; expected EPS

Question 15

The "degree of leverage" concept is designed to show how changes in sales will affect EBIT and EPS.If a 10 percent increase in sales causes EPS to increase from R1.00 to R1.50, and if the firm uses no debt, then what is its degree of operating leverage?

Accepted Answer

A)   3.6
B)   4.2
C)   4.7
D)   5.0
E)   5.5

Question 16

Which of the following statements is correct?

Accepted Answer

A)   As a rule, the optimal capital structure is found by determining the debt-equity mix that maximises expected EPS.
B)   The optimal capital structure simultaneously maximises EPS and minimises the WACC.
C)   The optimal capital structure minimises the cost of equity, which is a necessary condition for maximising the share price.
D)   The optimal capital structure simultaneously minimises the cost of debt, the cost of equity, and the WACC.
E)   Each of the above statements is false.

Question 17

The probability of incurring bankruptcy increase as the firm increases as the debt/equity ratio decreases.

Accepted Answer

A) True 
 B)False

Question 18

Generally, as debt is substituted for equity, risk, as measured by the coefficient of variation of EPS, increases.This negative effect works against the positive effect of substituting debt for equity, which is that higher leverage increases expected EPS.

Accepted Answer

A) True 
 B)False

Question 19

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 R60,000.The Famine state has a 40 percent chance of occurring and the EBIT is expected to be R20,000.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 R400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is R10.00 per share.
-Refer to Copybold Corporation.What is the coefficient of variation of expected EPS under the aggressive capital structure plan?

Accepted Answer

A)   1.00
B)   1.18
C)   2.45
D)   2.88
E)   3.76

Question 20

One implication of the signaling theory of capital structure is that firms should borrow as much as the trade-off theory of capital structure predicts.

Accepted Answer

A) True 
 B)False

Exam 12: Capital Structure

An all equity firm has some risk inherent in its operations.When the firm decides to finance some of its operations with debt, it exposes itself to financial risk and it increases its business risk.

Correct Answer
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Correct Answer
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Correct Answer
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Which of the following statements is correct?

Correct Answer
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A consistent supply of capital is essential for the long-run success of a firm.Although a firm may have access to capital under all types of economic conditions, the concept of financial flexibility implies that the firm can obtain capital on acceptable, competitive terms.

Correct Answer
verified

The management of a firm can control the degree of total leverage to some extent.

Correct Answer
verified

Which of the following statements is correct?

Correct Answer
verified

According to the text DFL stands for

Correct Answer
verified

The "degree of leverage" concept is designed to show how changes in sales will affect EBIT and EPS.If a 10 percent increase in sales causes EPS to increase from R1.00 to R1.50, and if the firm uses no debt, then what is its degree of operating leverage?

Correct Answer
verified

One implication of the signaling theory of capital structure is that firms should borrow as much as the trade-off theory of capital structure predicts.

Correct Answer
verified

The probability of incurring bankruptcy increase as the firm increases as the debt/equity ratio decreases.

Correct Answer
verified

Firms which maintain an adequate reserve borrowing capacity will be able to borrow money at reasonable cost when good investment opportunities arise.

Correct Answer
verified

If a change in sales results in a greater relative change in operating income (EBIT) , we know that the firm has

Correct Answer
verified

Which of the following are practical difficulties associated with capital structure and degree of leverage analyses?

Correct Answer
verified

A firm should raise capital according to its optimal capital structure so as to maximise its

Correct Answer
verified

The fact that some managers are more aggressive in their use of debt financing in attempting to boost profits does not influence the optimal or value-maximising capital structure.

Correct Answer
verified

Generally, as debt is substituted for equity, risk, as measured by the coefficient of variation of EPS, increases.This negative effect works against the positive effect of substituting debt for equity, which is that higher leverage increases expected EPS.

Correct Answer
verified

The optimal capital structure is the one that maximises , and this will always be lower than the debt/equity ratio that maximises .

Correct Answer
verified

The announcement of a share offering by a mature firm that seems to have financing alternatives is taken as a signal that the firm's prospects are very good.

Correct Answer
verified

One implication of information asymmetry between investors and firm managers is that if a firm raises new capital by issuing debt rather than by selling shares, it signals that the firm has very good prospects.

Correct Answer
verified

Exam 12: Capital Structure

An all equity firm has some risk inherent in its operations.When the firm decides to finance some of its operations with debt, it exposes itself to financial risk and it increases its business risk.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is correct?

Correct AnswerverifiedShow Answer

A consistent supply of capital is essential for the long-run success of a firm.Although a firm may have access to capital under all types of economic conditions, the concept of financial flexibility implies that the firm can obtain capital on acceptable, competitive terms.

Correct AnswerverifiedShow Answer

The management of a firm can control the degree of total leverage to some extent.

Correct AnswerverifiedShow Answer

Which of the following statements is correct?

Correct AnswerverifiedShow Answer

According to the text DFL stands for

Correct AnswerverifiedShow Answer

The "degree of leverage" concept is designed to show how changes in sales will affect EBIT and EPS.If a 10 percent increase in sales causes EPS to increase from R1.00 to R1.50, and if the firm uses no debt, then what is its degree of operating leverage?

Correct AnswerverifiedShow Answer

One implication of the signaling theory of capital structure is that firms should borrow as much as the trade-off theory of capital structure predicts.

Correct AnswerverifiedShow Answer

The probability of incurring bankruptcy increase as the firm increases as the debt/equity ratio decreases.

Correct AnswerverifiedShow Answer

Firms which maintain an adequate reserve borrowing capacity will be able to borrow money at reasonable cost when good investment opportunities arise.

Correct AnswerverifiedShow Answer

If a change in sales results in a greater relative change in operating income (EBIT) , we know that the firm has

Correct AnswerverifiedShow Answer

Which of the following are practical difficulties associated with capital structure and degree of leverage analyses?

Correct AnswerverifiedShow Answer

A firm should raise capital according to its optimal capital structure so as to maximise its

Correct AnswerverifiedShow Answer

The fact that some managers are more aggressive in their use of debt financing in attempting to boost profits does not influence the optimal or value-maximising capital structure.

Correct AnswerverifiedShow Answer

Generally, as debt is substituted for equity, risk, as measured by the coefficient of variation of EPS, increases.This negative effect works against the positive effect of substituting debt for equity, which is that higher leverage increases expected EPS.

Correct AnswerverifiedShow Answer

The optimal capital structure is the one that maximises __________, and this will always be lower than the debt/equity ratio that maximises __________.

Correct AnswerverifiedShow Answer

The announcement of a share offering by a mature firm that seems to have financing alternatives is taken as a signal that the firm's prospects are very good.

Correct AnswerverifiedShow Answer

One implication of information asymmetry between investors and firm managers is that if a firm raises new capital by issuing debt rather than by selling shares, it signals that the firm has very good prospects.

Correct AnswerverifiedShow Answer

Correct Answer
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Correct Answer
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Correct Answer
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The optimal capital structure is the one that maximises , and this will always be lower than the debt/equity ratio that maximises .

Correct Answer
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Correct Answer
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Correct Answer
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