Question 1

The TrunkLine Company debtholders are promised payments of $35 if the firm does well,but will receive only $20 if the firm does poorly. Bondholders are willing to pay $25. The promised return to the bondholders is approximately:

Accepted Answer

A)   2.9%
B)   16.9%
C)   27.3%
D)   40.0%
E)   100%F) A) and C)
G) A) and E)

Question 2

Corporations in the U.S. tend to:

Accepted Answer

A)   minimize taxes.
B)   underutilize debt.
C)   rely less on equity financing than they should.
D)   have extremely high debt-equity ratios.
E)   rely more heavily on bonds than stocks as the major source of financing.F) A) and C)
G) B) and E)

Question 3

Which of the following is true?

Accepted Answer

A)   A firm with low anticipated profit will likely take on a high level of debt.
B)   A successful firm will probably take on zero debt.
C)   Rational firms raise debt levels when profits are expected to decline.
D)   Rational investors are likely to infer a higher firm value from a zero debt level.
E)   Investors will generally view an increase in debt as a positive sign for the firm's valuE.F) A) and B)
G) B) and E)

Question 4

What are the advantages of a prepackaged bankruptcy for a firm?
 What are the disadvantages?

Accepted Answer

A prepack allows a firm to minimize its ...

Question 5

The MM theory with taxes implies that firms should issue maximum debt. In practice,this is not true because:

Accepted Answer

A)   debt is more risky than equity.
B)   bankruptcy is a disadvantage to debt.
C)   firms will incur large agency costs of short term debt by issuing long term debt.
D)   Both debt is more risky than equity; and bankruptcy is a disadvantage to debt.
E)   Both bankruptcy is a disadvantage to debt; and firms will incur large agency costs of short term debt by issuing long term debt.F) B) and E)
G) A) and D)

Question 6

When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends,these will result in:

Accepted Answer

A)   no action by debtholders since these are equity holder concerns.
B)   positive agency costs, as bondholders impose various restrictions and covenants which will diminish firm value.
C)   investments of the same risk class that the firm is in.
D)   undertaking scale enhancing projects.
E)   lower agency costs, as shareholders have more control over the firm's assets.F) C) and E)
G) B) and C)

Question 7

The optimal capital structure will tend to include more debt for firms with:

Accepted Answer

A)   the highest depreciation deductions.
B)   the lowest marginal tax rate.
C)   substantial tax shields from other sources.
D)   lower probability of financial distress.
E)   less taxable incomE.F) C) and D)
G) B) and D)

Question 8

One of the indirect costs of bankruptcy is the incentive for managers to take large risks. When following this strategy:

Accepted Answer

A)   the firm will rank all projects and take the project which results in the highest expected value of the firm.
B)   bondholders expropriate value from stockholders by selecting high risk projects.
C)   stockholders expropriate value from bondholders by selecting high risk projects.
D)   the firm will always take the low risk project.
E)   Both the firm will rank all projects and take the project which results in the highest expected value of the firm; and bondholders expropriate value from stockholders by selecting high risk projects.F) D) and E)
G) A) and B)

Question 9

Holly Berry Incorporated will earn $40 in one year if it does well. The debtholders are promised payments of $25 in one year if the firm does well. If the firm does poorly,expected earnings in one year will be $20 and the repayment will be $15 because of the dead weight cost of bankruptcy. The probability of the firm performing poorly or well is 50%. If bondholders are fully aware of these costs what will they pay for the debt? The interest rate on the bonds is 8%.

Accepted Answer

A)   $18.52
B)   $30.00
C)   $32.55
D)   $35.75
E)   $37.04F) A) and E)
G) A) and D)

Question 10

What three factors are important to consider in determining a target debt to equity ratio?

Accepted Answer

A)   Taxes, asset types, and pecking order and financial slack
B)   Asset types, uncertainty of operating income, and pecking order and financial slack
C)   Taxes, financial slack and pecking order, and uncertainty of operating income
D)   Taxes, asset types, and uncertainty of operating income
E)   None of these.F) B) and E)
G) A) and E) D

Question 11

The explicit costs,such as the legal expenses,associated with corporate default are classified as _____ costs.

Accepted Answer

A)   flotation
B)   beta conversion
C)   direct bankruptcy
D)   indirect bankruptcy
E)   unleveredF) A) and E)
G) A) and B) C

Question 12

The value of a firm in financial distress is diminished if the firm:

Accepted Answer

A)   is declared bankrupt and proceeds to be liquidated.
B)   is declared insolvent and undergoes financial reorganization.
C)   is a partnership.
D)   Both is declared bankrupt and proceeds to be liquidated; and is a partnership.
E)   Both is declared bankrupt and proceeds to be liquidated; and is declared insolvent and undergoes financial reorganization.F) A) and C)
G) B) and E)

Question 13

The pecking order states how financing should be raised. In order to avoid asymmetric information problems and misinterpretation of whether management is sending a signal on security overvaluation,the firm's first rule is to:

Accepted Answer

A)   finance with internally generated funds.
B)   always issue debt then the market won't know when management thinks the security is overvalued.
C)   issue new equity first.
D)   issue debt first.
E)   None of these.F) C) and D)
G) A) and D)

Question 14

Given the following information,leverage will add how much value to the unlevered firm per dollar of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 50%
Personal tax rate on income from stocks: 10%

Accepted Answer

A)   $-0.050
B)   $-0.188
C)   $0.188
D)   $0.633
E)   None of these.F) A) and E)
G) B) and D)

Question 15

Brad's Robotics Incorporated will earn $60 in one year if it does well. The debtholders are promised payments of $40 in one year if the firm does well. If the firm does poorly,expected earnings in one year will be $10 and the repayment will be $5 because of the dead weight cost of bankruptcy. The probability of the firm performing poorly or well is 40%. If bondholders are fully aware of these costs what will they pay for the debt? The interest rate on the bonds is 7%.

Accepted Answer

A)   $17.76
B)   $19.73
C)   $32.55
D)   $38.75
E)   $39.04F) B) and E)
G) All of the above A

Question 16

In a Miller equilibrium,what type of investments do high tax bracket investors tend to hold?

Accepted Answer

A)   Bonds
B)   Stocks
C)   Debentures
D)   Both stocks and bonds.
E)   Neither stocks nor bonds.F) None of the above
G) B) and C)

Question 17

Covenants restricting the use of leasing and additional borrowings primarily protect:

Accepted Answer

A)   the equityholders from added risk of default.
B)   the debtholders from the added risk of dilution of their claims.
C)   the debtholders from the transfer of assets.
D)   the management from having to pay agency costs.
E)   None of these.F) All of the above
G) D) and E)

Question 18

The TrunkLine Company will earn $60 in one year if it does well. The debtholders are promised payments of $35 in one year if the firm does well. If the firm does poorly,expected earnings in one year will be $30 and the repayment will be $20 because of the dead weight cost of bankruptcy. The probability of the firm performing poorly or well is 50%. If bondholders are fully aware of these costs what will they pay for the debt? The interest rate on the bonds is 10%.

Accepted Answer

A)   $25.00
B)   $27.50
C)   $29.55
D)   $32.50
E)   $35.00F) C) and D)
G) B) and D)

Question 19

When firms issue more debt,the tax shield on debt _____,the agency costs on debt (i.e.,costs of financial distress)  _____,and the agency costs on equity _____.

Accepted Answer

A)   increases; increase; increase
B)   decreases; decrease; decrease
C)   increases; increase; decrease
D)   decreases; decrease; increase
E)   increases; decrease; decreaseF) A) and B)
G) C) and D)

Question 20

The value of a firm is maximized when the:

Accepted Answer

A)   cost of equity is maximized.
B)   tax rate is zero.
C)   levered cost of capital is maximized.
D)   weighted average cost of capital is minimized.
E)   debt-equity ratio is minimized.F) D) and E)
G) C) and E)

Exam 17: Capital Structure: Limits to the Use of Debt

The TrunkLine Company debtholders are promised payments of $35 if the firm does well,but will receive only $20 if the firm does poorly. Bondholders are willing to pay $25. The promised return to the bondholders is approximately:

Correct Answer
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Corporations in the U.S. tend to:

Correct Answer
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Which of the following is true?

Correct Answer
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What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?

Correct Answer
verified
A prepack allows a firm to minimize its ...
View Answer

The MM theory with taxes implies that firms should issue maximum debt. In practice,this is not true because:

Correct Answer
verified

When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends,these will result in:

Correct Answer
verified

The optimal capital structure will tend to include more debt for firms with:

Correct Answer
verified

One of the indirect costs of bankruptcy is the incentive for managers to take large risks. When following this strategy:

Correct Answer
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Correct Answer
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What three factors are important to consider in determining a target debt to equity ratio?

Correct Answer
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D

The explicit costs,such as the legal expenses,associated with corporate default are classified as _____ costs.

Correct Answer
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C

The value of a firm in financial distress is diminished if the firm:

Correct Answer
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The pecking order states how financing should be raised. In order to avoid asymmetric information problems and misinterpretation of whether management is sending a signal on security overvaluation,the firm's first rule is to:

Correct Answer
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Given the following information,leverage will add how much value to the unlevered firm per dollar of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 50% Personal tax rate on income from stocks: 10%

Correct Answer
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Correct Answer
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A

In a Miller equilibrium,what type of investments do high tax bracket investors tend to hold?

Correct Answer
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Covenants restricting the use of leasing and additional borrowings primarily protect:

Correct Answer
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Correct Answer
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When firms issue more debt,the tax shield on debt ___,the agency costs on debt (i.e.,costs of financial distress) _,and the agency costs on equity ___.

Correct Answer
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The value of a firm is maximized when the:

Correct Answer
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Exam 17: Capital Structure: Limits to the Use of Debt

The TrunkLine Company debtholders are promised payments of $35 if the firm does well,but will receive only $20 if the firm does poorly. Bondholders are willing to pay $25. The promised return to the bondholders is approximately:

Correct AnswerverifiedShow Answer

Corporations in the U.S. tend to:

Correct AnswerverifiedShow Answer

Which of the following is true?

Correct AnswerverifiedShow Answer

What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?

Correct AnswerverifiedA prepack allows a firm to minimize its ...View AnswerShow Answer

The MM theory with taxes implies that firms should issue maximum debt. In practice,this is not true because:

Correct AnswerverifiedShow Answer

When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends,these will result in:

Correct AnswerverifiedShow Answer

The optimal capital structure will tend to include more debt for firms with:

Correct AnswerverifiedShow Answer

One of the indirect costs of bankruptcy is the incentive for managers to take large risks. When following this strategy:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

What three factors are important to consider in determining a target debt to equity ratio?

Correct AnswerverifiedD

The explicit costs,such as the legal expenses,associated with corporate default are classified as _____ costs.

Correct AnswerverifiedC

The value of a firm in financial distress is diminished if the firm:

Correct AnswerverifiedShow Answer

The pecking order states how financing should be raised. In order to avoid asymmetric information problems and misinterpretation of whether management is sending a signal on security overvaluation,the firm's first rule is to:

Correct AnswerverifiedShow Answer

Given the following information,leverage will add how much value to the unlevered firm per dollar of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 50% Personal tax rate on income from stocks: 10%

Correct AnswerverifiedShow Answer

Correct AnswerverifiedA

In a Miller equilibrium,what type of investments do high tax bracket investors tend to hold?

Correct AnswerverifiedShow Answer

Covenants restricting the use of leasing and additional borrowings primarily protect:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

When firms issue more debt,the tax shield on debt _____,the agency costs on debt (i.e.,costs of financial distress) _____,and the agency costs on equity _____.

Correct AnswerverifiedShow Answer

The value of a firm is maximized when the:

Correct AnswerverifiedShow Answer

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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A prepack allows a firm to minimize its ...
View Answer

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Correct Answer
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D

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C

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A

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Correct Answer
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When firms issue more debt,the tax shield on debt ___,the agency costs on debt (i.e.,costs of financial distress) _,and the agency costs on equity ___.

Correct Answer
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Correct Answer
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