Quiz about Financial Management Quiz

Question 1

Which one of the following is the equity risk related to a firm's capital structure policy?

Accepted Answer

financial

Answer

market

Answer

systematic

Answer

extrinsic

Answer

business

Question 2

The absolute priority rule determines:

Accepted Answer

which parties receive payment first in a bankruptcy proceeding

Answer

when a firm must be declared officially bankrupt

Answer

how a distressed firm is reorganized

Answer

which judge is assigned to a particular bankruptcy case

Answer

how long a reorganized firm is allowed to remain under bankruptcy protection

Question 3

Which one of the following states that the value of a firm is unrelated to the firm's capital structure?

Accepted Answer

M & M Proposition I

Answer

Capital Asset Pricing Model

Answer

M & M Proposition II

Answer

Law of One Price

Answer

Efficient Markets Hypothesis

Question 4

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called?

Accepted Answer

cost of equity

Answer

dividend yield

Answer

capital gains yield

Answer

cost of capital

Answer

income return

Question 5

Which one of the following is the legal proceeding under which an insolvent firm can be reorganized?

Accepted Answer

bankruptcy

Answer

restructure process

Answer

forced merger

Answer

legal takeover

Answer

rights offer

Question 6

Homemade leverage is:

Accepted Answer

the borrowing or lending of money by individual shareholders as a means of adjusting their level of financial leverage.

Answer

the incurrence of debt by a corporation in order to pay dividends to shareholders.

Answer

the exclusive use of debt to fund a corporate expansion project.

Answer

best defined as an increase in a firm's debt-equity ratio.

Answer

the term used to describe the capital structure of a levered firm.

Question 7

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:

Accepted Answer

firm's earnings before interest and taxes are equal to zero

Answer

firm is just earning enough to pay for the cost of the debt

Answer

earnings per share for the levered option are exactly double those of the unlevered option

Answer

advantages of leverage exceed the disadvantages of leverage

Answer

firm has a debt-equity ratio of .50

Question 8

Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the:

Accepted Answer

cost of debt

Answer

compound rate

Answer

current yield

Answer

capital gains yield

Answer

cost of capital

Question 9

The cost of preferred stock is computed the same as the:

Accepted Answer

return on a perpetuity.

Answer

pre-tax cost of debt.

Answer

return on an annuity.

Answer

aftertax cost of debt.

Answer

cost of an irregular growth common stock.

Question 10

Assigning discount rates to individual projects based on the risk level of each project:

Accepted Answer

may cause the firm's overall weighted average cost of capital to either increase or decrease over time.

Answer

will prevent the firm's overall cost of capital from changing over time.

Answer

will cause the firm's overall cost of capital to decrease over time.

Answer

decreases the value of the firm over time.

Answer

negates the firm's goal of creating the most value for the shareholders.

Question 11

The unlevered cost of capital refers to the cost of capital for a(n):

Accepted Answer

all-equity firm

Answer

private entity

Answer

governmental entity

Answer

private individual

Answer

corporate shareholder

Question 12

50 by increasing its interest expense by $1,000. Which of the following terms is used to describe this tax savings?

Accepted Answer

interest tax shield

Answer

interest credit

Answer

financing shield

Answer

current tax yield

Answer

tax-loss interest

Question 13

The discount rate assigned to an individual project should be based on:

Accepted Answer

the firm's weighted average cost of capital.

Answer

the actual sources of funding used for the project.

Answer

an average of the firm's overall cost of capital for the past five years.

Answer

the current risk level of the overall firm.

Answer

the risks associated with the use of the funds required by the project.

Question 14

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

Accepted Answer

direct bankruptcy

Answer

flotation

Answer

issue

Answer

indirect bankruptcy

Answer

unlevered

Question 15

A business firm ceases to exist as a going concern as a result of which one of the following?

Accepted Answer

liquidation

Answer

divestiture

Answer

share repurchase

Answer

reorganization

Answer

capital restructuring

Question 16

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs.

Accepted Answer

indirect bankruptcy

Answer

flotation

Answer

direct bankruptcy

Answer

financial solvency

Answer

capital structure

Question 17

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:

Accepted Answer

reorganization

Answer

merger

Answer

repurchase program

Answer

liquidation

Answer

divestiture

Question 18

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?

Accepted Answer

M & M Proposition I

Answer

Capital Asset Pricing Model

Answer

M & M Proposition II

Answer

Law of One Price

Answer

Efficient Markets Hypothesis

Question 19

The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the:

Accepted Answer

weighted average cost of capital

Answer

reward to risk ratio

Answer

weighted capital gains rate

Answer

structured cost of capital

Answer

subjective cost of capital

Question 20

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:

Accepted Answer

the static theory of capital structure

Answer

M & M Proposition I

Answer

M & M Proposition II

Answer

the capital asset pricing model

Answer

the open markets theorem

Question 21

All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.

Accepted Answer

a reduction in the risk-free rate

Answer

a reduction in the dividend amount

Answer

an increase in the dividend amount

Answer

a reduction in the market rate of return

Answer

a reduction in the firm's beta

Question 22

Jones & Co. is funded by a group of individual investors for the sole purpose of providing funding for individuals who are trying to convert their new ideas into viable products. What is this type of funding called?

Accepted Answer

venture capital

Answer

green shoe funding

Answer

tombstone underwriting

Answer

red herring funding

Answer

life cycle capital

Question 23

What is the form called that is filed with the SEC and discloses the material information on a securities issuer when that issuer offers new securities to the general public?

Accepted Answer

registration statement

Answer

prospectus

Answer

red herring

Answer

indenture

Answer

public disclosure statement

Question 24

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?

Accepted Answer

interest tax shield

Answer

interest credit

Answer

financing shield

Answer

current tax yie

Question 25

The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations?

Accepted Answer

II. firms that pay a constant dividend

Accepted Answer

III. firms that pay an increasing dividend

Answer

I. firms that have a 100 percent retention ratio

Answer

IV. firms that pay a decreasing dividend

Question 26

Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of 0.40 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity?

Accepted Answer

by using the capital asset pricing model

Answer

by adding the market risk premium to the aftertax cost of debt

Answer

by multiplying the market risk premium by (1 - 0.40)

Answer

by using the dividend growth model

Answer

by averaging the costs based on the dividend growth model and the capital asset pricing model

Question 27

Miller & Chase is offering $4 million of new securities to the general public. Which SEC regulation governs this offering?

Accepted Answer

Regulation A

Answer

Regulation C

Answer

Regulation G

Answer

Regulation Q

Answer

Regulation R

Question 28

The pre-tax cost of debt:

Accepted Answer

is based on the current yield to maturity of the firm's outstanding bonds.

Answer

is equal to the coupon rate on the latest bonds issued by a firm.

Answer

is equivalent to the average current yield on all of a firm's outstanding bonds.

Answer

is based on the original yield to maturity on the latest bonds issued by a firm.

Answer

has to be estimated as it cannot be directly observed in the market.

Question 29

Which of the following statements are correct?

Accepted Answer

I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk

Accepted Answer

IV. The SML approach assumes the reward-to-risk ratio is constant

Answer

II. The SML approach can be applied to firms that retain all of their earnings

Answer

III. The SML approach assumes a firm's future risks are similar to its past risks

Question 30

Which one of the following is the primary determinant of a firm's cost of capital?

Accepted Answer

debt-equity ratio

Answer

applicable tax rate

Answer

cost of equity

Answer

cost of debt

Answer

use of the funds

Question 31

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:

Accepted Answer

sell some shares of Quantro stock and hold the proceeds in cash

Answer

borrow some money and purchase additional shares of Quantro stock

Answer

maintain her current equity position as the debt of the firm did not affect her personally

Answer

sell some shares of Quantro stock and loan out the sale proceeds

Question 32

Which one of the following is the equity risk that is most related to the daily operations of a firm?

Accepted Answer

business risk

Answer

market risk

Answer

systematic risk

Answer

extrinsic risk

Answer

financial risk

Question 33

Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following statements is correct?

Accepted Answer

The firm's cost of equity is unaffected by a change in the firm's tax rate.

Answer

The aftertax cost of debt will be greater than the current yield-to-maturity on the firm's bonds.

Answer

The firm's cost of preferred is most likely less than the firm's actual cost of debt.

Answer

The cost of equity can only be estimated using the SML approach.

Answer

The firm's weighted average cost of capital will remain constant as long as the capital structure remains constant.

Question 34

Markley and Stearns is a multi-divisional firm that uses its WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to:

Accepted Answer

receive less project funding if its line of business is riskier than that of the other divisions.

Answer

avoid risky projects so it can receive more project funding.

Answer

become less risky over time based on the projects that are accepted.

Answer

have equal probability of receiving funding as compared to the other divisions.

Answer

prefer higher risk projects over lower risk projects.

Question 35

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.

Accepted Answer

select the unlevered option since the expected EBIT is less than the break-even level

Answer

select the leverage option because the debt-equity ratio is less than 0.50

Answer

select the leverage option since the expected EBIT is less than the break-even level

Answer

select the unlevered option since the debt-equity ratio is less than 0.50

Answer

cannot be determined from the information provided

Question 36

A firm should select the capital structure that:

Accepted Answer

maximizes the value of the firm

Answer

produces the highest cost of capital

Answer

minimizes taxes

Answer

is fully unlevered

Answer

equates the value of debt with the value of equity

Question 37

The optimal capital structure has been achieved when the:

Accepted Answer

debt-equity ratio results in the lowest possible weighted average cost of capital

Answer

debt-equity ratio is equal to 1

Answer

weight of equity is equal to the weight of debt

Answer

cost of equity is maximized given a pre-tax cost of debt

Answer

debt-equity ratio is such that the cost of debt exceeds the cost of equity

Question 38

The capital structure weights used in computing the weighted average cost of capital:

Accepted Answer

are based on the market value of the firm's debt and equity securities.

Answer

are based on the book values of total debt and total equity.

Answer

are computed using the book value of the long-term debt and the book value of equity.

Answer

remain constant over time unless the firm issues new securities.

Answer

are restricted to the firm's debt and common stock.

Question 39

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _____ approach.

Accepted Answer

pure play

Answer

subjective risk

Answer

divisional cost of capital

Answer

capital adjustment

Answer

security market line

Question 40

Which one of the following makes the capital structure of a firm irrelevant?

Accepted Answer

homemade leverage

Answer

taxes

Answer

interest tax shield

Answer

100 percent dividend payout ratio

Answer

debt-equity ratio that is greater than 0 but less than 1

Question 41

Mangrove Fruit Farms has a $250,000 bond issue outstanding that is selling at 92 percent of face value. The firm also has 1,500 shares of preferred stock and 15,000 shares of common stock outstanding. The preferred stock has a market price of $35 a share compared to a price of $24 a share for the common stock. What is the weight of the preferred stock as it relates to the firm's weighted average cost of capital?

Accepted Answer

7.75 percent

Answer

6.75 percent

Answer

7.20 percent

Answer

8.03 percent

Answer

8.17 percent

Question 42

Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Assume there are no taxes.

Accepted Answer

The earnings per share will equal zero when EBIT is zero for a levered firm

Answer

At the break-even point, there is no advantage to debt

Answer

The advantages of leverage are inversely related to the level of EBIT

Answer

The use of leverage at any level of EBIT increases the EPS

Answer

EPS are more sensitive to changes in EBIT when a firm is unlevered

Question 43

Which one of the following is a preliminary prospectus?

Accepted Answer

red herring

Answer

tombstone

Answer

green shoe

Answer

registration statement

Answer

rights offer

Question 44

Tony currently owns 12,000 shares of GL Tools. He has just been notified that the firm is issuing additional shares of stock and that he is being given a chance to purchase some of these shares prior to the shares being offered to the general public. What is this type of an offer called?

Accepted Answer

rights offer

Answer

best efforts offer

Answer

firm commitment offer

Answer

general cash offer

Answer

priority offer

Question 45

What is an issue of securities that is offered for sale to the general public on a direct cash basis called?

Accepted Answer

general cash offer

Answer

best efforts underwriting

Answer

firm commitment underwriting

Answer

rights offer

Answer

herring offer

Question 46

Advertisements in a financial newspaper announcing a public offering of securities, along with a list of the investment banks handling the offering, are called:

Accepted Answer

tombstones

Answer

red herrings

Answer

Green Shoes

Answer

registration statements

Answer

cash offers

Question 47

Soup Galore is a partnership that was formed three years ago for the purpose of creating, producing, and distributing healthy soups in a dried form. The firm has been extremely successful thus far and has decided to incorporate and offer shares of stock to the general public. What is this type of an equity offering called?

Accepted Answer

initial public offering

Answer

venture capital offering

Answer

shelf offering

Answer

private placement

Answer

seasoned equity offering

Question 48

Samuelson Plastics has 7.5 percent preferred stock outstanding. Currently, this stock has a market value per share of $52 and a book value per share of $38. What is the cost of preferred stock?

Accepted Answer

7.50 percent

Answer

13.88 percent

Answer

14.42 percent

Answer

19.29 percent

Answer

19.74 percent

Question 49

Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure.

Accepted Answer

The model generally produces the same cost of equity as the dividend growth model

Answer

This model considers a firm's rate of growth

Answer

The model applies only to non-dividend paying firms

Answer

The model is dependent upon a reliable estimate of the market risk premium

Answer

This approach generally produces a cost of equity that equals the firm's overall cost of capital

Question 50

Sewer's Paradise is an all equity firm that has 5,000 shares of stock outstanding at a market price of $15 a share. The firm's management has decided to issue $30,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 10 percent. What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes.

Accepted Answer

$1.50

Answer

$1.46

Answer

$1.67

Answer

$1.88

Answer

$1.94

Question 51

The value of a firm is maximized when the:

Accepted Answer

weighted average cost of capital is minimized

Answer

cost of equity is maximized

Answer

tax rate is zero

Answer

levered cost of capital is maximized

Answer

debt-equity ratio is minimized

Question 52

Miller's Dry Goods is an all equity firm with 48,000 shares of stock outstanding at a market price of $50 a share. The company's earnings before interest and taxes are $128,000. Miller's has decided to add leverage to its financial operations by issuing $250,000 of debt at 8 percent interest. The debt will be used to repurchase shares of stock. You own 400 shares of Miller's stock. You also loan out funds at 8 percent interest. How many shares of Miller's stock must you sell to offset the leverage that Miller's is assuming? Assume you loan out all of the funds you receive from the sale of stock. Ignore taxes.

Accepted Answer

41.67 shares

Answer

35.6 shares

Answer

40.0 shares

Answer

47.5 shares

Answer

50.1 shares

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