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Exam 12: Leverage and Capital Structure

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Question 21

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Management has just discovered an excellent investment for which it needs additional funding.Relative to the discussion on asymmetric information,the firm will ________.

A) finance with new common stock if management believes the firm is undervalued
B) finance with debt if management believes the firm is undervalued
C) finance with debt if management believes the firm is overvalued
D) finance with preferred stock if the firm is at value

E) B) and C)
F) A) and D)

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Question 22

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The base level of sales must be held constant to compare the total leverage associated with different levels of fixed costs.

A) True
B) False

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Question 23

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With the existence of fixed operating costs,a decrease in sales will result in ________ in EBIT.

Table 13.1 -Assuming a 21 percent tax rate,what is the financial breakeven point for each plan? (See Table 13.1)

Comparison of the degree of operating leverage of two firms is valid only when the base level of sales used for each firm is the same.

The preferred approach to breakeven analysis for a multiproduct firm is the ________.

As fixed operating costs increase and all other factors are held constant,________.

One of the limitations of breakeven analysis is its short-term time horizon.A large outlay in the current financial period could significantly raise the firm's breakeven point,while the benefits may occur over a period of years.

________ costs are a function of time,not sales,and are typically contractual.

The EBIT-EPS approach to capital structure proposes that an optimal capital structure be selected which ________.

If a firm's fixed operating costs decrease,the firm's ________.

Generally,the greater a firm's times interest earned ratio,the less able it is to meet payments as they come due.

As financial leverage increases,the cost of debt initially remains constant and then rises,while the cost of equity always rises.

Which of the following is a basic source of capital for a firm?

Effective capital structure decisions can lower the cost of capital,resulting in higher NPVs and more acceptable projects,thereby increasing the value of a firm.

Whenever the percentage change in earnings before interest and taxes resulting from a given percentage change in sales is greater than the percentage change in sales,operating leverage exists.

The pecking order theory describes a hierarchy of financing beginning with retained earnings,followed by debt financing,and finally external equity financing.

Because risk premiums increase with increases in financial leverage,maximizing EPS does not assure owners' wealth maximization.

A firm's capital structure can significantly affect the firm's value by affecting its risk and return.

The amount of leverage in a firm's capital structure-the mix of long-term debt and equity maintained by the firm-can significantly affect its value by affecting return and risk.