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FIN 701 W6 Exam Questions with Correct Answers
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A firm should select the capital structure that: - Answer-maximizes the value of the firm The value of a firm is maximized when the: - Answer-weighted average cost of capital is minimized The optional capital structure has been achieved when the: - Answer-debt-equity ratio results in the lowe...

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  • August 23, 2024
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  • 2024/2025
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  • fin 701 w6 exam questions with correct answers
  • a firm should select the capital structure that

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FIN 701 W6 Exam Questions with
Correct Answers
A firm should select the capital structure that: - Answer-maximizes the value of the firm

The value of a firm is maximized when the: - Answer-weighted average cost of capital is
minimized

The optional capital structure has been achieved when the: - Answer-debt-equity ratio
results in the lowest possible weighted average cost of capital

Assume you are reviewing a graph that plots earnings per share (EPS) against earnings
before interest and taxes (EBIT). The steeper the slope of the plotted line the: - Answer-
greater the sensitivity of EPS to changes in EBIT

You have computed the break-even point between a levered and an unlettered capital
structure. Ignore taxes at the break-even level, the: - Answer-company is earning just to
pay for the cost of the debt

Which one of the following statements is correct in relation to M&M Proposition II,
without taxes: - Answer-the required return on assets is equal to the weighted average
cost of capital

The business risk of a company: - Answer-has a positive relationship with the
company's cost of equity

Which one of the following is the equity risk that is most related to the daily operations
of a firm: - Answer-financial risk

Financial risk is: - Answer-dependent upon a company's capital structure

Which one of the following states that the value of a company is unrelated to the
company's capital structure: - Answer-M&M Proposition I, no tax

Westover Mills reduced its taxes last year by $210 by increasing its interest expense
buy $1,000. Which one of the following terms is used to describe this tax savings: -
Answer-interest tax shield

M&M Proposition I with tax implies that the: - Answer-weighted average cost of capital
decreases as the debt-equity ratio increases

The interest tax shield is a key reason why: - Answer-the net cost of debt is generally
less than the cost of equity

, The explicit costs, such as legal and administrative expenses, associated with corporate
default are classified as ____ costs - Answer-direct bankruptcy

The costs incurred by a business in an effort to avoid bankruptcy are classified as ____
costs - Answer-indirect bankruptcy

The proposition that a company borrows up to the point where the marginal benefit of
the interest tax should derived from increased debt is just equal to the marginal expense
of the resulting increase in financial distress costs is called: - Answer-the static theory of
capital structure

Which one of the following is a marketed claim against the cash flows of a company: -
Answer-dividend payment to shareholders

The optimal capital structure of a company: - Answer-maximizes the value of that
company's marketed claims

Katlin Markets is debating between a levered and an unlettered capital structure. The
all-equity capital structure would consist of $60,000 shares of stock. The debt and
equity option would consist of $45,000 shares of stock plus $250,000 of debt with an
interest rate of 7.25 percent. What is the break-even level of earnings before interest
and taxes between these two options? Ignore taxes - Answer-$72,500

Holly's is currently an all-equity firm that has 7,200 shares of stock outstanding at a
market price of $41 a share. The firm has decided to leverage its operations by issuing
$60,000 of debt at an interest rate of 7.6 percent. This new debt will be used to
repurchase shares of the outstanding stock. The restructuring is expected to increase
the earnings per share. What is the minimum level of earnings before interest and taxes
that the firm is expecting? Ignore taxes - Answer-$22,435

Paradise Travels is an all-equity firm that has 9,000 shares of stock outstanding at a
market price of $27 a share. Management has decided to issue $25,000 worth of debt
and use the funds to repurchase shares of the outstanding stock. The interest rate on
the debt will be 7.3 percent. What are the earnings per share at the break-even level of
earnings before interest and taxes? Ignore taxes - Answer-$1.97

Lamont Corp. is debt-free and has a weighted average cost of capital of 12.7 percent.
The current market value of the equity is $2.3 million and there are no taxes. According
to M&M Proposition I, what will be the value of the company if it changes to a debt-
equity ratio of .85: - Answer-$2,300,000

Ignoring taxes, Pewter & Glass has a weighted average cost of capital of 10.82 percent.
The company can borrow at 7.4 percent. What is the cost of equity if the debt-equity
ratio is .68: - Answer-13.15%

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