Chapter 16
Capital Structure: Basic Concepts
Multiple Choice Questions
1. The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called: A. homemade leverage. B. dividend recapture.
C. the weighted average cost of capital. D. private debt placement. E. personal offset.
2. The proposition that the value of the firm is independent of its capital structure is called: A. the capital asset pricing model. B. MM Proposition I. C. MM Proposition II. D. the law of one price.
E. the efficient markets hypothesis.
3. The proposition that the cost of equity is a positive linear function of capital structure is called:
A. the capital asset pricing model. B. MM Proposition I. C. MM Proposition II. D. the law of one price.
E. the efficient markets hypothesis.
4. The tax savings of the firm derived from the deductibility of interest expense is called the: A. interest tax shield. B. depreciable basis. C. financing umbrella. D. current yield.
E. tax-loss carry forward savings.
5. The unlevered cost of capital is:
A. the cost of capital for a firm with no equity in its capital structure. B. the cost of capital for a firm with no debt in its capital structure. C. the interest tax shield times pretax net income.
D. the cost of preferred stock for a firm with equal parts debt and common stock in its capital structure.
E. equal to the profit margin for a firm with some debt in its capital structure.
6. The cost of capital for a firm, rWACC, in a zero tax environment is:
A. equal to the expected earnings divided by market value of the unlevered firm. B. equal to the rate of return for that business risk class.
C. equal to the overall rate of return required on the levered firm. D. is constant regardless of the amount of leverage. E. All of the above.
7. The difference between a market value balance sheet and a book value balance sheet is that a market value balance sheet:
A. places assets on the right hand side. B. places liabilities on the left hand side.
C. does not equate the right hand with the left hand side. D. lists items in terms of market values, not historical costs. E. uses the market rate of return.
8. The firm's capital structure refers to: A. the way a firm invests its assets. B. the amount of capital in the firm. C. the amount of dividends a firm pays.
D. the mix of debt and equity used to finance the firm's assets. E. how much cash the firm holds.
9. A general rule for managers to follow is to set the firm's capital structure such that: A. the firm's value is minimized. B. the firm's value is maximized.
C. the firm's bondholders are made well off.
D. the firms suppliers of raw materials are satisfied. E. the firms dividend payout is maximized.
10. A levered firm is a company that has:
A. Accounts Payable as the only liability on the balance sheet. B. some debt in the capital structure. C. all equity in the capital structure. D. All of the above. E. None of the above.
11. A manager should attempt to maximize the value of the firm by:
A. changing the capital structure if and only if the value of the firm increases.
B. changing the capital structure if and only if the value of the firm increases to the benefit of inside management.
C. changing the capital structure if and only if the value of the firm increases only to the benefits of the debtholders.
D. changing the capital structure if and only if the value of the firm increases although it decreases the stockholders' value.
E. changing the capital structure if and only if the value of the firm increases and stockholder wealth is constant.
12. The effect of financial leverage depends on the operating earnings of the company. Which of the following is not true?
A. Below the indifference or break-even point in EBIT the non-levered structure is superior. B. Financial leverage increases the slope of the EPS line.
C. Above the indifference or break-even point the increase in EPS for all equity structures is less than debt-equity structures.
D. Above the indifference or break-even point the increase in EPS for all equity structures is greater than debt-equity structures.
E. The rate of return on operating assets is unaffected by leverage.