1. Chapter 17: Capital Structure Determination
1. The term "capital structure" refers to:
long-term debt, preferred stock, and common stock equity.
current assets and current liabilities.
total assets minus liabilities.
shareholders' equity.
2. A critical assumption of the net operating income (NOI) approach to valuation is:
that debt and equity levels remain unchanged.
that dividends increase at a constant rate.
that ko remains constant regardless of changes in leverage.
that interest expense and taxes are included in the calculation.
3. The traditional approach towards the valuation of a company assumes:
that the overall capitalization rate holds constant with changes in financial
leverage.
2. that there is an optimum capital structure.
that total risk is not altered by changes in the capital structure.
that markets are perfect.
4. Two firms that are virtually identical except for their capital structure are selling
in the market at different values. According to M&M
one will be at greater risk of bankruptcy.
the firm with greater financial leverage will have the higher value.
this proves that markets cannot be efficient.
this will not continue because arbitrage will eventually cause the firms to
sell at the same
value.
5. The cost of monitoring management is considered to be a (an):
bankruptcy cost.
transaction cost.
agency cost.
institutional cost.
6. What is the value of the tax shield if the value of the firm is $5 million, its value if
3. unlevered would be $4.78 million, and the present value of bankruptcy and agency
costs is $360,000?
$140,000
$220,000
$360,000
$580,000
7. According to the concept of financial signaling, management behavior results in
new debt issues being regarded as " news" by investors.
good
bad
non-event
risk-neutral
8. The cost of capital for a firm -- when we allow for taxes, bankruptcy, and agency
costs --
remains constant with increasing levels of financial leverage.
first declines and then ultimately rises with increasing levels of financial
leverage.
increases with increasing levels of financial leverage.
4. decreases with increasing levels of financial leverage.
9. When sequential long-term financing is involved, the choice of debt or equity
influences the future financial of the firm.
timing
flexibility
liquidity
Which of the following dividends is never in the form of cash?
A)
Regular dividend
B)
Special dividend
C)
Stock dividend
D)
Liquidation dividend
2
Dividends are decided by:
A)
The managers of a firm
Clear Answ ers
5. B)
The employees of a firm
C)
The board of directors
D)
The government
3
Which of these events occurs last in time (when arranged in
chronological order)?
A)
Payment date
B)
Ex-dividend date
C)
Record date
D)
Dividend declaration date
4
A stock dividend is essentially the same as:
A)
A stock split
B)
A stock repurchase
C)
A cash dividend
6. D)
None of the above
5
How can a firm repurchase its stock?
A)
Buy them in the open market
B)
Use a tender offer
C)
Employ a Dutch auction
D)
All of the above
6
Which of the following is true?
A)
Managers focus more on dividend changes than on absolute levels
B)
Dividend changes follow shifts in long-run sustainable earnings
C)
Managers are reluctant to make dividend changes that might have to
be reversed
D)
All of the above
7
Generally, a reduction in dividend is interpreted by investors as:
A)
Bad news and the stock price drops
7. B)
Good news and the stock price increases
C)
A non-event and does not affect the stock prices
D)
A sign of new growth
8
One key assumption of the Miller and Modigliani dividend irrelevance
argument is that:
A)
Future stock prices are certain
B)
There are no capital gains taxes
C)
New shares are sold at a fair price
D)
All investments are risk-free
9
The indifference proposition regarding dividend policy:
A)
States that investors will pay higher prices for shares of firms with
high dividend payouts
B)
States that investors will not pay higher prices for shares of firms
with high dividend payouts
C)
States that firms should worry about their dividends
8. D)
States that dividends should not fluctuate as a by-product of
investing and financing decisions
10
One possible reason that shareholders often insist on higher dividends is:
A)
They agree with Miller and Modigliani
B)
They do not trust managers to spend retained earnings wisely
C)
The stock market is efficient
D)
Tax consideration
11
If both dividends and capital gains are taxed at the same ordinary
income tax rate, the tax effect is still different because:
A)
Capital gains are actually taxed, while dividends are taxed on paper
only
B)
Dividends are taxed when distributed while capital gains are deferred
until the stock is sold
C)
Both dividends and capital gains are taxed every year
D)
All of the above
12
Which of the following investors have the strongest tax reason to prefer
dividends over capital gains?
9. A)
Pension funds
B)
Financial institutions
C)
Individuals
D)
Corporations
13
Company J has 500 shares outstanding. It earns $1,000 per year and
expects repurchase its shares in the open market instead of paying
dividends. Calculate the number of shares outstanding at the end of Year
1, if the required rate of return is 10%.
A)
20
B)
50
C)
550
D)
1,500
14
According to behavioral finance, investors prefer dividends because:
A)
The discipline that comes from spending only the dividends
B)
The tax consideration
10. C)
The stock market is efficient
D)
All of the above
15
The theory developed by Modigliani and Miller assumes which of the
following?
A)
No taxes
B)
No transaction costs
C)
No other market imperfections
D)
All of the above
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