Finance Chapter 13

The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as: homemade leverage
Which one of the following statements matches M&M Proposition I? The value of a firm is independent of the firm’s capital structure
Which one of the following states that a firm’s cost of equity capital is a positive linear function of the firm’s capital structure? M&M Proposition II
Which one of the following is the equity risk arising from the daily operations of a firm? Business risk
Which one of the following is the equity risk arising from the capital structure selected by a firm Financial risk
Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship? interest tax shield
Which one of the following is a direct bankruptcy cost? legal and accounting fees related to a bankruptcy proceeding
Which one of the following terms applies to the costs incurred by a firm which is trying to avoid filing for bankruptcy? indirect bankruptcy costs
Which one of the following terms is inclusive of both direct and indirect bankruptcy costs? financial distress costs
Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt? static theory of capital structure
Which one of the following best defines legal bankruptcy? a legal proceeding for liquidating or reorganizing a business
Which one of the following terms refers to the termination of a firm as a going concern? liquidation
Greenwood Motels has filed a petition for bankruptcy but hopes to continue its operations both during and after the bankruptcy process. Which one of the following terms best applies to this situation? reorganization
In the process of liquidation, some types of claims receive preference over other claims. which one of the following determines which type of claim is paid first? absolute priority rule
Which one of the following is minimized when the value of a firm is maximized? WACC
Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered. Which one of the following statements is correct regarding these two firms? The unlevered firm will have a higher EPS at relatively low levels of EBIT
Which one of the following statements concerning financial leverage is correct? financial leverage magnifies both profits and losses
You are comparing two possible capital structures for a firm. The first option is an all-equity firm. The second option involves the use of $3.8 million of debt. The break-even point between these two financing options occurs when the earnings before interest and taxes (EBIT) are $428,000. Given this, you know that leverage is beneficial to the firm: whenever EBIT exceeds $428,000
Which one of the following statements concerning financial leverage is correct? changes in the capital structure of a firm will generally change the firm’s earnings per share
T.L.C. Enterprises just revised its capital structure from a debt-equity ration of 0.30 to a debt-equity ratio of 0.45. The firm’s shareholders who prefer the old capital structure should: sell some shares and loan out the sale proceeds
Which one of the following statements if the core principle of M&M Proposition I, without taxes? the capital structure of a firm is totally irrelevant
Which one of the following supports the theory that the value of a firm increases as the firm’s level of debt increases? M&M Proposition 1, with taxes
Which one of the following is an implication of M&M Proposition II, without taxes? The risk of equity depends on both the degree of financial leverage and the riskiness of the firm’s operations
M&M Proposition II, without taxes, states that the: cost of equity increases as a firm increases its debt-equity ratio
The level of financial risk to which a firm is exposed is dependent upon the firm’s: debt-equity ratio
Which one of the following represents the present value of the interest tax shield? Tc x D
Which one of the following will increase the value of a levered firm according to M&M Proposition I, with taxes? I. decrease in the amount of the debt, II. increase in the value of the unlevered firm, III. decrease in the tax rate, IV. increase in the interest rate on the debt II only
Which one of the following statements correctly relate to M&M Proposition I, with taxes? I. Debt decreases the value of the firm, II. The levered value of a firm exceeds the firm’s unlevered value, III. The weighed average cost of capital is constant, IV. the optimal capital structure is zero debt II only
Which one of the following is an example of a direct bankruptcy cost? incurring legal fees for the preparation of bankruptcy filings
The static theory of capital structure assumes a firm: is fixed in terms of its assets
Which one of the following conditions exists at the point where a firm maximizes its value? WACC is minimized
Which one of the following statements related to the static theory of capital structure is correct? a firm’s value is maximized when a firm operates at is optimal debt level
Which one of the following is correct based on the static theory of capital structure? the costs of financial distress decrease the value of the firm
Assume both corporate taxes and financial distress costs apply to a firm. Given this, the static theory of capital structure illustrates that: a firm’s value and its weighted average cost of capital are inversely related
When is a firm insolvent from an accounting perspective? when the firm has a negative net worth
Peterboro recently defaulted on a bank loan. To avoid a bankruptcy proceeding, the bank agreed to a composition. This composition would do which one of the following? reduce the amount of the loan payments so Peterboro can pay timely
Which one of the following will generally receive the highest priority in a bankruptcy liquidation, assuming the absolute priority rule is followed? bankruptcy administrative expenses
Which one of the following is a key provision of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005? right granted to creditors to file their own reorganization plan once a firm is in bankruptcy for 18 months
Which one of the following statements is correct? Bankruptcy courts have “cram-down” powers
A prepack: is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan
Which one of the following statements is correct? a firm can file for Chapter 11 bankruptcy even if the firm is solvent

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