1. Which of the following statements regarding interest tax shields is correct?Multiple Choice

• Taxes are reduced by the amount of a firm’s interest-bearing debt.
• Taxable income is reduced by the amount of a firm’s interest-bearing debt.
• Taxes are reduced by the amount of the interest on a firm’s debt.
• Taxable income is reduced by the amount of the interest on a firm’s debt.

2. Which of the following would NOT be considered a cost of financial distress?Multiple Choice

• Lack of interest tax shields
• Bankruptcy costs
• Excessive risk-taking by shareholders
• Loss of customers or suppliers

3. When considering the impact of distress costs on capital structure, which of the following facts should lead ABC Corporation to set a higher target debt ratio than XYZ Corporation (all else equal)?Multiple Choice

• ABC’s cash flows from operations are less volatile than XYZ’s.
• ABC is a computer software firm, and XYZ is an electric utility.
• ABC operates in a more competitive industry than XYZ.
• ABC’s assets have lower resale values than XYZ’s assets.

4. According to the pecking order theory of capital structure, why do firms avoid issuing equity?Multiple Choice

• Because fees associated with issuing new equity are so high
• Because they want to avoid dilution of earnings per share
• Because they do not want to commit to paying dividends on the new equity
• Because equity issuance signals negative information about the firm

5. Under the simplifying assumptions of Modigliani and Miller, an increase in a firm’s financial leverage willMultiple Choice

• increase the variability in earnings per share.
• reduce the operating risk of the firm.
• increase the value of the firm.
• decrease the value of the firm.

6. Please refer to the financial information for Squamish Equipment above. For next year, calculate Squamish’s times-burden-covered ratio if Squamish sells 2 million new shares at $20 a share.Multiple Choice

• 1.03
• 1.38
• 1.60
• 1.89
• 2.10
• None of the options are correct.

7. Please refer to the financial information for Squamish Equipment above. For next year, calculate Squamish’s earnings per share if Squamish sells 2 million new shares at $20 a share.Multiple Choice

• 1.28
• 1.39
• 2.00
• 2.22
• 4.00
• None of the options are correct.

8. Please refer to the financial information for Squamish Equipment above. Calculate Squamish’s times-interest-earned ratio for next year assuming the firm issues $40 million of new debt at an interest rate of 7%.Multiple Choice

• 2.00
• 3.09
• 3.66
• 4.35
• None of the options are correct.

9. Please refer to the financial information for Squamish Equipment above. Calculate Squamish’s times-burden-covered ratio for the next year assuming the firm issues $40 million of new debt at an interest rate of 7%, and that annual sinking fund payments on the new debt will equal $8 million.Multiple Choice

• 1.01
• 1.08
• 1.38
• 1.49
• 1.95
• None of the options are correct.

10. Please refer to the financial information for Squamish Equipment above. Calculate Squamish’s earnings per share next year assuming Squamish issues $40 million of new debt at an interest rate of 7%.Multiple Choice

• 1.28
• 2.00
• 2.12
• 2.22
• 3.06
• None of the options are correct.

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