1. According to the pecking order theory of capital structure, why do firms avoid issuing equity?  Because equity issuance signals that managers believe their stock is overvalued, which causes the price of the stock to fall
2. According to the pecking order theory proposed by Stewart Myers of MIT, which of the following are correct?  I, II, and IV only
3. Debt financing results in lower after-tax earnings relative to equity financing.   True
4. Financial leverage:
   
   I. increases expected ROE but does not affect its variability.
   II. increases breakeven sales, like operating leverage, but increases the rate of earnings per share growth once breakeven is achieved.
   III. is a fundamental financial variable affecting sustainable growth.
   IV. increases expected return and risk to owners    II, III, and IV only
5. Homemade leverage is:  the borrowing or lending of money by individual shareholders as a means of adjusting their level of financial leverage.
6. If the maturity of a company’s liabilities is less than that of its assets, the company incurs a refinancing risk.  True
7. In general, the capital structures used by non-financial U.S. firms:   vary significantly across industries
8. In some instances, additional debt financing can encourage managers to act more in the interests of owners.    True
9. 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.   2.10
10. 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.   2.00
11. Please refer to the financial information for Squamish Equipment above. Calculate Squamish’s times-interest-earned ratio for next year assuming the firm raises $40 million of new debt at an interest rate of 7 percent.   4.35
12. Please refer to the financial information for Squamish Equipment above. Calculate Squamish’s times-burden-covered ratio for the next year assuming the firm raises $40 million of new debt at an interest rate of 7 percent and that annual sinking fund payments on the new debt will equal $8 million.   1.49
13. Please refer to the financial information for Squamish Equipment above. Calculate Squamish’s earnings per share next year assuming Squamish raises $40 million of new debt at an interest rate of 7 percent.    2.12
14. Salinas Corporation has net income of $15 million per year on net sales of $90 million per year. It currently has no long-term debt, but is considering a debt issue of $20 million. The interest rate on the debt would be 7%. Salinas Corp. currently faces an effective tax rate of 40%. What would be the annual interest tax shield to Salinas Corp. if it goes through with the debt issuance?  $560,000
15. The basic lesson of the M&M theory is that the value of a firm is dependent upon:   the total cash flow of the firm.
16. The best financing choice is the one that:   maximizes expected cash flows.
17. The evidence indicates that, on average, a company’s stock price declines when it announces a new issue of equity.   True
18. The interest tax shield has no value when a firm has:
    
    I. no taxable income.
    II. debt-equity ratio of 1.
    III. zero debt.
    IV. no leverage.     I, III, and IV only
19. The M&M irrelevance proposition assures financial managers that their choice between equity or debt financing will ultimately have no impact on firm value    false
20. The term “financial distress costs” includes which of the following?
    
    I. Direct bankruptcy costs
    II. Indirect bankruptcy costs
    III. Direct costs related to being financially distressed, but not bankrupt
    IV. Indirect costs related to being financially distressed, but not bankrupt     I, II, III, and IV
21. Under the simplifying assumptions of Modigliani and Miller, an increase in a firm’s financial leverage will:   increase the variability in earnings per share.
22. When a company is in financial distress, its shareholders may have an incentive to undertake excessively risky investments.  true
23. 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)?   ABC’s cash flows from operations are less volatile than XYZ’s.
24. Which of the following factors favor the issuance of debt in the financing decision?
    
    I. Market signaling
    II. Distress costs
    III. Tax benefits
    IV. Financial flexibility     I and III only
25. Which of the following factors favor the issuance of debt in the financing decision?
    
    I. Market signaling
    II. Distress costs
    III. Management incentives
    IV. Financial flexibility     I and III only
26. Which of the following factors favor the issuance of equity in the financing decision?
    
    I. Market signaling
    II. Distress costs
    III. Management incentives
    IV. Financial flexibility      II and IV only
27. Which of the following is NOT a likely financing policy for a rapidly growing business?  Borrow funds rather than limit growth, thereby limiting growth only as a last resort.
28. Which of the following is NOT an implication of the pecking order theory of capital structure?   More-profitable firms (all else equal) should have higher debt ratios.
29. Which of the following is/are helpful for evaluating the effect of leverage on a company’s risk and potential returns?
    
    I. Estimated pro forma coverage ratios
    II. The recognition that financing decisions do not affect firm or shareholder value
    III. A range of earnings chart and proximity of expected EBIT to the breakeven value
    IV. A conservative debt policy that obviates the need to evaluate risk    I and III only
30. Which of the following statements regarding interest tax shields is correct?  Taxable income is reduced by the amount of the interest on a firm’s debt.
31. Which of the following would not be considered a cost of financial distress?   Lack of interest tax shields

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