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People completed the quiz: 258
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Current max score of the quiz: 96.5 points
Current quiz passing score: 67% or 64.7 points
 
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Users' average score: 53 points


Questions
1

Which ONE of the following statements is most correct?

Options Count    
A. Since debt financing raises the firm’s financial risk, increasing a company’s debt ratio will always increase the company’s WACC. 7 3%
B. Increasing a company’s debt ratio will typically reduce the marginal costs of both debt and equity financing; however, it still may raise the company’s WACC. 30 14%
C. Statements A and B are correct. 9 4%
D. Only statement A is correct. 11 5%
E. None of the statements above are correct. 150 69%
2

Select the keyword that best defines the following:

Deals with long-term investment decisions and is simply a process of deciding which capital projects to pursue and which to reject.  {blank1}
Deals with where the money for capital projects come from and further tells you how the company pays or finances its assets.  {blank2}
Options Count    
Correct 97 48%
Incorrect 106 3%
3

Decide whether the statement is TRUE or FALSE:

The weighted average cost of capital (WACC) reflects the expected average future cost of funds over the long run. {blank1}
Options Count    
Correct 146 75%
Incorrect 49 -46%
4

Which ONE of the following statements is/are FALSE in the Traditional View Theory of Capital Structure?

  1. There is no optimal structure of capital where the weighted average cost of capital (WACC) is minimised and the market value of assets are maximised.
  2. The firm’s value increases to a certain level of debt capital, after which it tends to remain constant and eventually begins to decrease.
  3. Wealth is only created by purchasing investments in assets that yield positive return on investment solely through equity.
Options Count    
A. I and II only 26 14%
B. II and III only 27 15%
C. I and III only 109 59%
D. I, III and II 20 11%
5

Decide whether the statement is TRUE or FALSE:

Extensive research conducted in recent years shows that it is now possible for financial managers to pinpoint a firm’s optimal capital structure with great accuracy. {blank1}
Options Count    
Correct 138 77%
Incorrect 42 -38%
6

In terms of relative risk, which ONE of the following is TRUE?

Options Count    
A. Debt is risky for investors while equity is risky for the firm. 17 10%
B. Debt is risky for the firm while equity is risky for the investors. 127 71%
C. Both are equally risky for investors. 25 14%
D. Both are equally risky for the firm. 9 5%
7

Which ONE of the statements below about when a precise optimal capital gearing ratio exists is CORRECT?

Options Count    
A. There is a precise gearing ratio at which the risk of the tax shield is exactly matched by the increasing benefit of financial distress. 14 8%
B. There is a precise gearing ratio at which the benefit of the tax shield is exactly matched by the increasing risk of financial distress. 147 85%
C. There is a precise gearing ratio at which the benefit of the tax shield is exactly matched by the increasing risk of agency. 9 5%
D. There is a precise gearing ratio at which the benefit of managerial motivation is exactly matched by the increasing risk of agency. 3 2%
8

Which ONE of the following choices matches M&M’s second position on the effect of capital gearing on weighted average cost of capital (WACC)?

Options Count    
A. There is a negative relationship between financial gearing and the WACC because of the effect of the tax shield. 118 69%
B. There is a negative relationship between financial gearing and the WACC because of financial distress. 18 11%
C. There is a positive relationship between financial gearing and the WACC because of the increased volatility of the return on equity (ROE). 19 11%
D. There is no relationship between financial gearing and the WACC as there are no benefits from higher gearing. 14 8%
9

Modigliani and Miller recognise that dividends do somehow affect stock prices. Which ONE of the following describes which aspect of dividend increase the positive effects on stock prices are attributable to?

Options Count    
A. Not the dividend itself but the informational content of the dividends with respect to future earnings. 130 77%
B. The dividend policy directly. 12 7%
C. The optimal capital structure directly. 8 5%
D. Not the information content but the consistency in the payment of dividends. 19 11%
10

Smart Communications has a capital structure that consists of 70% common stock and 30% long-term debt. An analyst has accumulated the following information to get Smart Communication’s weighted average cost of capital (WACC):

  • Currently, the company has 15-year bonds outstanding with annual coupon payments of 8%. The bonds have a face value of $$9,000,0000.
  • The risk-free rate is 5%.
  • The market risk premium is 4%.
  • The beta on Smart Communication’s common stock is 1.1
  • The company’s retained earnings are sufficient that they do not have to issue any new common stock to fund capital projects.
  • The company’s tax rate is 38%.
What is the weighted average cost of capital (WACC) of Smart Communications, assuming that they operate in a country where tax is payable?  {blank1}
Options Count    
Correct 109 63%
Incorrect 64 -9%
11

Smart Communications has a capital structure that consists of 70% common stock and 30% long-term debt. An analyst has accumulated the following information to get Smart Communication’s weighted average cost of capital (WACC):

  • Currently, the company has 15-year bonds outstanding with annual coupon payments of 8%. The bonds have a face value of $$9,000,0000.
  • The risk-free rate is 5%.
  • The market risk premium is 4%.
  • The beta on Smart Communication’s common stock is 1.1
  • The company’s retained earnings are sufficient that they do not have to issue any new common stock to fund capital projects.
  • The company’s tax rate is 38%.
What is the weighted average cost of capital (WACC) of Smart Communications, assuming that they operate in a country where no tax is payable?  {blank1}
Options Count    
Correct 123 74%
Incorrect 44 -23%
12

Which ONE of the following statements is CORRECT?

Options Count    
A. The optimal capital structure is the one that simultaneously maximises the price of the firm’s stock, minimises the WACC and maximises the EPS. 46 28%
B. If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to increase their use of debt. 28 17%
C. If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt. 78 48%
D. None of the statements above is correct. 11 7%
13

Which ONE of the following statements is INCORRECT regarding the cost of capital?

Options Count    
A. The weighted average cost of capital (WACC) measures the marginal after-tax cost of capital. 8 5%
B. A company’s target capital structure affects its weighted average cost of capital (WACC). 9 5%
C. Following M&M’s second position, if a company’s tax rate increases, then, all else being equal, its weighted average cost of capital (WACC) will increase. 116 70%
D. Flotation costs can increase the WACC. 31 19%
14

Warner Sisters is estimating its weighted average cost of capital (WACC). The company has collected the following information:

  • The capital structure consists of 40% debt and 60% common equity.
  • Warner Sisters has $$5,000,000 20-year bonds outstanding with a 9% annual coupon.
  • The company’s tax rate is 40%.
  • The risk-free rate is 5.5%.
  • The market risk premium is 5%.
  • The stock’s beta is 1.4.
What is the weighted average cost of capital (WACC) of Warner Sisters, assuming M&M’s second position on the effect of capital gearing on WACC?  {blank1}
Options Count    
Correct 123 77%
Incorrect 36 -23%
15

Warner Sisters is estimating its weighted average cost of capital (WACC). The company has collected the following information:

  • The capital structure consists of 40% debt and 60% common equity.
  • Warner Sisters has $$5,000,000 20-year bonds outstanding with a 9% annual coupon.
  • The company’s tax rate is 40%.
  • The risk-free rate is 5.5%.
  • The market risk premium is 5%.
  • The stock’s beta is 1.4.

Warner Brothers, a rival company, has identical operating and risk characteristics except that it is solely equity-financed.

What is the value of Warner Brothers, assuming M&M’s 1958 without-tax proposition?

 {blank1}
Options Count    
Correct 99 63%
Incorrect 58 1%
16

An analyst is studying the tax exposures and capital structures of Alpha Corporation and Omega Corporation. Both companies have equivalent weights of debt and equity in their capital structures. Pre-tax component costs of capital are the same for both companies. Alpha has total capital of $$50 million while Omega has total capital of $$70 million. The marginal tax rates for Alpha and Omega are 35% and 40%, respectively.

Which of the following statements regarding Alpha and Omega is the LEAST accurate?

Options Count    
A. Omega Corporation has a lower WACC than Alpha Corporation. 24 16%
B. Omega Corporation has a higher WACC than Alpha Corporation. 102 66%
C. An increase in Alpha Corporation’s tax rate would decrease its WACC. 14 9%
D. An increase in Alpha Corporation’s tax rate will decrease its WACC, since it produces the larger tax shield. 13 8%
17

Which ONE of the following statements is the MOST correct?

Options Count    
A. If a company were to issue debt and use the money to increase assets, the company’s return on equity (ROE) would increase (assumption: ROA remains unchanged). 59 38%
B. If a company were to issue debt and use the money to repurchase common stock, the company’s return on assets (ROA) would not be affected (assumption: repurchase of stocks will not affect operating income). 55 35%
C. If Congress were to pass legislation stating that the personal tax rate will be increased and corporate tax rate will be decreased, companies would be encouraged to increase their debt ratios. 20 13%
D. Statements B and C are most correct. 22 14%
18

Fill in the blanks with the correct answer by choosing the keyword choices below:

Manuel Company will increase its debt ratio in its capital structure when there is an increase in the {blank1} and a decrease in the {blank2}.

Options Count    
Correct 116 72%
Incorrect 44 -16%
19

Decide which of the following statements is TRUE and which is FALSE:

A company’s capacity to borrow can be increased even though they are not able to provide valuable assets as collateral so long as the promise to pay is well-documented and honored. {blank1}
In the real world, Modigliani & Miller’s view that debt is risk-free and that the cost of debt will be constant at all levels of gearing is practised and applicable. {blank2}
Modigliani & Miller’s tax theory is a perfect theory to implement and practice in the real world because M&M’s belief suggests that the benefits of tax relief on debt interest will help reduce the company’s cost of capital at all levels of gearing. {blank3}
Options Count    
Correct 82 52%
Incorrect 75 18%
20

Which ONE of the following is TRUE for geared or leveraged beta?

Options Count    
A. Leveraged beta represents financial risk from gearing or leverage. 50 32%
B. Leveraged beta represents fundamental operational risk. 5 3%
C. Leveraged beta represents fundamental operational risk plus financial risk from leverage. 97 62%
D. Leveraged beta represents fundamental operational risk minus financial risk from leverage. 4 3%
21

Which ONE of the following statements about capital structure is TRUE?

Options Count    
A. The capital structure that maximises stock price is also the capital structure that maximises the times interest earned (TIE) ratio. 4 3%
B. The capital structure that maximises stock price is also the capital structure that minimises the weighted average cost of capital (WACC). 121 77%
C. The capital structure that maximises stock price is also the capital structure that maximises the earnings per share (EPS). 16 10%
D. Statements A and B are true. 16 10%
22

Peach Tree Systems has total assets of $$10 million and a debt to total assets (D/TA) ratio of 30%. Peach Tree is considering acquisition of Plum Tree Company, which has total assets of $$6 million and a D/TA ratio of 70%. The component costs of capital for the combined firm will be 12% before tax on debt and 15% on equity. The firm’s tax rate is 40%.

What is the capital structure weight of equity (E/V) of the merged firm?  {blank1}
Options Count    
Correct 64 42%
Incorrect 87 36%
23

Peach Tree Systems has total assets of $$10 million and a debt to total assets (D/TA) ratio of 30%. Peach Tree is considering acquisition of Plum Tree Company, which has total assets of $$6 million and a D/TA ratio of 70%. The component costs of capital for the combined firm will be 12% before tax on debt and 15% on equity. The firm’s tax rate is 40%.

What is the Kd or cost of debt of the merged firm?  {blank1}
Options Count    
Correct 105 71%
Incorrect 42 -5%
24

Peach Tree Systems has total assets of $$10 million and a debt to total assets (D/TA) ratio of 30%. Peach Tree is considering acquisition of Plum Tree Company, which has total assets of $$6 million and a D/TA ratio of 70%. The component costs of capital for the combined firm will be 12% before tax on debt and 15% on equity. The firm’s tax rate is 40%.

What is the weighted average cost of capital (WACC) of the merged firm?  {blank1}
Options Count    
Correct 106 74%
Incorrect 38 -6%
25

Palawan Diamond Company is choosing its optimal capital structure. Currently, the company has 40% debt ratio and expects to generate a dividend next year of $$4.89/share with expected constant dividend growth rate of 5%. The stockholders currently require 10.89% return on their investment. Palawan Diamond Company is considering a change in its capital structure if it will benefit the stockholders. The company estimates that if it increases the debt ratio to 50% the expected dividend will be $$5.24/share and expected constant dividend growth rate will be 6%.

However, the stockholders are demanding an increase in the required rate of return to 11.34% due to the added risk.

What is the value per share for Palawan Diamond Company under the current capital structure?  {blank1}
Options Count    
Correct 72 51%
Incorrect 70 28%
26

Palawan Diamond Company is choosing its optimal capital structure. Currently, the company has 40% debt ratio and expects to generate a dividend next year of $$4.89/share with expected constant dividend growth rate of 5%. The stockholders currently require 10.89% return on their investment. Palawan Diamond Company is considering a change in its capital structure if it will benefit the stockholders. The company estimates that if it increases the debt ratio to 50% the expected dividend will be $$5.24/share and expected constant dividend growth rate will be 6%.

However, the stockholders are demanding an increase in the required rate of return to 11.34% due to the added risk.

What is the value per share of Palawan Diamond Company under the proposed capital structure?  {blank1}
Options Count    
Correct 108 77%
Incorrect 32 -8%
27

Palawan Diamond Company is choosing its optimal capital structure. Currently, the company has 40% debt ratio and expects to generate a dividend next year of $$4.89/share with expected constant dividend growth rate of 5%. The stockholders currently require 10.89% return on their investment. Palawan Diamond Company is considering a change in its capital structure if it will benefit the stockholders. The company estimates that if it increases the debt ratio to 50% the expected dividend will be $$5.24/share and expected constant dividend growth rate will be 6%.

However, the stockholders are demanding an increase in the required rate of return to 11.34% due to the added risk.

Will changing the capital structure benefit Palawan Diamond Company?  {blank1}
Options Count    
Correct 132 93%
Incorrect 10 -32%
28

The CFO of Emerald Holdings has suggested that the firm should issue $$400 million worth of common stock and use the proceeds to reduce some of the firm’s outstanding debt. Assume that Emerald Holdings adopts this policy and that total assets and operating income (EBIT) remain the same. The firm’s tax rate will also remain the same.

Which ONE of the following will occur?

Options Count    
A. The firm will pay less tax. 5 3%
B. The firm’s taxable income will fall. 27 18%
C. The firm’s net income will increase. 99 67%
D. All of the statements above are correct. 16 11%
29

Decide whether each statement is TRUE or FALSE:

Since retained earnings seems to be a more expensive source of financing compared to debt and preferred stock, the weighted average cost of capital (WACC) of Sky Aviation Co will fall once retained earnings have been exhausted. {blank1}
As the volume of Sky Aviation Co’s financing increases, the costs of the various types of financing will decrease, reducing the firm’s WACC. {blank2}
Sky Aviation Co may face increases in the weighted average cost of capital (WACC) either when retained earnings have been exhausted or due to increases in debt, preferred stock and common equity costs as additional new funds are required. {blank3}
Options Count    
Correct 58 41%
Incorrect 85 42%
30

Cebu Pacific has complied the following data:

Source of Capital Book Value Market Value Cost
Long Term Debt $$ 10,000,000.00 $$ 8,500,000.00 5%
Preferred Stock $$ 1,000,000.00 $$ 1,500,000.00 14%
Common Equity $$ 9,000,000.00 $$ 15,000,000,00 20%
TOTAL $$ 20,000,000.00 $$ 25,000,000.00  

 

What is the weighted average cost of capital (WACC) using the Book Value weights?  {blank1}
Options Count    
Correct 100 70%
Incorrect 43 0%
31

Cebu Pacific has complied the following data:

Source of Capital Book Value Market Value Cost
Long term Debt $$ 10,000,000.00 $$ 8,500,000.00 5%
Preferred Stock $$ 1,000,000.00 $$ 1,500,000.00 14%
Common Equity $$ 9,000,000.00 $$ 15,000,000,00 20%
TOTAL $$ 20,000,000.00 $$ 25,000,000.00  

 

What is the weighted average cost of capital (WACC) using the Market Value weights?  {blank1}
Options Count    
Correct 113 82%
Incorrect 24 -13%
32

Cathay Air has a capital structure that consists of 60% debt and 40% common stock. The company recently issued $$9 million bonds with a yield to maturity of 9%. The risk-free rate is 6%, the market risk premium is 6% and Cathy Air’s beta is equal to 1.5. The company’s profit before income and taxes is $$2,000,000 and its tax rate is 35%. Cathy Air is considering raising additional debt finance of another $$10 million with a new coupon rate of 8% per annum.

The operating profit remains constant after the new finance has been raised.

What is Cathy Air’s weighted average cost of capital (WACC) before the additional debt finance?  {blank1}
Options Count    
Correct 114 81%
Incorrect 26 -14%
33

Cathay Air has a capital structure that consists of 60% debt and 40% common stock. The company recently issued $$9 million bonds with a yield to maturity of 9%. The risk-free rate is 6%, the market risk premium is 6% and Cathy Air’s beta is equal to 1.5. The company’s profit before income and taxes is $$2,000,000 and its tax rate is 35%. Cathy Air is considering raising additional debt finance of another $$10 million with a new coupon rate of 8% per annum. The operating profit remains constant after the new finance has been raised.

What is Cathy Air’s interest cover after the new finance has been raised?  {blank1}
Options Count    
Correct 107 77%
Incorrect 32 -7%
34

Cathay Air has a capital structure that consists of 60% debt and 40% common stock. The company recently issued $$9 million bonds with a yield to maturity of 9%. The risk-free rate is 6%, the market risk premium is 6% and Cathy Air’s beta is equal to 1.5. The company’s profit before income and taxes is $$2,000,000 and its tax rate is 35%. Cathy Air is considering raising additional debt finance of another $$10 million with a new coupon rate of 8% per annum. The operating profit remains constant after the new finance has been raised.

What is Cathy Air’s capital gearing ratio, measured as Debt/Debt+Equity, after the new finance has been raised?  {blank1}
Options Count    
Correct 91 65%
Incorrect 49 9%
35

San Miguel Corporation (SMC) has two (2) divisions, Division A and Division B. SMC looks at competing pure-play firms to estimate the betas of each of the two divisions. After this analysis, San Miguel Corporation concludes that Division A and B have betas of 1.3 and 1.8 respectively. The two divisions are of the same size. The risk-free rate is 10% and the market risk premium is 11%. Assume that San Miguel Corporation is 100% equity-financed.

What is the cost of equity (Ke) of Division B?  {blank1}
Options Count    
Correct 112 78%
Incorrect 31 -12%
36

San Miguel Corporation (SMC) has two (2) divisions, Division A and Division B. SMC looks at competing pure-play firms to estimate the betas of each of the two divisions. After this analysis, San Miguel Corporation concludes that Division A and B have betas of 1.3 and 1.8 respectively. The two divisions are of the same size. The risk-free rate is 10% and the market risk premium is 11%. Assume that San Miguel Corporation is 100% equity-financed.

What is the cost of debt (Kd) of San Miguel Corporation (SMC)?  {blank1}
Options Count    
Correct 114 81%
Incorrect 26 -14%
37

San Miguel Corporation (SMC) has two (2) divisions, Division A and Division B. SMC looks at competing pure-play firms to estimate the betas of each of the two divisions. After this analysis, San Miguel Corporation concludes that Division A and B have betas of 1.3 and 1.8 respectively. The two divisions are of the same size. The risk-free rate is 10% and the market risk premium is 11%. Assume that San Miguel Corporation is 100% equity-financed.

What is the weighted average cost of capital for San Miguel Corporation (SMC)?  {blank1}
Options Count    
Correct 98 70%
Incorrect 42 2%
38

Joe Bananas Company has a debt ratio of 33.33% and they need to raise $$100,000 to expand. The management feels that an optimal debt ratio would be 16.67%. Sales are currently $$750,000 and the total assets turnover is 7.5.

What are the total assets after the new finance has been raised?  {blank1}
Options Count    
Correct 71 51%
Incorrect 69 29%
39

Joe Bananas Company has a debt ratio of 33.33% and they need to raise $$100,000 to expand. The management feels that an optimal debt ratio would be 16.67%. Sales are currently $$750,000 and the total assets turnover is 7.5.

How should the expansion be financed so as to produce the desired debt ratio?  {blank1}
Options Count    
Correct 84 62%
Incorrect 51 16%
40

Netcom Consultants Inc is a wholly owned subsidiary of Casten Inc. The following information applies to Netcom Consultants Inc:

Operating Income (EBIT) $$300,000 Shares Capital @ Par of 2 $$2,000,000
Debt (borrowings from parent) $$5,000,000 Stock Price $$17.40
Debt (bank borrowings) $$2,000,000 Reserves $$1,000,000
Tax Rate               40%    

The interest rate for borrowings from both parent and the bank is 8%. The borrowing from the parent company is 30% more than Netcom Consultants Inc could have raised from the bank at that time. The tax authorities consider a company thinly capitalised if its gearing ratio (Debt/Equity) is above 60:40.

How much is the interest payable on the parent company borrowing that will be allowable for tax relief?  {blank1}
Options Count    
Correct 52 38%
Incorrect 86 48%
41

Netcom Consultants Inc is a wholly owned subsidiary of Casten Inc. The following information applies to Netcom Consultants Inc:

Operating Income (EBIT) $$300,000 Shares Capital @ Par of 2 $$2,000,000
Debt (Borrowings from Parent) $$5,000,000 Stock Price $$17.40
Debt (Bank Borrowings) $$2,000,000 Reserves $$1,000,000
Tax Rate               40%    

The interest rate for borrowings from both the parent and the bank is 8%. The borrowing from the parent company is 30% more than Netcom Consultants Inc could have raised from the bank at that time. The tax authorities consider a company thinly capitalised if its gearing ratio (Debt/Equity) is above 60:40.

How much is the interest payable on the parent company borrowing that will be disallowable for tax relief?  {blank1}
Options Count    
Correct 96 71%
Incorrect 40 4%