1. Holders of record are stockholders whose 13.

The residual theory of dividends tends to

names are recorded on the date of record. suggest that the required return of investors is not
Answer: TRUE influenced by the firms dividend policy and, thus,
2. Purchasers of a stock selling ex-dividend dividend policy is irrelevant.
receive the current dividend. Answer: TRUE
Answer: FALSE 14. The clientele effect is the argument that a
3. Date of record (dividends) is the actual firm attracts shareholders whose preferences with
date on which the company will mail the respect to the payment and stability of dividends
dividend payment to the holders of record. corresponds to the payment pattern and stability
Answer: FALSE of the firm itself.
4. The payment date is five days after the Answer: TRUE
date of record, on which the company will mail 15. According to the bird-in-the-hand
the dividend to the holders of record. argument, current dividend payments reduce
Answer: FALSE investor uncertainty and result in a higher value
5. The ex-dividend period begins four for the firms stock.
business days prior to the payment date during Answer: TRUE
which a stock will be sold without paying the 16. The residual theory of dividends implies
current dividend. that if the firm can not earn a return (IRR) from
Answer: FALSE investment of its earnings that is in excess of cost
6. The payment of cash dividends to (WMCC), it should distribute the earnings by
corporate stockholders is decided by the firms paying dividends to stockholders.
chief financial officer. Answer: TRUE
Answer: FALSE 17. In the dividend relevance arguments,
7. Dividend reinvestment plans (DRPs) enable current dividend payments are believed to
stockholders to use dividends received on the reduce investors uncertainty, therebyall else
firms stock to acquire additional shares or being equalplacing a higher value on the firms
fractional shares at little or no transaction stock.
(brokerage) cost. Answer: TRUE
Answer: TRUE 18. While an earnings requirement limiting the
8. Because retained earnings are a form of amount of dividends paid is sometimes imposed,
internal financing, the dividend decision can the firm is not prohibited from paying more in
significantly affect the firms external financing dividends than its current earnings.
requirements. Answer: TRUE
Answer: TRUE 19. Generally, legal constraints prohibit the
9. Ignoring general market fluctuations, the payment of cash dividends until a certain level of
stocks price would be expected to drop by the earnings has been achieved or limit the amount
amount of the declared dividend on the ex- of dividends paid to a certain dollar amount or
dividend date. percentage of earnings.
Answer: TRUE Answer: FALSE
10. The dividend decisions can significantly 20. Since lenders are generally reluctant to
affect the firms share price and external make loans to a firm to pay dividends, the firms
financing requirements. ability to pay cash dividends is generally
Answer: TRUE constrained by the amount of excess cash
11. According to Modigliani and Miller, a firms available.
value is determined solely by the earning power Answer: TRUE
and risk of its assets and that the manner in which 21. In establishing a dividend policy, a firm
it splits its earnings stream between dividends and should retain funds for investment in projects
internally retained funds does not affect this yielding higher returns than the owners could
value. obtain from external investments of equal risk.
Answer: TRUE Answer: TRUE
12. Due to clientele effect, Modigliani and 22. If a firm pays out a higher percentage of
Miller argue that the shareholders get what they earnings, new equity capital will have to be
expect and, thus, the value of the firms stock is raised with common stock, which will result in
unaffected by dividend policy. higher control and earnings for the existing
Answer: TRUE owners.
Answer: FALSE 34. A stock split commonly increases the
23. Regular dividend policy is a dividend number of shares outstanding and the stocks per
policy based on the payment of a certain share par value.
percentage of earnings to owners in each Answer: FALSE
dividend period. 35. In a 2-for-1 stock split, the number of shares
Answer: FALSE outstanding decreases by fifty percent and the
24. A constant-payout-ratio dividend policy is stocks per-share par value will double.
a dividend policy based on the payment to Answer: FALSE
existing owners of a dividend in the form of stock 36. Reverse stock splits are initiated when a
as a certain percentage of the firms total stock is selling at too low a price to appear
number of stocks outstanding in each dividend respectable.
period. Answer: TRUE
Answer: FALSE 37. The treasury stock is an accounting entry
25. The regular dividend policy provides the on the firms balance sheet to designate the
owners with generally positive information, firms total investment in government securities.
indicating that the firm is okay and thereby Answer: FALSE
minimizing their uncertainty. 38. The repurchase of common stock results in
Answer: TRUE a type of reverse dilution, since the earnings per
26. Since regularly paying a fixed or increasing share and the market price of stock are
dividend eliminates uncertainty about the increased by reducing the number of shares
frequency and magnitude of dividends, it outstanding.
increases the owners wealth. Answer: TRUE
Answer: TRUE 39. Generally as long as earnings remain
27. The payment of a stock dividend is a constant, the repurchase of shares reduces the
shifting of funds between capital accounts rather number of outstanding shares, raising the
than a use of funds. earnings per share and therefore the market
Answer: TRUE price per share.
28. In case of stock dividend, the Answer: TRUE
shareholders proportion of ownership in the firm 40. Dividends provide information about the
remains the same, and as long as the firms firms current and future performance.
earnings remain unchanged, so does his or her Answer: TRUE
share of total earnings. 41. Dividends provide information about the
Answer: TRUE firms current performance but little or no
29. If the firms earnings remain constant and information about the firms future performance.
total cash dividends do not increase, a stock Answer: FALSE
dividend results in a lower per-share market value 42. The dividend payment date is set by the
for the firms stock. firms board of directors and represents the
Answer: TRUE actual date on which the firm mails the dividend
30. The shareholder receiving a stock dividend payment to the holders of record.
receives a share of common stock of equal value Answer: TRUE
to their existing shares of common stock. 43. The dividend payment date is set by the
Answer: FALSE firms chief executive officer and represents the
31. After the stock dividend is paid, the per actual date on which the firm mails the dividend
share value of the stockholders stock will remain payment to the holders of record.
the same as the value before the stock dividend Answer: FALSE
and, thus, the market value of his or her total 44. By purchasing shares through a firms
holdings in the firm will remain unchanged. dividend reinvestment plan (or DRIP),
Answer: FALSE shareholders typically can acquire shares at
32. If the stock dividend is paid so that cash about 5 percent below the prevailing market
can be retained to satisfy past-due bills, a decline price.
in market value may result. Answer: TRUE
Answer: TRUE 45. By purchasing shares through a firms
33. The stock repurchase can be viewed as a dividend reinvestment plan (or DRIP),
cash dividend. shareholders typically can acquire shares at
Answer: TRUE
about 25 percent below the prevailing market
price.
Answer: FALSE
46. The Jobs Growth Tax Relief Reconciliation
Act of 2003 significantly changed the tax
treatment of corporate dividends for most
taxpayers by dropping the tax rate to the rate
applicable on capital gains, which is a maximum
rate of 15 percent.
Answer: TRUE
47. The Jobs Growth Tax Relief Reconciliation
Act of 2003 significantly changed the tax
treatment of corporate dividends for most
taxpayers by dropping the tax rate to the rate
applicable on capital gains, which is a maximum
rate of 25 percent.
Answer: FALSE
48. The residual theory of dividends, as
espoused by Modigliani and Miller, suggests that
dividends represent an earnings residual rather
than an active decision variable that affects firm
value; this means that a firms decision to pay
dividends or not will not have any impact on a
firms share price.
Answer: TRUE
49. The representative theory of dividends, as
espoused by Modigliani and Miller, suggests that
dividends represent a significant, active decision
variable that affects firm value; this means that a
firms decision to pay dividends can have a
significant impact on a firms share price.
Answer: FALSE
50. The bird-in-the-hand argument espousing
the importance of dividends or dividend
relevance suggests that investors view a current
(certain) dividend as less risky than future
(uncertain) dividends or capital gains; this
suggests that whether a firm pays a dividend or
not can have a significant impact on share price.
Answer: TRUE
51. The bird-in-the-hand argument espousing
the importance of dividends or dividend
relevance suggests that investors view a current
(certain) dividend as less risky than future
(uncertain) dividends or capital gains;
nevertheless, proponents of this theory argue that
this will have no significant impact on share price.
Answer: FALSE
52. In most states, legal capital is measured
either by the par value of common stock; other
states, however, define legal capital to include
not only the par value of the stock, but also any
paid in capital in excess of par.
Answer: TRUE
53. In most states, legal capital is measured
not only by the par value and paid in capital of
the stock, but also by any accumulated retained
earnings.
Answer: FALSE
54. If a firm has overdue liabilities or is legally
insolvent or bankrupt, most states prohibit its
payment of cash dividends.
55. The level of dividends a firm expects to
pay is often directly related to how rapidly it
expects to grow as well as the level of asset
investments required.
Answer: TRUE
56. The level of dividends a firm expects to
pay is generally unrelated to how rapidly it
expects to grow as well as the level of asset
investments required.
Answer: FALSE
57. Because dividends are taxed at the same
rate as capital gains under the 2003 Tax Act, a
firms strategy of paying low or no dividends
primarily offers tax advantages to wealthy
stockholders through tax deferral rather than as a
result of a lower tax rate on current income.
Answer: TRUE
58. In general, the market rewards firms that
adopt a constant dividend payout policy rather
than a fixed or increasing level of dividends
through higher share prices.
Answer: FALSE
59. In general, the market rewards firms that
adopt a fixed or increasing level of dividends
rather than a fixed dividend payout policy
through higher share prices.
Answer: TRUE
60. A shareholder receiving a stock dividend
typically receives nothing of value.
Answer: TRUE
1. Business risk is the risk to the firm of being Answer: TRUE
unable to cover operating costs. Level of Difficulty: 1
Answer: TRUE Learning Goal: 2
2. The target capital structure is the desired Topic: Flotation Costs
optimal mix of debt and equity financing that 13. Flotation costs reduce the net proceeds
most firms attempt to achieve and maintain. from the sale of a bond whether sold at a
Answer: TRUE premium, at a discount, or at its par value.
3. The cost of capital is the rate of return a Answer: TRUE
firm must earn on investments in order to leave Level of Difficulty: 1
share price unchanged. Learning Goal: 2
Answer: TRUE Topic: Flotation Costs
4. The cost of capital is used to decide 14. The net proceeds used in calculation of
whether a proposed corporate investment will the cost of long-term debt are funds actually
increase or decrease the firms stock price. received from the sale after paying for flotation
Answer: TRUE costs and taxes.
5. The cost of capital reflects the cost of Answer: FALSE
funds over the long run measured at a given Level of Difficulty: 1
point in time, based on the best information Learning Goal: 2
available. Topic: Flotation Costs
Answer: TRUE 15. Since preferred stock is a form of
6. The cost of each type of capital depends ownership, the stock will never mature.
on the risk-free cost of that type of funds, the Answer: TRUE
business risk of the firm, and the financial risk of Level of Difficulty: 1
the firm. Learning Goal: 2
Answer: TRUE Topic: Cost of Preferred Stock
7. The cost of capital acts as a major link 16. Preferred stock represents a special type
between the firms long-term investment of ownership interest in the firm and, thus, the
decisions and the wealth of the owners as preferred stockholders must receive their stated
determined by investors in the marketplace. dividends prior to the distribution of any earnings
Answer: TRUE to common stockholders and bondholders.
8. The cost of capital can be thought of as Answer: FALSE
the rate of return required by the market suppliers Level of Difficulty: 1
of capital in order to attract their funds to the Learning Goal: 2
firm. Topic: Cost of Preferred Stock
Answer: TRUE 17. When the net proceeds from sale of a
9. Business risk is the risk to the firm of being bond equal its par value, the before-tax cost
unable to cover required financial obligations. would just equal the coupon interest rate.
Answer: FALSE Answer: TRUE
10. Holding risk constant, the implementation Level of Difficulty: 2
of projects with a rate of return above the cost of Learning Goal: 2
capital will decrease the value of the firm, and Topic: Cost of Long-Term Debt
vice versa. 18. The amount of preferred stock dividends
Answer: FALSE that must be paid each year may be stated in
11. The specific cost of each source of dollars (i.e.,
financing is the after-tax cost of obtaining the x-dollar preferred stock) or as a percentage of
financing using the historically based cost the firms earnings (i.e., x-percent preferred
reflected by the existing financing on the firms stock).
books. Answer: FALSE
Answer: FALSE Level of Difficulty: 2
Level of Difficulty: 2 Learning Goal: 2
Learning Goal: 1 Topic: Cost of Preferred Stock
Topic: Basic Concept of Cost of Capital 19. The cost of preferred stock is typically
12. In general, floatation costs include two higher than the cost of long-term debt (bonds)
components, underwriting costs and because the cost of long-term debt (interest) is
administrative costs. tax deductible.
Answer: TRUE Answer: TRUE
Level of Difficulty: 2 Level of Difficulty: 2
Learning Goal: 2 Learning Goal: 3
Topic: Cost of Preferred Stock Compared to Topic: Cost of Retained Earnings
Long-Term Debt 27. Since the net proceeds from sale of new
20. The cost of common stock equity may be common stock will be less than the current
measured using either the constant growth market price, the cost of new issues will always be
valuation model or the capital asset pricing less than the cost of existing issues.
model. Answer: FALSE
Answer: TRUE Level of Difficulty: 2
Level of Difficulty: 1 Learning Goal: 3
Learning Goal: 3 Topic: Cost of New Common Stock Equity
Topic: Cost of Common Stock Equity 28. The Gordon model is based on the
21. A firm can retain more of its earnings if it premise that the value of a share of stock is equal
can convince its stockholders that it will earn at to sum of all future dividends it is expected to
least their required return on the reinvested funds. provide over an infinite time horizon.
Answer: TRUE Answer: FALSE
Level of Difficulty: 1 Level of Difficulty: 2
Learning Goal: 3 Learning Goal: 3
Topic: Cost of Common Stock Equity Topic: Constant Growth Model
22. In computing the cost of retained 29. The cost of retained earnings to the firm is
earnings, the net proceeds represents the the same as the cost of an equivalent fully
amount of money retained net of any subscribed issue of additional common stock.
underpricing and/or flotation costs. Answer: TRUE
Answer: FALSE Level of Difficulty: 2
Level of Difficulty: 1 Learning Goal: 3
Learning Goal: 3 Topic: Cost of Retained Earnings
Topic: Cost of Retained Earnings 30. Using the Capital Asset Pricing Model
23. The cost of common stock equity is the (CAPM), the cost of common stock equity is the
rate at which investors discount the expected return required by investors as compensation for
dividends of the firm to determine its share value. the firms nondiversifiable risk.
Answer: TRUE Answer: TRUE
Level of Difficulty: 1 Level of Difficulty: 3
Learning Goal: 3 Learning Goal: 3
Topic: Cost of Common Stock Equity Topic: Capital Asset Pricing Model
24. The constant growth model uses the 31. Use of the Capital Asset Pricing Model
market price as a reflection of the expected risk- (CAPM) in measuring the cost of common stock
return preference of investors in the marketplace. equity differs from the constant growth valuation
Answer: TRUE model in that it directly considers the firms risk as
Level of Difficulty: 2 reflected by beta.
Learning Goal: 3 Answer: TRUE
Topic: Constant Growth Model Level of Difficulty: 3
25. The cost of common stock equity capital Learning Goal: 3
represents the return required by existing Topic: Capital Asset Pricing Model
shareholders on their investment in order to leave 32. When the constant growth valuation
the market price of the firms outstanding share model is used to find the cost of common stock
unchanged. equity capital, it can easily be adjusted for
Answer: TRUE flotation costs to find the cost of new common
Level of Difficulty: 2 stock; the Capital Asset Pricing Model (CAPM)
Learning Goal: 3 does not provide a simple adjustment
Topic: Cost of Common Stock Equity mechanism.
26. The cost of retained earnings is always Answer: TRUE
lower than the cost of a new issue of common Level of Difficulty: 3
stock due to the absence of flotation costs when Learning Goal: 3
financing projects with retained earnings. Topic: CAPM and Constant Growth Model
33. The cost of new common stock is normally 40. Since retained earnings is a more
greater than any other long-term financing cost. expensive source of financing than debt and
Answer: TRUE preferred stock, the weighted average cost of
Level of Difficulty: 3 capital will fall once retained earnings have been
Learning Goal: 3 exhausted.
Topic: Cost of New Common Stock Equity Answer: FALSE
34. The capital asset pricing model describes Level of Difficulty: 3
the relationship between the required return, or Learning Goal: 4
the cost of common stock equity capital, and the Topic: Weighted Marginal Cost of Capital
nonsystematic risk of the firm as measured by the 41. A firm may face increases in the weighted
beta coefficient. average cost of capital either when retained
Answer: FALSE earnings have been exhausted or due to
Level of Difficulty: 3 increases in debt, preferred stock, and common
Learning Goal: 3 equity costs as additional new funds are required.
Topic: Capital Asset Pricing Model Answer: TRUE
35. The weighted average cost that reflects Level of Difficulty: 3
the interrelationship of financing decisions can be Learning Goal: 4
obtained by weighing the cost of each source of Topic: Weighted Marginal Cost of Capital
financing by its target proportion in the firms 42. The weighted marginal cost of capital is
capital structure. the firms weighted average cost of capital
Answer: TRUE associated with its next dollar of total financing.
Level of Difficulty: 1 Answer: TRUE
Learning Goal: 4 Level of Difficulty: 1
Topic: Target Market Value Weights Learning Goal: 5
36. In computing the weighted average cost Topic: Weighted Marginal Cost of Capital
of capital, the historic weights are either book 43. The weighted marginal cost of capital
value or market value weights based on actual schedule is a graph that relates the firms
capital structure proportions. weighted average cost of capital to the level of
Answer: TRUE total new financing.
Level of Difficulty: 1 Answer: TRUE
Learning Goal: 4 Level of Difficulty: 1
Topic: Market Value versus Book Value Weights Learning Goal: 5
37. In computing the weighted average cost Topic: Weighted Marginal Cost of Capital
of capital, the target weights are either book 44. At any given time, the firms financing
value or market value weights based on actual costs and investment returns will be affected by
capital structure proportions. the volume of financing and investment
Answer: FALSE undertaken.
Level of Difficulty: 1 Answer: TRUE
Learning Goal: 4 Level of Difficulty: 2
Topic: Market Value versus Book Value Weights Learning Goal: 5
38. In computing the weighted average cost Topic: Weighted Marginal Cost of Capital
of capital, from a strictly theoretical point of view, 45. As the volume of financing increases, the
the preferred weighing scheme is target market costs of the various types of financing will
value proportions. decrease, reducing the firms weighted average
Answer: TRUE cost of capital.
Level of Difficulty: 1 Answer: FALSE
Learning Goal: 4 Level of Difficulty: 2
Topic: Target Market Value Weights Learning Goal: 5
39. The weighted average cost of capital Topic: Weighted Marginal Cost of Capital
(WACC) reflects the expected average future 46. The weighted marginal cost of capital is an
cost of funds over the long run. increasing function of the level of total new
Answer: TRUE financing.
Level of Difficulty: 1 Answer: TRUE
Learning Goal: 4 Level of Difficulty: 2
Topic: Weighted Average Cost of Capital Learning Goal: 5
Topic: Weighted Marginal Cost of Capital 54. According to the firms owner wealth
47. The breaking point is the level of total new maximization goal, the firm should accept
financing at which the cost of one of the projects up to the point where the marginal
financing components rises. return on its investment is equal to its weighted
Answer: TRUE marginal cost of capital.
Level of Difficulty: 2 Answer: TRUE
Learning Goal: 5 Level of Difficulty: 3
Topic: WMCC Break Points Learning Goal: 6
48. A firms investment opportunities schedule Topic: WMCC and IOS
is a ranking of investment possibilities from best 55. The cost of capital can be thought of as
(highest return) to worst (lowest return). the magic number that is used to decide
Answer: TRUE whether a proposed corporate investment will
Level of Difficulty: 1 increase or decrease the firms stock price.
Learning Goal: 6 Answer: TRUE
Topic: Investment Opportunities Schedule Level of Difficulty: 2
49. The larger the volume of new financing, Learning Goal: 1
the greater the risk and, thus, the higher the Topic: Basic Concept of Cost of Capital
financing costs. 56. The cost of common stock equity can be
Answer: TRUE thought of as the magic number that is used to
Level of Difficulty: 2 decide whether a proposed corporate
Learning Goal: 6 investment will increase or decrease the firms
Topic: Weighted Marginal Cost of Capital stock price.
50. The investment opportunity schedule (IOS) Answer: FALSE
is the graph that relates the firms weighted Level of Difficulty: 3
average cost of capital (WACC) to the level of Learning Goal: 1
total new financing. Topic: Basic Concept of Cost of Capital
Answer: FALSE 57. The cost of capital is a static concept; it is
Level of Difficulty: 3 not affected by economic and firm-specific
Learning Goal: 6 factors such as business risk and financial risk.
Topic: WMCC and IOS Answer: FALSE
51. The acceptance of projects beginning Level of Difficulty: 2
with those having the greatest positive difference Learning Goal: 1
between IRR and the weighted average cost of Topic: Basic Concept of Cost of Capital
capital, Ka, down to the point at which IRR just 58. The cost of capital is a dynamic concept;
equals ka should result in the maximum total NPV it is affected by economic and firm-specific
for all independent projects accepted. factors such as business risk and financial risk.
Answer: TRUE Answer: TRUE
Level of Difficulty: 3 Level of Difficulty: 2
Learning Goal: 6 Learning Goal: 1
Topic: WMCC and IOS Topic: Basic Concept of Cost of Capital
52. As the cumulative amount of money 59. In using the cost of capital, it is important
invested in a firms capital projects increases, its that it reflects the historical cost of raising funds
returns on the projects will increase. over the long run.
Answer: FALSE Answer: FALSE
Level of Difficulty: 3 Level of Difficulty: 3
Learning Goal: 6 Learning Goal: 1
Topic: WMCC and IOS Topic: Basic Concept of Cost of Capital
53. While the return will increase with the 60. From a bond issuers perspective, the IRR
acceptance of more projects, the weighted on a bonds cash flows is its cost to maturity; from
marginal cost of capital will increase because the investors perspective, the IRR on a bonds
greater amounts of financing will be required. cash flows is the yield to maturity (YTM).
Answer: FALSE Answer: TRUE
Level of Difficulty: 3 Level of Difficulty: 3
Learning Goal: 6 Learning Goal: 2
Topic: WMCC and IOS Topic: Cost of Long-Term Debt
61. From a bond issuers perspective, the IRR Nico Tradings cost of preferred stock would be
on a bonds cash flows is its yield to maturity 7.5 percent.
(YTM); from the investors perspective, the IRR on Answer: FALSE
a bonds cash flows is the cost to maturity. Level of Difficulty: 3
Answer: FALSE Learning Goal: 2
Level of Difficulty: 3 Topic: Cost of Preferred Stock (Equation 11.3)
Learning Goal: 2 66. The cost of retained earnings for Tangshan
Topic: Cost of Long-Term Debt Mining would be 16.64 percent if the firm just paid
62. Nico Trading Corporation is considering a dividend of $4.00, the stock price is $50.00,
issuing long-term debt. The debt would have a 30 dividends are expected to grow at 8 percent
year maturity and a 10 percent coupon rate. In indefinitely, and flotation costs are $5.00 per
order to sell the issue, the bonds must be share.
underpriced at a discount of 5 percent of face Answer: TRUE
value. In addition, the firm would have to pay Level of Difficulty: 3
flotation costs of 5 percent of face value. The Learning Goal: 3
firms tax rate is 35 percent. Given this Topic: Cost of Retained Earnings (Equation 11.5)
information, the after tax cost of debt for Nico 67. The cost of retained earnings for Tangshan
Trading would be 7.26 percent. Mining would be 17.60 percent if the firm just paid
Answer: TRUE a dividend of $4.00, the stock price is $50.00,
Level of Difficulty: 4 dividends are expected to grow at 8 percent
Learning Goal: 2 indefinitely, and flotation costs are $5.00 per
Topic: Cost of Long-Term Debt (Equation 11.2) share.
63. Nico Trading Corporation is considering Answer: FALSE
issuing long-term debt. The debt would have a 30 Level of Difficulty: 3
year maturity and a 10 percent coupon rate. In Learning Goal: 3
order to sell the issue, the bonds must be Topic: Cost of Retained Earnings (Equation 11.5)
underpriced at a discount of 5 percent of face 68. The cost of new common stock equity for
value. In addition, the firm would have to pay Tangshan Mining would be 17.60 percent if the
flotation costs of 5 percent of face value. The firm just paid a dividend of $4.00, the stock price
firms tax rate is 35 percent. Given this is $50.00, dividends are expected to grow at 8
information, the after tax cost of debt for Nico percent indefinitely, and flotation costs are $5.00
Trading would be 11.17 percent. per share.
Answer: FALSE Answer: TRUE
Level of Difficulty: 4 Level of Difficulty: 3
Learning Goal: 2 Learning Goal: 3
Topic: Cost of Long-Term Debt (Equation 11.2) Topic: Cost of New Common Stock Equity
64. Nico Trading Corporation is considering (Equation 11.8 and Equation 11.8a)
issuing preferred stock. The preferred stock would 69. The cost of retained earnings equity for
have a par value of $75 and a preferred dividend Tangshan Mining would be 18.00 percent if the
of 7.5 percent of par. In order to issue the stock, expected return on U.S. Treasury Bills is 5.00
Nico trading would have to pay flotation costs of percent, the market risk premium is 10.00 percent,
6 percent of par value. Given this information, and the firms beta is 1.3.
Nico Tradings cost of preferred stock would be Answer: TRUE
7.98 percent. Level of Difficulty: 3
Answer: TRUE Learning Goal: 3
Level of Difficulty: 3 Topic: Cost of Retained Earnings (Equation 11.6)
Learning Goal: 2 70. The cost of retained earnings equity for
Topic: Cost of Preferred Stock (Equation 11.3) Tangshan Mining would be 18.00 percent if the
65. Nico Trading Corporation is considering expected return on U.S. Treasury Bills is 5.00
issuing preferred stock. The preferred stock would percent, the market return is 10.00 percent, and
have a par value of $75 and a preferred dividend the firms beta is 1.3.
of 7.5 percent of par. In order to issue the stock, Answer: FALSE
Nico trading would have to pay flotation costs of Level of Difficulty: 3
6 percent of par value. Given this information, Learning Goal: 3
Topic: Cost of Retained Earnings (Equation 11.6)
71. Weights that use accounting values to Answer: FALSE
measure the proportion of each type of capital in Level of Difficulty: 3
the firms financial structure are called market Learning Goal: 4
value weights. Topic: Economic Value Added
Answer: FALSE 78. The break point is the level of total new
Level of Difficulty: 2 financing at which the cost of one of the
Learning Goal: 4 financing components rises, thereby causing an
Topic: Alternative Weighting Schemes upward shift in the weighted marginal cost of
72. Weights that use accounting values to capital.
measure the proportion of each type of capital in Answer: TRUE
the firms financial structure are called book Level of Difficulty: 2
value weights. Learning Goal: 5
Answer: TRUE Topic: Breaking Points
Level of Difficulty: 2 79. The investment opportunity point is the
Learning Goal: 4 level of total new financing at which the cost of
Topic: Alternative Weighting Schemes one of the financing components rises, thereby
73. Historical weights are either book value or causing an upward shift in the weighted marginal
market value weights based on the actual cost of capital.
historical capital structure proportions. Answer: FALSE
Answer: TRUE Level of Difficulty: 2
Level of Difficulty: 2 Learning Goal: 5
Learning Goal: 4 Topic: Breaking Points
Topic: Alternative Weighting Schemes 80. The weighted marginal cost of capital is
74. Target weights are either book value or the firms weighted average cost of capital
market value weights based on the actual associated with the next dollar of total new
historical capital structure proportions. financing.
Answer: FALSE Answer: TRUE
Level of Difficulty: 2 Level of Difficulty: 2
Learning Goal: 4 Learning Goal: 5
Topic: Alternative Weighting Schemes Topic: Weighted Marginal Cost of Capital
75. Target weights are either book value or
market value weights based on desired capital
structure proportions.
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 4
Topic: Alternative Weighting Schemes
76. Economic value added is the difference
between an investments net operating profit
after taxes and the cost of funds used to finance
the investment, which is found by multiplying the
dollar amount of the funds used to finance the
investment by the firms weighted average cost
of capital.
Answer: TRUE
Level of Difficulty: 3
Learning Goal: 4
Topic: Economic Value Added
77. The investment operating schedule is the
difference between an investments net
operating profit after taxes and the cost of funds
used to finance the investment, which is found by
multiplying the dollar amount of the funds used to
finance the investment by the firms weighted
average cost of capital.
1. Generally, increases in leverage result in Level of Difficulty: 1
increased return and risk. Learning Goal: 1
Answer: TRUE Topic: Capital Structure
Level of Difficulty: 1 9. The levels of fixed-cost assets and funds
Learning Goal: 1 that management selects affect the variability of
Topic: Leverage returns.
2. Breakeven analysis is used by the firm to Answer: TRUE
determine the level of operations necessary to Level of Difficulty: 2
cover all fixed operating costs and to evaluate Learning Goal: 1
the profitability associated with various levels of Topic: Total Leverage
sales. 10. The amount of leverage in the firms
Answer: FALSE capital structurethe mix of long-term debt and
Level of Difficulty: 1 equity maintained by the firmcan significantly
Learning Goal: 1 affect its value by affecting return and risk.
Topic: Breakeven Analysis Answer: TRUE
3. The firms operating breakeven point is the Level of Difficulty: 2
level of sales necessary to cover all fixed Learning Goal: 1
operating costs. Topic: Financial Leverage
Answer: FALSE 11. Sales commission may be considered as a
Level of Difficulty: 1 semivariable cost because it may be fixed for a
Learning Goal: 1 certain volume of sales and then increase to
Topic: Operating Breakeven Point higher levels for higher volumes.
4. Leverage results from the use of fixed-cost Answer: TRUE
assets or funds to magnify returns to the firms Level of Difficulty: 2
owners. Learning Goal: 1
Answer: TRUE Topic: Operating Leverage
Level of Difficulty: 1 12. At the operating breakeven point, the
Learning Goal: 1 sales revenue is equal to the sum of the fixed and
Topic: Leverage variable operating costs.
5. Operating leverage is concerned with the Answer: TRUE
relationship between the firms sales revenue and Level of Difficulty: 2
its operating expenses. Learning Goal: 1
Answer: FALSE Topic: Operating Breakeven Point
Level of Difficulty: 1 13. Earnings before interest and taxes are
Learning Goal: 1 positive above the operating breakeven point,
Topic: Operating Leverage and a loss occurs below it.
6. Financial leverage is concerned with the Answer: TRUE
relationship between the firms earnings after Level of Difficulty: 2
interest and taxes and its common stock earnings Learning Goal: 1
per share. Topic: Operating Breakeven Point
Answer: FALSE 14. For sales levels below the operating
Level of Difficulty: 1 breakeven point, sales revenue exceeds total
Learning Goal: 1 operating costs, and earnings before interest and
Topic: Financial Leverage taxes is greater than zero.
7. Total leverage is concerned with the Answer: FALSE
relationship between the firms sales revenue and Level of Difficulty: 2
its common stock earnings per share. Learning Goal: 1
Answer: TRUE Topic: Operating Breakeven Point
Level of Difficulty: 1 15. An increase in cost (fixed cost or variable
Learning Goal: 1 cost) tends to increase the operating breakeven
Topic: Total Leverage point, whereas an increase in the sales price per
8. Firms capital structure is the mix of the unit will decrease the operating breakeven point.
short-term debt, long-term debt, and equity Answer: TRUE
maintained by the firm. Level of Difficulty: 3
Answer: FALSE Learning Goal: 1
Topic: Operating Breakeven Point Level of Difficulty: 4
16. The use of a dollar breakeven point is Learning Goal: 1
important when a firm has more than one Topic: Cash Operating Breakeven Point
product, especially when each product is selling 23. Generally, increases in leverage result in
at a different price. increased return and risk, whereas decreases in
Answer: TRUE leverage result in decreased return and risk.
Level of Difficulty: 3 Answer: TRUE
Learning Goal: 1 Level of Difficulty: 1
Topic: Dollar Breakeven Point Learning Goal: 2
17. The contribution margin is defined as the Topic: Leverage
percent of each sales dollar that remains after 24. Total leverage can be defined as the
satisfying fixed operating costs. potential use of fixed costs, both operating and
Answer: FALSE financial, to magnify the effect of changes in
Level of Difficulty: 4 sales on the firms earnings per share.
Learning Goal: 1 Answer: TRUE
Topic: Contribution Margin Level of Difficulty: 1
18. The breakeven point in dollars can be Learning Goal: 2
computed by dividing the contribution margin Topic: Total Leverage
into the fixed operating costs. 25. The relationship between operating and
Answer: TRUE financial leverage is additive rather than
Level of Difficulty: 4 multiplicative.
Learning Goal: 1 Answer: FALSE
Topic: Operating Breakeven Point Level of Difficulty: 1
19. Due to the difficulty of allocating costs to Learning Goal: 2
products in a multiproduct firm, the breakeven Topic: Total Leverage
model may fail to determine breakeven points for 26. Operating leverage results from the
each product line. existence of operating costs in the firms income
Answer: TRUE stream.
Level of Difficulty: 4 Answer: FALSE
Learning Goal: 1 Level of Difficulty: 1
Topic: Breakeven Analysis Learning Goal: 2
20. Since the sales price per unit generally Topic: Operating Leverage
decreases with volume and the cost per unit 27. The total leverage measures the
generally increases with volume, the true combined effect of operating and financial
breakeven point may be different from those leverage on the firms risk.
obtained using linear revenue and cost functions Answer: TRUE
as assumed in the breakeven analysis. Level of Difficulty: 1
Answer: TRUE Learning Goal: 2
Level of Difficulty: 4 Topic: Total Leverage
Learning Goal: 1 28. Operating leverage may be defined as
Topic: Breakeven Analysis the potential use of fixed operating costs to
21. One of the limitations of breakeven magnify the effects of changes in sales on the
analysis is its short-term time horizon. A large firms earnings before interest and taxes (EBIT).
outlay in the current financial period could Answer: TRUE
significantly raise the firms breakeven point, while Level of Difficulty: 2
the benefits may occur over a period of years. Learning Goal: 2
Answer: TRUE Topic: Operating Leverage
Level of Difficulty: 4 29. Operating leverage is present when a firm
Learning Goal: 1 has fixed operating cost.
Topic: Breakeven Analysis Answer: TRUE
22. The cash breakeven point is used when Level of Difficulty: 2
certain noncash charges, such as depreciation, Learning Goal: 2
constitute an important portion of the firms fixed Topic: Operating Leverage
operating costs.
Answer: TRUE
30. Financial leverage results from the increase in sales results in a more-than-
presence of variable financial costs in the firms proportional increase in EBIT, and a decrease in
income stream. sales results in a more-than-proportional decrease
Answer: FALSE in EBIT.
Level of Difficulty: 2 Answer: TRUE
Learning Goal: 2 Level of Difficulty: 2
Topic: Financial Leverage Learning Goal: 2
31. Financial leverage may be defined as the Topic: Operating Leverage
potential use of variable financial costs to 37. Whenever the percentage change in EBIT
magnify the effects of changes in earnings resulting from a given percentage change in
before interest and taxes (EBIT) on the firms sales is greater than the percentage change in
earnings per share (EPS). sales, operating leverage exists.
Answer: FALSE Answer: TRUE
Level of Difficulty: 2 Level of Difficulty: 2
Learning Goal: 2 Learning Goal: 2
Topic: Financial Leverage Topic: Operating Leverage
32. Whenever the percentage change in 38. The closer the base sales level used is to
earnings before interest and taxes resulting from the operating breakeven point, the smaller the
a given percentage change in sales is greater operating leverage.
than the percentage change in sales, operating Answer: FALSE
leverage exists. Level of Difficulty: 3
Answer: TRUE Learning Goal: 2
Level of Difficulty: 2 Topic: Operating Leverage
Learning Goal: 2 39. The base level of EBIT must be held
Topic: Operating Leverage constant to compare the financial leverage
33. The effect of financial leverage is such that associated with different levels of fixed financial
an increase in the firms earnings before interest costs.
and taxes (EBIT) results in a more than Answer: TRUE
proportional increase in the firms earnings per Level of Difficulty: 3
share (EPS), while a decrease in the firms EBIT Learning Goal: 2
results in a less than proportional decrease in EPS. Topic: Financial Leverage
Answer: FALSE 40. The base level of sales must be held
Level of Difficulty: 2 constant to compare the total leverage
Learning Goal: 2 associated with different levels of fixed costs.
Topic: Financial Leverage Answer: TRUE
34. Whenever the percentage change in Level of Difficulty: 3
earnings per share (EPS) resulting from a given Learning Goal: 2
percentage change in sales is greater than the Topic: Total Leverage
percentage change in sales, financial leverage 41. The degree of operating leverage will
exists. increase if a firm decides to compensate its sales
Answer: FALSE representatives with a fixed salary and bonus
Level of Difficulty: 2 rather than with a pure percent-of-sales
Learning Goal: 2 commission.
Topic: Financial Leverage Answer: TRUE
35. Total leverage exists whenever the Level of Difficulty: 3
percentage change in earnings per share (EPS) Learning Goal: 2
resulting from a given percentage change in Topic: Operating Leverage
sales is greater than the percentage change in 42. Comparison of the degree of operating
sales. leverage of two firms is valid only when the base
Answer: TRUE level of sales used for each firm is the same.
Level of Difficulty: 2 Answer: TRUE
Learning Goal: 2 Level of Difficulty: 4
Topic: Total Leverage Learning Goal: 2
36. When a firm has fixed operating costs, Topic: Operating Leverage
operating leverage is present. In that case, an
43. The degree of operating leverage Learning Goal: 3
depends on the base level of sales used as a Topic: Financial Leverage
point of reference. The closer the base sales level 51. Symmetric information results when
used is to the operating breakeven point, the managers of a firm have more information about
greater the operating leverage. operations and future prospects than do
Answer: TRUE investors.
Level of Difficulty: 4 Answer: TRUE
Learning Goal: 2 Level of Difficulty: 2
Topic: Operating Leverage Learning Goal: 3
44. In general, the greater the firms operating Topic: Asymmetric Information
leverage, the higher its business risk. 52. In general, non-U.S. companies have
Answer: TRUE much higher debt ratios than do their U.S.
Level of Difficulty: 1 counterparts because financial markets are
Learning Goal: 3 much more developed in the United States than
Topic: Operating Leverage elsewhere and have played a much greater role
45. The probability that a firm will become in corporate financing than has been the case in
bankrupt is largely dependent on its level of both other countries.
business risk and financial risk. Answer: TRUE
Answer: TRUE Level of Difficulty: 2
Level of Difficulty: 1 Learning Goal: 3
Learning Goal: 3 Topic: International Aspects of Capital Structure
Topic: Business Risk and Financial Risk 53. Effective capital structure decisions can
46. The firms capital structure is the mix of lower the cost of capital, resulting in higher NPVs
short-term and long-term debt and equity and more acceptable projects, thereby
maintained by the firm. increasing the value of the firm.
Answer: FALSE Answer: TRUE
Level of Difficulty: 1 Level of Difficulty: 2
Learning Goal: 3 Learning Goal: 3
Topic: Capital Structure Basics Topic: Capital Structure Basics
47. The firms capital structure can significantly 54. Pecking order is a hierarchy of financing
affect the firms value by affecting its risk and beginning with retained earnings followed by
return. debt financing and finally external equity
Answer: TRUE financing.
Level of Difficulty: 1 Answer: TRUE
Learning Goal: 3 Level of Difficulty: 2
Topic: Capital Structure Basics Learning Goal: 3
48. All items on the right-hand side of the firms Topic: Pecking Order Theory
balance sheet, excluding current liabilities are 55. The relative inexpensiveness of debt
called capital. capital is due to the fact that the lenders take the
Answer: TRUE least risk of any long-term contributors of capital.
Level of Difficulty: 1 Answer: TRUE
Learning Goal: 3 Level of Difficulty: 2
Topic: Capital Structure Basics Learning Goal: 3
49. In general, low debt-payment ratios are Topic: Capital Structure Basics
associated with high degrees of financial 56. Poor capital structure decisions can result
leverage. in a high cost of capital, thereby making some
Answer: TRUE unacceptable investments acceptable.
Level of Difficulty: 2 Answer: FALSE
Learning Goal: 3 Level of Difficulty: 3
Topic: Financial Leverage Learning Goal: 3
50. The more fixed cost financing a firm has in Topic: Capital Structure Basics
its capital structure, the greater its financial 57. The debt capital has a lower risk because
leverage and risk. the lenders have a far stronger legal pressure
Answer: TRUE against the company to make payment than do
Level of Difficulty: 2 preferred or common stockholders.
Answer: TRUE Answer: TRUE
Level of Difficulty: 3 Level of Difficulty: 2
Learning Goal: 3 Learning Goal: 4
Topic: Capital Structure Basics Topic: Optimal Capital Structure
58. Due to its secondary position relative to 65. With increasing costs, especially fixed
equity, suppliers of debt capital take greater risk operating and financial costcomes increasing
and therefore must be compensated with higher risk, since the firm will have to achieve a higher
expected returns than suppliers of equity capital. level of sales just to break even.
Answer: FALSE Answer: TRUE
Level of Difficulty: 3 Level of Difficulty: 3
Learning Goal: 3 Learning Goal: 4
Topic: Capital Structure Basics Topic: Business Risk and Financial Risk
59. In default, debtholders and preferred 66. The cost of equity is greater than the cost
stockholders may receive a voice in of debt and increases with increasing financial
management; otherwise, only common leverage, but generally less rapidly than the cost
stockholders have voting rights. of debt.
Answer: TRUE Answer: FALSE
Level of Difficulty: 3 Level of Difficulty: 3
Learning Goal: 3 Learning Goal: 4
Topic: Capital Structure Basics Topic: Cost of Equity and Financial Leverage
60. A shift toward more fixed costs increases 67. The cost of equity increases with increasing
business risk, which in turn causes earnings before financial leverage in order to compensate the
interest and taxes to increase by less for a given stockholders for the higher degree of financial
increase in sales. risk.
Answer: FALSE Answer: TRUE
Level of Difficulty: 4 Level of Difficulty: 3
Learning Goal: 3 Learning Goal: 4
Topic: Business Risk Topic: Cost of Equity and Financial Leverage
61. When considering fixed operating cost 68. As financial leverage increases, the cost of
increases, the financial manager must weigh the debt remains constant and then rises, while the
increased financial risk associated with greater cost of equity always rises.
operating leverage against the expected Answer: TRUE
increase in returns. Level of Difficulty: 3
Answer: FALSE Learning Goal: 4
Level of Difficulty: 4 Topic: Cost of Debt and Financial Leverage
Learning Goal: 3 69. If we assume that EBIT is constant, the
Topic: Business Risk and Financial Risk value of the firm is maximized by minimizing the
62. Business risk is the risk to the firm of being weighted average cost of capital.
unable to cover operating costs. Answer: TRUE
Answer: TRUE Level of Difficulty: 3
Level of Difficulty: 1 Learning Goal: 4
Learning Goal: 4 Topic: Capital Structure and Firm Value
Topic: Business Risk 70. The EBIT-EPS approach to capital structure
63. Minimizing the weighted average cost of involves selecting the capital structure that
capital allows management to undertake a maximizes earnings before interest and taxes
larger number of profitable projects, thereby (EBIT) over the expected range of earnings per
further increasing the value of the firm. share (EPS).
Answer: TRUE Answer: FALSE
Level of Difficulty: 2 Level of Difficulty: 2
Learning Goal: 4 Learning Goal: 5
Topic: Optimal Capital Structure Topic: EBIT-EPS Approach
64. Optimal capital structure is the capital 71. The EBIT-EPS analysis tends to concentrate
structure at which the weighted average cost of on maximization of earnings rather than
capital is minimized, thereby maximizing the firms maximization of owners wealth.
value. Answer: TRUE
Level of Difficulty: 2 Topic: Operating Breakeven point
Learning Goal: 5 79. Both operating and financial leverage
Topic: EBIT-EPS Approach result in the magnification of return as well as risk.
72. The higher the financial breakeven point Answer: TRUE
and the steeper the slope of the capital structure Level of Difficulty: 2
line, the greater the financial risk. Learning Goal: 1
Answer: TRUE Topic: Operating and Financial Leverage
Level of Difficulty: 3 80. While operating leverage results only in a
Learning Goal: 5 magnification of returns, financial leverage results
Topic: EBIT-EPS Approach only in a magnification of risk.
73. Because risk premiums increase with Answer: FALSE
increases in financial leverage, the maximization Level of Difficulty: 2
of EPS does not assure owners wealth Learning Goal: 1
maximization. Topic: Operating and Financial Leverage
Answer: TRUE 81. The dollar breakeven sales level can be
Level of Difficulty: 3 solved for by dividing fixed costs by the
Learning Goal: 5 contribution margin ratio.
Topic: EBIT-EPS Approach Answer: TRUE
74. The higher the degree of financial Level of Difficulty: 3
leverage (DFL), the greater the leverage a plan Learning Goal: 1
has, and the steeper its slope when plotted on Topic: Operating Breakeven point
EBIT-EPS axes. 82. The dollar breakeven sales level can be
Answer: TRUE solved for by dividing fixed costs by the dollar
Level of Difficulty: 3 contribution margin.
Learning Goal: 5 Answer: FALSE
Topic: EBIT-EPS Approach Level of Difficulty: 3
75. The steeper the slope of the EBIT-EPS Learning Goal: 1
capital structure line, the lower the financial risk. Topic: Operating Breakeven point
Answer: FALSE 83. Holding all other factors constant, a firm
Level of Difficulty: 3 that is subject to a greater level of business risk
Learning Goal: 5 should employ less operating leverage than an
Topic: EBIT-EPS Approach otherwise equivalent firm that is subject to a lesser
76. Financial breakeven point represents the level of business risk.
level of earnings before interest and taxes Answer: TRUE
necessary for the firm to cover its fixed operating Level of Difficulty: 3
and financial changesthat is, the point at Learning Goal: 2
which earnings per share (EPS) is equal to zero. Topic: Business Risk and Operating Leverage
Answer: FALSE 84. Holding all other factors constant, a firm
Level of Difficulty: 3 that is subject to a greater level of business risk
Learning Goal: 5 should employ more operating leverage than an
Topic: EBIT-EPS Approach otherwise equivalent firm that is subject to a lesser
77. Firms having stable and predictable level of business risk.
revenues can more safely undertake highly Answer: FALSE
leveraged capital structures than can firms with Level of Difficulty: 3
volatile patterns of sales revenue. Learning Goal: 2
Answer: TRUE Topic: Business Risk and Operating Leverage
Level of Difficulty: 1 85. Holding all other factors constant, a firm
Learning Goal: 6 that is subject to a greater level of business risk
Topic: Business Risk and Capital Structure should employ less financial leverage than an
78. The operating breakeven point can be otherwise equivalent firm that is subject to a lesser
found by solving for the sales level that just covers level of business risk.
total fixed and variable costs. Answer: TRUE
Answer: TRUE Level of Difficulty: 3
Level of Difficulty: 2 Learning Goal: 2
Learning Goal: 1 Topic: Business Risk and Financial Leverage
86. Holding all other factors constant, a firm disadvantage of debt financing against the
that is subject to a greater level of business risk increase probability of bankruptcy that results
should employ more financial leverage than an from its use.
otherwise equivalent firm that is subject to a lesser Answer: FALSE
level of business risk. Level of Difficulty: 3
Answer: FALSE Learning Goal: 3
Level of Difficulty: 3 Topic: Capital Structure Theory
Learning Goal: 2 93. The pecking order explanation of capital
Topic: Business Risk and Financial Leverage structure states that a hierarchy of financing exists
87. Holding all other factors constant, a firm for firms in which retained earnings are employed
that is subject to a greater level of business risk first, followed by debt financing and finally by
should employ less total leverage than an external equity financing.
otherwise equivalent firm that is subject to a lesser Answer: TRUE
level of business risk. Level of Difficulty: 3
Answer: TRUE Learning Goal: 3
Level of Difficulty: 3 Topic: Pecking Order Theory
Learning Goal: 2 94. The pecking order explanation of capital
Topic: Business Risk and Total Leverage structure states that a hierarchy of financing exists
88. Holding all other factors constant, a firm for firms in which new external debt financing is
that is subject to a greater level of business risk employed first, followed by retained earnings and
should employ more total leverage than an finally by external equity financing.
otherwise equivalent firm that is subject to a lesser Answer: FALSE
level of business risk. Level of Difficulty: 3
Answer: FALSE Learning Goal: 3
Level of Difficulty: 3 Topic: Pecking Order Theory
Learning Goal: 2 95. The asymmetric information explanation of
Topic: Business Risk and Total Leverage capital structure suggests that firms will issue new
89. Because of the extensive research equity only when the managers believe the firms
conducted in recent years in the area of capital stock is overvalued; as a result, issuing new equity
structure theory, it is now possible for financial is considered a negative signal that will result in a
managers to pinpoint with great accuracy a decline in share price.
firms optimal capital structure. Answer: TRUE
Answer: FALSE Level of Difficulty: 4
Level of Difficulty: 3 Learning Goal: 3
Learning Goal: 3 Topic: Asymmetric Information
Topic: Capital Structure Theory 96. The asymmetric information explanation of
90. Despite the extensive research conducted capital structure suggests that firms will issue new
in recent years in the area of capital structure debt only when the managers believe the firms
theory, it is not yet possible to provide financial stock is overvalued; as a result, issuing new debt is
managers with a specified methodology for use considered a negative signal that will result in a
in determining a firms optimal capital structure. decline in share price.
Answer: TRUE Answer: FALSE
Level of Difficulty: 3 Level of Difficulty: 4
Learning Goal: 3 Learning Goal: 3
Topic: Capital Structure Theory Topic: Asymmetric Information
91. In general, a firms theoretical optimal 97. In theory, a firms optimal capital structure
capital structure is that which balances the tax is that which minimized the firms overall cost of
benefits of debt financing against the increase capital resulting in a maximization of the market
probability of bankruptcy that result from its use. value of the firm.
Answer: TRUE Answer: TRUE
Level of Difficulty: 3 Level of Difficulty: 3
Learning Goal: 3 Learning Goal: 4
Topic: Capital Structure Theory Topic: Optimal Capital Structure
92. In general, a firms theoretical optimal 98. The basic shortcoming of EBIT-EPS analysis
capital structure is that which balances the tax is that this model focuses on the maximization of
earnings rather than on the maximization of share
price.
Answer: TRUE
Level of Difficulty: 3
Learning Goal: 5
Topic: EBIT-EPS Analysis
99. The basic shortcoming of EBIT-EPS analysis
is that this model focuses on the maximization of
stock returns rather than on the maximization of
share price.
Answer: FALSE
Level of Difficulty: 3
Learning Goal: 5
Topic: EBIT-EPS Analysis
100. The overriding objective of the capital
structure decision should be to choose the level
of debt that results in the largest possible share
price.
Answer: TRUE
Level of Difficulty: 3
Learning Goal: 4
Topic: Optimal Capital Structure