Sample Questions Ch 16

Sample Questions - CHAPTER 16

True-False

Bankruptcy costs

[i]. Because creditors can foresee, to at least some extent, the costs of bankruptcy, they charge a higher rate of interest to compensate for the present value of bankruptcy costs.

a. True

b. False

Business risk

[ii]. The firm's business risk is largely determined by the financial characteristics of its industry.

a. True

b. False

Financial risk

[iii]. Financial risk refers to the extra risk stockholders bear as a result of the use of debt as compared with the risk they would bear if no debt were used.

a. True

b. False

Financial risk

[iv]. The firm's financial risk may have both market risk and diversifiable risk components.

a. True

b. False

Financial risk

[v]. In a stand-alone risk context, financial risk can be measured as

(ROE(L) - (ROE(U).

a. True

b. False

Financial leverage

[vi]. Whenever a firm goes into debt, it is using financial leverage.

a. True

b. False

Use of debt financing

[vii]. If a firm utilizes debt financing, a decrease in earnings before interest and taxes (EBIT) will result in a more than proportionate decrease in earnings per share.

a. True

b. False

Use of financial leverage

[viii]. The graphical probability distribution of net income, when financial leverage is used, would tend to be more peaked than a distribution where no leverage is present, other things held constant.

a. True

b. False

Financial leverage

[ix]. Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.

a. True

b. False

Operating and financial leverage

[x]. Financial leverage affects both EPS and EBIT, while operating leverage only affects EBIT.

a. True

b. False

Trade-off theory

[xi]. The trade-off theory tells us that the capital structure decision involves a...