Finance Chapter 14

Finance 2, IBA programme

Multiple-choice questions

Sheet # 3

Question 1

Which of the following would lead to an increase in leverage in a firm's optimal capital structure according to

the agency cost/tax shield trade-off model?

A)

B)

C)

D)

E)

An increase in the agency costs of equity.

A decline in the corporate tax rate.

An increase in indirect bankruptcy costs.

An increase in the agency costs of debt.

None of the above.

Question 2

A firm faces perfect capital markets and has access to a project with free cash flows in one year of $90,000

in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial

investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest

rate is 5%. Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free

rate, then the cash flow that equity holders will receive in one year in a weak economy is closest to:

A)

B)

C)

D)

E)

$33,000

$10,000

$6,000

$0

$15,000

Question 3

Consider the following income statement for Kroger Inc. (all figures in $ Millions)

Year

Total Sales

Cost of goods sold

Selling, general & admin expenses

Depreciation

Operating Income

Other Income

EBIT

Interest expense

Earnings before tax

Taxes (35%)

Net Income

2008

60,553

45,565

11,688

1,265

2,035

0

2,035

510

1,525

534

991

2007

56,434

42,140

12,191

1,256

847

0

847

557

290

102

189

2006

53,791

39,637

11,575

1,209

1,370

0

1,370

604

766

268

498

The income that would be available to equity holders in 2008 if Kroger was not levered is closest to:

A)

B)

C)

D)

E)

$1,525 million

$2,035 million

$1,500 million

$1,325 million

$1,250 million

1

Question 4

The CFO of a company is suggesting to issue debt in order to finance an upcoming project, even though the

firm has large cash reserves. She believes the market is currently underpricing the...