Capital Structure

Question 1

Which of the following is not a source of long-term financing?

a. Common stocks
b. Bonds
c. Preferred stocks
d. Floating lien

Answer 1

D

Question 2

One of the sources of long-term financing is the issuance of common stocks. The advantages (to the issuer) of issuing common stocks are as follows, except

a. the sale of common stocks increases credit worthiness of the firm by providing more equity.
b. common stock cash dividends are not tax deductible as expense.
c. common stock is frequently more attractive to investors than debt because it grows in value with the success of the firm.
d. common stock dividends are not fixed - they are paid from profits when available.

Answer 2

B

Question 3

It is a hybrid of debt and equity. It has a fixed charge and increases leverage, but payment of dividends is not a legal obligation.

a. Preferred stock
b. Common stock
c. Bonds
d. Commercial paper

Answer 3

A

Question 4

Bonds, a source of long-term financing, are long-term debt instruments. They are similar to term loans, except that they are usually offered to the public and sold to many investors. Among the advantages (to the issuer) of issuing bonds are as follows, except

a. cost of debt is limited - bondholders usually do not participate in the superior earnings of the firm.
b. interest paid on debt (bonds) is tax deductible.
c. debt adds risk to a firm.
d. basic control of the firm is not shared with the debt holders.

Answer 4

C

Question 5

Leasing has become a major means of financing because it offers a variety of tax. and other benefits. The three principal forms of operating lease
lease are sale-leaseback, operating lease, and capital lease. The operating lease

a. involves the sale of property by the owner and a lease of the property back to the seller.
b. is non-cancelable and fully amortizes the cost of the leased asset over the term of the basic lease contract.
c. transfers substantially all of the benefits and risks of ownership of property to the lessee.
d. is a form of off-balance-sheet financing.

Answer 5

D

Question 6

Which of the following brings in additional capital to the firm?

a. Issuance of stock dividend
b. Two-for-one stock split.
c. Exercise of warrants
d. Conversion of convertible bonds to common stocks

Answer 6

C

Question 7

Warrants are long-term options that give holders the right to buy common stocks in the future at a specified price. Issuers of debt sometimes attach stock purchase warrants to debt instrument as an inducement to investors. A major use of warrants in financing is to

a. increase the return on debt.
b. lower the cost of debt.
c. avoid dilution in earnings per share.
d. maintain managerial control.

Answer 7

B

Question 8

To acquire additional capital while attempting to maximize earnings per share, a company should normally

a. select debt over equity initially.
b. select equity over debt initially.
c. issue both bonds and stocks in equal proportion.
d. discontinue paying dividends and use current cash flows to raise capital funds.

Answer 8

A

Question 9

If a firm’s degree of operating leverage is higher than the industry average, such firm

a. is more profitable.
b. is less risky.
c. has profits that are more sensitive to changes in sales volume.
d. has higher sales.

Answer 9

C

Question 10

The weighted average cost of capital approach to decision making is not directly affected by the

a. cost of debt outstanding
b. value of the common stocks
c. current budget for capital expansion
d. proposed mix of debt, equity, and existing funds used to implement the project.

Answer 10

C

Question 11

Which of the following statements about cost of capital is false?

a. Cost of capital is based on what the company pays for its capital, not the return earned on the capital employed.
b. The overall cost of capital is the minimum rate a firm must earn on all investments to cover capital costs.
c. The overall cost of capital is the cost of the firm’s equity capital at which the market value of the firm will remain unchanged.
d. The overall cost of capital is the weighted average cost of the various debt and equity components in a firm’s capital structure.

Answer 11

C

Question 12

Ideally, a firm’s optimal capital structure is the one that balances the cost of debt and equity capital and their associated risk levels.
The optimal capital structure minimizes the firm’s

a. weighted average cost of capital.
b. cost of debt.
c. cost of equity capital.
d. earnings per share.

Answer 12

A

Question 13

Which of the following statements is incorrect?

a. Capital structure is the mix of the long term sources of funds used by the firm.
b. Capital structure consists of the firms long-term financing, l.e., long-term debt and stockholders’ equity.
c. The optimum capital structure is a combination of long-term debt and equity that minimizes the cost of capital and value of the firm.
d. Debt is cheaper than equity, but excessive use of debt increases the firm’s risk and drives up the weighted average cost of capital.

Answer 13

C

Question 14

Which of the following statements is incorrect?

a. An increase in the corporate income tax rate might encourage a firm to increase the amount of debt in its capital structure.
b. An increase in economic uncertainty encourages equity financing.
c. In general, debt financing is more expensive than equity financing.
d. When calculating the cost of capital, the cost assigned to retained earnings should be lower than the cost of external common equity.

Answer 14

C