TestReview3 - Test Review for Test 3 Name (print):_ Answer...

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Test Review for Test 3 Name (print):_________________________________ Answer 11 out of the following 14 multiple choice questions.Circle your final answer with an ink pen. 1. The trade-off theory tells us that the capital structure decision involves a tradeoff between the costs of debt financing and the benefits of debt financing. a. True b. False 2. If Miller and Modigliani had considered the cost of bankruptcy, it is unlikely that they would have concluded that 100 percent debt financing is optimal for the firm. a. True b. False 3. Which of the following statements is most correct? a. Since debt financing raises the firm's financial risk, raising a company’s debt ratio will always increase the company’s WACC. b. Since debt financing is cheaper than equity financing, raising a company’s debt ratio will always reduce the company’s WACC. c. Increasing a company’s debt ratio will typically reduce the marginal cost of both debt and equity financing; however, it still may raise the company’s WACC. d. Statements a and c are correct. e. None of the statements above is correct. 4. Which of the following events is likely to encourage a company to raise its target debt ratio? a. An increase in the corporate tax rate. b. An increase in the personal tax rate. c. An increase in the company’s operating leverage. d. Statements a and c are correct. e. All of the statements above are correct. 5. Which of the following would increase the likelihood that a company would increase its debt ratio in its capital structure? a. An increase in costs incurred when filing for bankruptcy. b. An increase in the corporate tax rate. c. An increase in the personal tax rate. d. A decrease in the firm’s business risk. e. Statements b and d are correct. 1
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6. Volga Publishing is considering a proposed increase in its debt ratio, which will also increase the company’s interest expense. The plan would involve the company issuing new bonds and using the proceeds to buy back shares of its common stock. The company’s CFO expects that the plan will not change the company’s total assets or operating income. However, the company’s CFO does estimate that it will increase the company’s earnings per share (EPS). Assuming the CFO’s estimates are correct, which of the following statements is most correct? a. Since the proposed plan increases Volga’s financial risk, the company’s stock price still might fall even though its EPS is expected to increase. b. If the plan reduces the company’s WACC, the company’s stock price is also likely to decline. c. Since the plan is expected to increase EPS, this implies that net income is also expected to increase. d. Statements a and b are correct. e.
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This note was uploaded on 12/14/2010 for the course FIN 422 taught by Professor Sridharsundaram during the Fall '09 term at Grand Valley State University.

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TestReview3 - Test Review for Test 3 Name (print):_ Answer...

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