Debt Policy 3 Flashcards
True or False: According to Modigliani and Miller Proposition II, since the expected rate of return on debt is less than the expected rate of return on equity, the weighted average cost of capital declines as more debt is issued.
FALSE
True or False: According to Modigliani and Miller Proposition II, the firm’s expected return on assets depends on several factors including the firm’s capital structure.
F
True or False: Financial leverage increases the expected return and risk of the shareholder.
T
True or False: Modigliani and Miller’s Proposition I states that the market value of any firm is independent of its capital structure
T
True or False: Modigliani and Miller Proposition II states that the rate of return required by shareholders increases steadily as the firm’s debt-equity ratio increases.
T
True or False: The firm’s asset beta is usually higher than the firm’s equity beta.
F
True or False: The principle of value additivity holds for the aggregation of assets but does not apply to the division of assets.
F
According to the graph of WACC for Union Pacific, which of the following is (are) true?
I) The cost of equity is an increasing function of the debt-equity ratio.
II) The cost of debt is an increasing function of the debt-equity ratio.
III) The weighted average cost of capital (WACC) is a decreasing function of the debt-equity ratio.
I, II
Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk? A. expected risk formula B. time value of money equation C. capital asset pricing model D. unsystematic risk equation E. market performance equation
The capital asset pricing model
Which two methods of project analysis are the most biased towards short-term projects?
A. discounted payback and profitability index
B. payback and discounted payback
C. net present value and internal rate of return
D. net present value and discounted payback
E. internal rate of return and profitability index
Payback and discounted payback
An analysis of the change in a project’s NPV when a single variable is changed is called _____ analysis.
Sensitivity
Which one of the following measures the amount of systematic risk present in a particularly risky asset relative to the systematic risk present in an average risky asset
Beta
Par value or face value of a bond
It is a static value determined at the time of issuance and, unlike market value, it doesn’t fluctuate.
There are a number of factors by which a company sets a par value for each common stock share offered.
- Initial capitalization target
- Number of public shares to be offered, as well as the ownership position of the initial owners
- Prediction of share price changes after shares are offered in the market
Yield to Maturity (YTM)
Otherwise referred to as redemption or book yield – is the speculative rate of return or interest rate of fixed-rate security, such as a bond.
YTM is typically expressed as an annual percentage rate (APR). It is determined through the use of the following formula:
C + FV - PV/t / FV + PV / 2 C – Interest/coupon payment FV – Face value of the security PV – Present value/price of the security t – How many years does it take the security to reach maturity
when securities drop in price, yields
rise
As the Yield to maturity increases the:
A. Value of the bond decreases
B. Longer the time to Maturity
C. Lower the Desired coupon
D. Value of the bond increases
Value of the bond decreases
Erosion
can include any negative impact on a company’s associated assets or funds
Financial requirements will relate to expenses that affect
costs and margins
the marginal cost of production is the
change in total production cost that comes from making or producing one additional unit
Which one of the following is a breakdown of the ROE into its three component parts?
a. equity analysis
b. sustainable growth
C. Du Pont identity
d. profitability ratios
e. efficiency breakout
Du Pont identity
An analysis which combines scenario analysis with sensitivity analysis is called _____ analysis.
a. forecasting
b. scenario
c. sensitivity
d. simulation
e. break-even
simulation
Which of the following questions are appropriate to address during the financial planning process?
I. Should the firm merge with a competitor?
II. Should additional shares of stock be sold?
III. Should a particular division be sold?
IV. Should a new product be introduced?
II, III, and IV only
The cash flow of a firm that is available for distribution to the firm's creditors and stockholders is called the A. net working capital. B. operating cash flow. C. cash flow to stockholders. D. net capital spending. E. cash flow from assets.
Cash Flow from Assets
For a tax-paying firm, an increase in \_\_\_\_\_ will cause the cash flow from assets to increase. A. depreciation B. change in net working capital C. net capital spending D. taxes E. production costs
Deprecation
You want to have $1 million in your savings account when you retire. You plan on investing a single lump sum today to fund this goal. You are planning on investing in an account which will pay 7.5 percent annual interest. Which of the following will reduce the amount that you must deposit today if you are to have your desired $1 million on the day you retire?
I. Invest in a different account paying a higher rate of interest.
II. Invest in a different account paying a lower rate of interest.
III. Retire later.
IV. Retire sooner.
A. I and IV only B. II and III only C. I and III only D. II only E. I only
I and III only
Which of these important relationships are true?
I: For a given interest rate - the longer the time period, the higher the future value
II: For a given interest rate - the longer the time period, the higher the present value
III: For a given time period - the higher the interest rate, the lower the future value
IV: For a given time period - the higher the interest rate, the lower the present value
A. I, II, III, and IV
B. II and IV only
C. II and III only
D. I and III only
E. I and IV only
I and IV only
Present value (PV)
Present value states that an amount of money today is worth more than the same amount in the future. Present value (PV) is the current value of a future sum of money or stream of cash flows given a specified rate of return.
All else constant, a bond will sell at \_\_\_\_\_ when the coupon rate is \_\_\_\_\_ the yield to maturity. A. a discount; less than B. a discount; higher than C. par; less than D. a premium; less than E. a premium; equal to
discount; less than
The Walthers Company has a semi-annual coupon bond outstanding. An increase in the market rate of interest will have one of the following effects on this bond?
A. decrease the market price B. increase the market price C. increase the coupon rate D. decrease the coupon rate E. increase the time period
decrease the market price
Which one of the following is a capital budgeting decision?
A. determining how many shares of stock to issue
B. deciding how to refinance a debt issue that is maturing
C. determining how much inventory to keep on hand
D. determining how much money should be kept in the checking account
E. deciding whether or not to purchase a new machine for the production line
deciding whether or not to purchase a new machine for the production line
Which one of the following is a capital structure decision?
A. determining which one of two projects to accept
B. determining how much debt should be assumed to fund a project
C. determining how much inventory will be needed to support a project
D. determining how to allocate investment funds to multiple projects
E. determining the amount of funds needed to finance customer purchases of a new product
determining how much debt should be assumed to fund a project
Which one of the following is a working capital management decision?
A. determining the amount of long-term debt required to complete a project
B. determining the number of shares of stock to issue to fund an acquisition
C. determining whether to pay cash for a purchase or use the credit offered by the supplier
D. determining the amount of equipment needed to complete a job
E. determining whether or not a project should be accepted
determining whether to pay cash for a purchase or use the credit offered by the supplier
The primary goal of a publicly-owned firm interested in serving its stockholders should be to:
A. maximize share price.
B. minimize expected EPS.
C. minimize the chances of losses.
D. minimize shareholder wealth.
E. maximize expected total corporate profit.
Maximize share price
An increase in which of the following will increase the return on equity, all else constant? I. sales II. net income III. depreciation IV. total equity
A. I, II, and III only B. II and III only C. I and II only D. I only E. II and IV only
I and II only
A bond has a market price that exceeds its face value. Which of the following features currently apply to this bond?
I. discounted price
II. premium price
III. yield-to-maturity that exceeds the coupon rate
IV. yield-to-maturity that is less than the coupon rate
A. III only B. I and III only C. I and IV only D. II and III only E. II and IV only
II and IV
Which one of the following is a type of equity security that has a fixed dividend and a priority status over other equity securities? A. warrant B. debenture C. common stock D. preferred stock E. senior bond
Preferred stock
National Trucking has paid an annual dividend of $1.00 per share on its common stock for the past fifteen years and is expected to continue paying a dollar a share long into the future. Given this, one share of the firm’s stock is:
A. equal in value to the present value of $1 paid one year from today.
B. worth $1 a share in the current market.
C. basically worthless as it offers no growth potential.
D. valued at an assumed growth rate of one percent.
E. priced the same as a $1 perpetuity
Priced the same as a $1 perpetuity
The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the: A. structured cost of capital. B. subjective cost of capital. C. weighted capital gains rate. D. reward to risk ratio. E. weighted average cost of capital.
weighted average cost of capital.
