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business
fundamentals of financial management

Questions and Answers of Fundamentals Of Financial Management

Six-month T-bills have a nominal rate of 7 percent, while default-free Japanese bonds that mature in 6 months have a nominal rate of 5.5 percent. In the spot exchange market, one yen equals SO. 009.'
A television set costs S500 in the United States. The same set costs 725 euros. If purchasing power parity holds, what is the spot exchange rate between the euro and the dollar?AppendixLO1
What four factors affect the target capital structure?AppendixLO1
In what sense does capital structure policy involve a trade-off between risk and return?AppendixLO1
What is business risk, and how can it be measured?AppendixLO1
What are some determinants of business risk?AppendixLO1
Why does business risk vary from industry to industry?AppendixLO1
What is operating leverage?AppendixLO1
How does operating leverage affect business risk?AppendixLO1
What is financial risk, and how does it arise?AppendixLO1
Explain this statement: "Using leverage has both good and bad effects.AppendixLO1
What happens to the costs of debt and equity when the debt/assets ratio increases?Explain.AppendixLO1
Using the Hamada equation, show the effect of financial leverage on beta.Give the equation for calculating a firm's unlevered beta.AppendixLO1
Using a graph and illustrative data, identify the premiums for financial risk and business risk at different debt levels. Do these premiums vary depending on the debt level? Explain.AppendixLO1
Is expected EPS maximized at the optimal capital structure?AppendixLO1
Why does M&M's theory with taxes lead to 100 percent debt?AppendixLO1
How would an increase in corporate taxes affect firms' capital structure decisions?AppendixLO1
What about personal taxes?AppendixLO1
Explain how "asymmetric information" and "signals" affect capital structure decisions.AppendixLO1
What is meant by reserve borrowing capacity, and why is it important to firms?AppendixLO1
How can the use of debt serve to discipline managers?AppendixLO1
How does sales stability affect the target capital structure?AppendixLO1
How do the types of assets used affect a firm's capital structure?AppendixLO1
How do taxes affect the target capital structure?AppendixLO1
How do lender and rating agency attitudes affect capital structure?AppendixLO1
How does the firm's internal condition affect its actual capital structure?AppendixLO1
What is "financial flexibility," and is it increased or decreased by a high debt ratio?AppendixLO1
Why do wide variations in the use of financial Leverage occur both across industries and among individual firms in each industry?AppendixLO1
Explain why the following statement is true: "Other things the same, firms with relatively stable sales are able to carry relatively high debt ratios."AppendixLO1
Why do public utilities pursue a different financial policy than retail firms?AppendixLO1
Why is EBIT generally considered to be independent of financial leverage? Why might EBIT actually be influenced by financial leverage at high debt levels?AppendixLO1
If a firm went from zero debt to successively higher levels of debt, why would you expect its stock price to first rise, then hit a peak, and then begin to decline?AppendixLO1
Why is the debt level that maximizes a firm's expected EPS generally higher than the one that maximizes its stock price?AppendixLO1
When the Bell System was originally broken up, the old AT&T was split into a new AT&T plus seven regional telephone companies. The specific reason for forcing the breakup was to increase the degree
Assume that you are advising the management of a firm that is about to double its assets to serve its rapidly growing market. It must choose between a highly automated production process and a less
Your firm's R&D department has been working on a new process that, if it works, can produce oil from coal at a cost of about $5 per barrel versus a current market price of $30 per barrel.The company
Explain how profits or losses will be magnified for a firm with high operating leverage as opposed to a firm with lower operating leverage.AppendixLO1
What data are necessary to construct a breakeven analysis?AppendixLO1
What would be the effect of each of the following on a firm's breakeven point?a. An increase in the sales price with no change in unit costs.b. A change from straight-line depreciation to the MACRS
If Congress considers a change in the Tax Code that will increase personal tax rates but reduce corporate tax rates, what effect would this Tax Code change have on the average company's capital
Which of the following are likely to encourage a firm to increase the amount of debt in its capital structure?a. The corporate tax rate increases.b. The personal tax rate increases.c. The firm's
Define each of the following terms:Key termsa. Target capital structureb. Business risk; financial riskc. Financial leverage; operating leverage; operating breakevend. Hamada equation; unlevered
Explain the differences among the dividend irrelevance theory, the bird-in-thehand theory, and the tax preference theory.AppendixLO1
What did Modigliani and Miller assume about taxes and brokerage costs when they developed their dividend irrelevance theory?AppendixLO1
How did the bird-in-the-hand theory get its name?AppendixLO1
In what sense does MM's theory represent a middle-ground position between the other two theories?AppendixLO1
What have been the results of empirical tests of the dividend theories?AppendixLO1
Define (1) information content and (2) the clientele effect, and explain how they affect dividend policy.AppendixLO1
What does the term "stable dividend policy" mean?AppendixLO1
What are the two components of dividend stability?AppendixLO1
Explain the logic of the residual dividend model, the steps a firm would take to implement it, and why it is more likely to be used to establish a long-run payout target than to set the actual
How do firms use planning models to help set dividend policy?AppendixLO1
Which are more critical to the dividend decision, earnings or cash flow? Explain.AppendixLO1
Explain the procedures used to actually pay the dividend.AppendixLO1
Why is the ex-dividend date important to investors?AppendixLO1
What are dividend reinvestment plans?AppendixLO1
What are their advantages and disadvantages from both the stockholders' and the firm's perspectives?AppendixLO1
Identify the four broad sets of factors that affect dividend policy.AppendixLO1
What constraints affect dividend policy?AppendixLO1
How do investment opportunities affect dividend policy?AppendixLO1
How does the availability and cost of outside capital affect dividend policy?AppendixLO1
Describe the dividend policy decision process. Be sure to discuss all the factors that influence the decision.AppendixLO1
What are stock dividends and stock splits?AppendixLO1
How do stock dividends and splits affect stock prices?AppendixLO1
In what situations should managers consider the use of stock dividends?AppendixLO1
In what situations should they consider the use of stock splits?AppendixLO1
Explain how repurchases can (1) help stockholders hold down taxes and (2) help firms change their capital structures.AppendixLO1
What is treasury stock?AppendixLO1
What are three procedures a firm can use to repurchase its stock?AppendixLO1
What are some advantages and disadvantages of stock repurchases?AppendixLO1
How can stock repurchases help a company operate in accordance with the residual dividend model?AppendixLO1
How would each of the following changes tend to affect aggregate (that is, the average for all corporations) payout ratios, other things held constant? Explain your answers.a. An increase in the
Discuss the pros and cons of having the directors formally announce what a (inn's dividend policy will be in the future.AppendixLO1
Most firms would like to have their stock selling at a high P/E ratio, and they would also like to have extensive public ownership (many different shareholders). Explain how stock dividends or stock
What is the difference between a stock dividend and a stock split? As a stockholder, would vou prefer to see your company declare a 100 percent stock dividend or a two-for-one split? Assume that
"The cost of retained earnings is less than the cost of new outside equity capital. Consequently, it is totally irrational for a firm to sell a new issue of stock and to pay dividends during the same
Would it ever be rational for a firm to borrow money in order to pay dividends? Explain.AppendixLO1
"Executive salaries have been shown to be more closely correlated to the size of the firm than to its profitability. If a firm's board of directors is controlled by management instead of by outside
Modigliani and Miller (MM) on the one hand and Gordon and Lintner (GL) on the other have expressed strong views regarding the effect of dividend policy on a firm's cost of capital and value.a. In
More NYSE companies had stock dividends and stock splits during 1983 and 1984 than ever before. What events in these years could have made stock splits and stock dividends so popular?Explain the
One position expressed in the financial literature is that firms set their dividends as a residual after using income to support new investment.a. Explain what a residual dividend policy implies,
Indicate whether the following statements are true or false. If the statement is false, explain why.a. If a firm repurchases its stock in the open market, the shareholders who tender the stock are
Define each of the following terms:Key terms a. Optimal dividend policyb. Dividend irrelevance theory; bird-in-the-hand theory; tax preference theoryc. Information content, or signaling, hypothesis;
Why should the cost of capital used in capital budgeting be calculated as a weighted average of the various types of funds the firm generally uses, not the cost of the specific financing used to fund
Identify the firm's three major capital structure components, and give their respective component cost symbols.AppendixLO1
Why is the after-tax cost of debt rather than the before-tax cost used to calculate the weighted average cost of capital?AppendixLO1
Is the relevant cost of debt the interest rate on already outstanding debt or that on new debt? Why?AppendixLO1
Is a tax adjustment made to the cost of preferred stock? Why or why not?AppendixLO1
Why must a cost be assigned to retained earnings?AppendixLO1
What three approaches are used to estimate the cost of common equity?AppendixLO1
Identify some problems with the CAPM approach.AppendixLO1
What is the reasoning behind the bond-yield-plus-risk-premium approach?AppendixLO1
Which of the two components of the constant growth DCF formula, the dividend yield or the growth rate, is more difficult to estimate? Why?AppendixLO1
Explain briefly the two approaches that can be used to adjust for flotation costs.AppendixLO1
Would firms that have many good investment opportunities be likely to have higher or lower dividend payout ratios than firms with few good investment opportunities?Explain.AppendixLO1
Write out the equation for the weighted average cost of capital WACC.AppendixLO1
Is short-term debt included in the capital structure used to calculate WACC? Why or why not?AppendixLO1
Why does the WACC at every amount of capital raised represent the marginal cost of that capital?AppendixLO1
What two factors that affect the cost of capital are generally beyond the firm's control?AppendixLO1
What policies under the firm's control are likely to affect its cost of capital?AppendixLO1

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