1.Business risk is affected by a firm's operations. Which of the following is NOT directly associated with (or does not directly contribute to) business risk?
Answer
a. Input price variability.
b. The extent to which interest rates on the firm's debt fluctuate.
c. Sales price variability.
d. The extent to which operating costs are fixed.
e. Demand variability.


2.Which of the following statements is CORRECT?
Answer
a. Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC.
b. Since a firm's beta coefficient is not affected by its use of financial leverage, leverage does not affect the cost of equity.
c. Since debt financing raises the firm's financial risk, increasing the target debt ratio will always increase the WACC.
d. Increasing a company's debt ratio will typically reduce the marginal costs of both debt and equity financing. However, this action still may raise the company's WACC.
e. Increasing a company's debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company's WACC.

3.Which of the following statements is CORRECT?
Answer
a. The capital structure that maximizes expected EPS also maximizes the price per share of common stock.
b. The capital structure that minimizes the interest rate on debt also maximizes the expected EPS.
c. The capital structure that gives the firm the best bond rating also maximizes the stock price.
d. The capital structure that minimizes the WACC also maximizes the price per share of common stock.
e. The capital structure that minimizes the required return on equity also maximizes the stock price.


4.Based on the information below, what is the firm's optimal capital structure?
Answer
a. Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90.
b. Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20.
c. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.
d. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40.
e. Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.


5.Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant?
Answer
a. A decrease in costs incurred when filing for bankruptcy.
b. The Federal Reserve tightens interest rates in an effort to fight inflation.
c. Statements a and b are correct.
d. An increase in the personal tax rate.
e. An increase in the company's operating leverage.