Q11

Financial risk refers to the extra risk stockholders bear as a result of the use of debt as compared with the risk they would bear if no debt were used.

	True
	False

Q12

A firm's capital structure can never affect its free cash flows.

	True
	False

Q13

If a firm utilizes debt financing, a decrease in earnings before interest and taxes (EBIT) will result in a more than proportionate decrease in earnings per share.

	True
	False

Q14

Two firms, although they operate in different industries, have the same expected earnings per share and the same standard deviation of expected EPS. Thus, the two firms must have the same business risk.

	True
	False

Q15

A consultant has collected the following information regarding Young Publishing Total assets $3,000 million Tax rate 40% Operating income (EBIT) $800 million Debt ratio 0% Interest expense $0 million WACC 10% Net income $480 million M/B ratio 1.00 #215 Share price $32.00 EPS = DPS =$3.20 The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). The consultant believes that if the company moves to a capital structure financed with 20 percent debt and 80 percent equity (based on market values) that the cost of equity will increase to 11 percent and that the pre-tax cost of debt will be 10 percent. If the company makes this change, what would be the total market value of the firm? (The answers are in millions.)

	a. $3,200
	b. $3,600

	c. $4,000
	d. $4,200

e. $4,800

Q16

Financial leverage affects both EPS and EBIT.

	True
	False

Q17

Firms A & B are similar firms in the same industry. Firm A and B have the same profit margin and total asset turnover when compared. However, Firm A's capital structure is 50% debt and Firm B's capital structure is 66% debt. Which firm, given the above conditions, will experience the highest return on equity (ROE) ?

	A
	B

Can't tell from information given.

Q18

If debt financing is used, which of the following is true?

	In response to a given percentage change in sales, the percentage change in operating income is greater than the percentage change in net income.
	In response to a given percentage change in sales, the percentage change in operating income is equal to the percentage change in net income.

	In response to a given percentage change in sales, the percentage change in net income is greater than the percentage change in operating income.
	The degree of operating leverage is greater than 1.

Q19

As a general rule, the capital structure that maximizes firm value, or stock price also

	mximizes the expected rate of return on equity (ROE)
	maximizes the weighted average cost of capital (WACC)

	minimizes the weighted average cost of capital (WACC)
	maximizes EPS

minimizes bankruptcy costs

Q20

Simon Software Co. currently has a capital structure that consists of 20 percent debt and 80 percent equity. (Its D/E ratio is 0.25.) The risk-free rate is 6 percent and the market risk premium, Rm - Rrf, is 5 percent. Currently the company's cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 40 percent. What would be Simon's estimated cost of equity if it were to change its capital structure to 50 percent debt and 50 percent equity? (Hint: Use the Hamada equations.)

	14.35%
	30.00%

	14.72%
	15.60%

13.64%