1. rue or False : In perfect capital markets (no taxes, no financial distress costs), the value of a firm is unaffected by the firms capital structure.

2. The law of conservation of value implies that:

	a.	The return on a firm's common stock is unchanged when debt is added to its capital structure.
	b.	The value of any asset is preserved regardless of the nature of the claims against it.
	c.	The return on a firm's debt is unchanged when common stock is added to its capital structure.
	d.	The value of an asset increases as debt is reduced.

3. With corporate taxes but otherwise perfect capital markets (no personal taxes, no financial distress costs), the value of a firm:

	a.	Increases with the leverage of a firm
	b.	Decrease with the leverage of the firm
	c.	Is independent of the leverage of the firm
	d.	None of the above

4. True or False : One indication of the importance of bankruptcy costs in the leverage decision is that firms only shield a portion of their taxable income using interest on debt.
5. A firm may earn gross income but still pay no taxes and not benefit from debt tax shields because of:

	a.	Carry-forwards of past operating losses
	b.	Depreciation expenses
	c.	Investment tax credits
	d.	All of the above

6. Consideration of personal taxes in addition to corporate taxes causes the gain from leverage to be:

	a.	Larger
	b.	Smaller
	c.	Identical to when only corporate taxes are considered
	d.	Dependent upon the relative magnitudes of the corporate, personal-debt, and personal-equity tax rates

7. Lenders are willing to lend a larger proportion of the market value of tangible assets?such as property, plant, and equipment?than the market value of intangible assets, such as patents and goodwill, because:

	a.	Tangible assets hold their value better if the firm/bank is forced to sell them in financial distress.
	b.	A secondary (resale) market is more likely to exist for tangible than intangible assets.
	c.	If the intangible assets include the creativity and intellects of employees, these assets are not even owned by the firm and have no value in bankruptcy.
	d.	All of the above

8. True or false : The statement: "The direct costs of bankruptcy are much larger than the indirect costs?such as lost sales, depressed product prices, and the loss of key personnel"?is:

True

False

9. Under the current U.S. tax code, consideration of personal taxes implies that the gain from leverage is:

	a.	Higher than when only corporate taxes are considered
	b.	Lower than when only corporate taxes are considered
	c.	Identical to when only corporate taxes are considered
	d.	Indeterminate

10. True or False : Under the trade-off theory, the statement: "Choosing a firm's optimal capital structure essentially consists of setting the D/V ratio to maximize firm value considering jointly the tax shield benefits of debt and the expected costs associated with financial distress/bankruptcy" is:

True

False

11. Which of the following are predictions of trade-off theory, all else equal?

	a.	Firms with a larger proportion of intangible assets like R&D researchers should have higher leverage.
	b.	Firms with a larger proportion of assets whose use is unique to the firm should have higher leverage.
	c.	Firms with higher earnings volatility should have higher leverage.
	d.	Firms with diversified lines of business should have higher leverage.

12. An investor can create the effect of leverage on his/her account by:

I) Buying equity of an unlevered firm

II) Investing in risk-free debt like T-bills

III) Borrowing on his/her own account

	a.	I only
	b.	II only
	c.	III only
	d.	I and III only

13. An investor can undo the effect of leverage on his/her own account by:

I) Investing in the equity of a levered firm

II) Borrowing on his/her own account

III) Investing in bonds

	a.	I only
	b.	II only
	c.	III only
	d.	I and III only

14. The indirect costs of bankruptcy are borne principally by:

	a.	Bondholders
	b.	Stockholders
	c.	Managers
	d.	The federal government

15. The trade-off theory of capital structure predicts that (all else equal):

	a.	Firms with a larger proportion of intangible assets should have higher leverage ratios.
	b.	Firms with more stable cash flows should have higher leverage ratios than firms with risky cash flows.
	c.	Rapidly growing firms should borrow more than mature firms.
	d.	Increasing leverage increases firm value at high debt ratios.

16. True or false : The right to default is valuable to shareholders.

17. True or false : Financial distress always results in bankruptcy.

18. True or false : The present value of the interest tax shield is the same regardless of whether the firm plans to borrow permanently or temporarily.