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Chapter17-CapitalStructure:LimitstotheUseofDebt17-1Chapter17CapitalStructure:LimitstotheUseofDebtMultipleChoiceQuestions1.Theexplicitcosts,suchasthelegalexpenses,associatedwithcorporatedefaultareclassifiedas_____costs.A.flotationB.betaconversionC.directbankruptcyD.indirectbankruptcyE.unlevered2.Thecostsofavoidingabankruptcyfilingbyafinanciallydistressedfirmareclassifiedas_____costs.A.flotationB.directbankruptcyC.indirectbankruptcyD.financialsolvencyE.capitalstructure3.Theexplicitandimplicitcostsassociatedwithcorporatedefaultarereferredtoasthe_____costsofafirm.A.flotationB.defaultbetaC.directbankruptcyD.indirectbankruptcyE.financialdistress4.Indirectcostsoffinancialdistress:A.effectivelylimittheamountofequityafirmissues.B.serveasanincentivetoincreasethefinancialleverageofafirm.C.includedirectcostssuchaslegalandaccountingfees.D.tendtoincreaseasthedebt-equityratiodecreases.E.includethecostsincurredbyafirmasittriestoavoidseekingbankruptcyprotection.Chapter17-CapitalStructure:LimitstotheUseofDebt17-25.Thelegalproceedingforliquidatingorreorganizingafirmoperatingindefaultiscalleda:A.tenderoffer.B.bankruptcy.C.merger.D.takeover.E.proxyfight.6.Thevalueofafirmismaximizedwhenthe:A.costofequityismaximized.B.taxrateiszero.C.leveredcostofcapitalismaximized.D.weightedaveragecostofcapitalisminimized.E.debt-equityratioisminimized.7.Theoptimalcapitalstructurehasbeenachievedwhenthe:A.debt-equityratioisequalto1.B.weightofequityisequaltotheweightofdebt.C.costofequityismaximizedgivenapre-taxcostofdebt.D.debt-equityratioissuchthatthecostofdebtexceedsthecostofequity.E.debt-equityratioselectedresultsinthelowestpossibleweighedaveragecostofcapital.8.Inaworldwithtaxesandfinancialdistress,whenafirmisoperatingwiththeoptimalcapitalstructure:I.thedebt-equityratiowillalsobeoptimal.II.theweightedaveragecostofcapitalwillbeatitsminimalpoint.III.therequiredreturnonassetswillbeatitsmaximumpoint.IV.theincreasedbenefitfromadditionaldebtisequaltotheincreasedbankruptcycostsofthatdebt.A.IandIVonlyB.IIandIIIonlyC.IandIIonlyD.II,III,andIVonlyE.I,II,andIVonlyChapter17-CapitalStructure:LimitstotheUseofDebt17-39.Theoptimalcapitalstructurewilltendtoincludemoredebtforfirmswith:A.thehighestdepreciationdeductions.B.thelowestmarginaltaxrate.C.substantialtaxshieldsfromothersources.D.lowerprobabilityoffinancialdistress.E.lesstaxableincome.10.Theoptimalcapitalstructureofafirm_____themarketedclaimsand_____thenonmarketedclaimsagainstthecashflowsofthefirm.A.minimizes;minimizesB.minimizes;maximizesC.maximizes;minimizesD.maximizes;maximizesE.equates;(leaveblank)11.Theoptimalcapitalstructure:A.willbethesameforallfirmsinthesameindustry.B.willremainconstantovertimeunlessthefirmmakesanacquisition.C.ofafirmwillvaryovertimeastaxesandmarketconditionschange.D.placesmoreemphasisontheoperationsofafirmratherthanthefinancingofafirm.E.isunaffectedbychangesinthefinancialmarkets.12.ThebasiclessonofMMtheoryisthatthevalueofafirmisdependentuponthe:A.capitalstructureofthefirm.B.totalcashflowsofthefirm.C.percentageofafirmtowhichthebondholdershaveaclaim.D.taxclaimplacedonthefirmbythegovernment.E.sizeofthestockholdersclaimsonthefirm.Chapter17-CapitalStructure:LimitstotheUseofDebt17-413.CorporationsintheU.S.tendto:A.minimizetaxes.B.underutilizedebt.C.relylessonequityfinancingthantheyshould.D.haveextremelyhighdebt-equityratios.E.relymoreheavilyonbondsthanstocksasthemajorsourceoffinancing.14.Ingeneral,thecapitalstructuresusedbyU.S.firms:A.tendtooverweighdebtinrelationtoequity.B.areeasilyexplainedintermsofearningsvolatility.C.areeasilyexplainedbyanalyzingthetypesofassetsownedbythevariousfirms.D.tendtobethosewhichmaximizetheuseofthefirm'savailabletaxshelters.E.varysignificantlyacrossindustries.15.TheMMtheorywithtaxesimpliesthatfirmsshouldissuemaximumdebt.Inpractice,thisisnottruebecause:A.debtismoreriskythanequity.B.bankruptcyisadisadvantagetodebt.C.firmswillincurlargeagencycostsofshorttermdebtbyissuinglongtermdebt.D.BothAandB.E.BothBandC.16.Althoughtheuseofdebtprovidestaxbenefitstothefirm,debtalsoputspressureonthefirmto:A.meetinterestandprincipalpaymentswhich,ifnotmet,canputthecompanyintofinancialdistress.B.makedividendpaymentswhichifnotmetcanputthecompanyintofinancialdistress.C.meetbothinterestanddividendpaymentswhichwhenmetincreasethefirmcashflow.D.meetincreasedtaxpaymentstherebyincreasingfirmvalue.E.Noneoftheabove.Chapter17-CapitalStructure:LimitstotheUseofDebt17-517.Givenrealisticestimatesoftheprobabilityandcostofbankruptcy,thefuturecostsofapossiblebankruptcyareborneby:A.allinvestorsinthefirm.B.debtholdersonlybecauseifdefaultoccursinterestandprincipalpaymentsarenotmade.C.shareholdersbecausedebtholderswillpaylessforthedebtprovidinglesscashfortheshareholders.D.managementbecauseifthefirmdefaultstheywilllosetheirjobs.E.Noneoftheabove.18.Conflictsofinterestbetweenstockholdersandbondholdersareknownas:A.trusteecosts.B.financialdistresscosts.C.dealercosts.D.agencycosts.E.underwritingcosts.19.Oneoftheindirectcostsofbankruptcyistheincentiveformanagerstotakelargerisks.Whenfollowingthisstrategy:A.thef