Exam 15: Cap Structure

A) The capital structure that minimizes the interest rate on debt also maximizes the expected EPS.
B) The capital structure that minimizes the required return on equity also maximizes the stock price.
C) The capital structure that minimizes the WACC also maximizes the price per share of common stock.
D) The capital structure that gives the firm the best credit rating also maximizes the stock price.
E) The capital structure that maximizes expected EPS also maximizes the price per share of common stock.

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A) normally lead to a decrease in its business risk.
B) normally lead to a decrease in the standard deviation of its expected EBIT.
C) normally lead to a decrease in the variability of its expected EPS.
D) normally lead to a reduction in its fixed assets turnover ratio.
E) normally lead to an increase in its fixed assets turnover ratio.

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A) Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries.
B) Drug companies (prescription, not illegal!) generally have high debt-to-equity ratios because their earnings are very stable and, thus, they can cover the high interest costs associated with high debt levels.
C) Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes.
D) Since most stocks sell at or very close to their book values, book value capital structures are almost always adequate for use in estimating firms' costs of capital.
E) Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry.

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A) The ROA would remain unchanged.
B) The basic earning power ratio would decline.
C) The basic earning power ratio would increase.
D) The ROE would increase.
E) The ROA would increase.

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A) 1.53%
B) 1.70%
C) 1.87%
D) 2.05%
E) 2.26%

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A) -5.20%
B) -5.78%
C) -6.36%
D) -6.99%
E) -7.69%

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A) 4,250
B) 4,500
C) 4,750
D) 5,000
E) 5,250

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A) 10.95%
B) 11.91%
C) 12.94%
D) 14.07%
E) 15.29%

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A) The optimal capital structure simultaneously maximizes EPS and minimizes the WACC.
B) The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price.
C) The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC.
D) The optimal capital structure simultaneously maximizes stock price and minimizes the WACC.
E) As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.

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D

A) 0.64
B) 0.67
C) 0.71
D) 0.75
E) 0.79

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A) The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share.
B) All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio.
C) Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.
D) Since debt is cheaper than equity, increasing a company's debt ratio will always reduce its WACC.
E) When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase.

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B

A) Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC.
B) Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing. However, this action still may raise the company's WACC.
C) Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing. However, this action still may lower the company's WACC.
D) Since a firm's beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity.
E) Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.

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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 = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40.
D) Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.
E) Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.

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A) Company HD has a lower ROA than Company LD.
B) Company HD has a lower ROE than Company LD.
C) The two companies have the same ROA.
D) The two companies have the same ROE.
E) Company HD has a higher net income than Company LD.

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A) The company's earnings per share would decline.
B) The company's cost of equity would increase.
C) The company's ROA would increase.
D) The company's ROE would decline.
E) The company's net income would increase.

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B

A) Sales price variability.
B) The extent to which operating costs are fixed.
C) The extent to which interest rates on the firm's debt fluctuate.
D) Input price variability.
E) Demand variability.

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