ALFE 1. Business risk is concerned with the operations of the firm.

Which of the following is not associated with (or not a part of) business risk? a. b. c. d. e. Answer : D Demand variability. Sales price variability. The extent to which operating costs are fixed. Changes in required returns due to financing decisions. The ability to change prices as costs change.

2. The firms target capital structure is consistent with which of the following? a. b. c. d. e. Answer : D Maximum earnings per share (EPS). Minimum cost of debt (kd). Minimum risk. Minimum cost of equity (ks). Minimum weighted average cost of capital (WACC).

3. The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called: a. homemade leverage. b. dividend recapture. c. the weighted average cost of capital. d. private debt placement. e. personal offset. Answer : A 4. A levered firm is a company that has: a. Accounts Payable as the only liability on the balance sheet. b. has some debt in the capital structure. c. has all equity in the capital structure. d. All of the above. e. None of the above. Answer : B 5. Financial leverage impacts the performance of the firm by: a. increasing the volatility of the firm's EBIT. b. decreasing the volatility of the firm's EBIT. c. decreasing the volatility of the firm's net income. d. increasing the volatility of the firm's net income e. None of the above. Answer : D 6. The increase in risk to equity holders when financial leverage is introduced is evidenced by: a. higher EPS as EBIT increases. b. a higher variability of EPS with debt than all equity. c. increased use of homemade leverage. d. equivalence value between levered and unlevered firms in the presence of taxes. e. None of the above.

Answer : B 7. A firm should select the capital structure which: a. produces the highest cost of capital. b. maximizes the value of the firm. c. minimizes taxes. d. is fully unlevered. e. has no debt. Answer : B 8. The capital structure chosen by a firm doesnt really matter because of: a. taxes. b. the interest tax shield. c. the relationship between dividends and earnings per share. d. the effects of leverage on the cost of equity. e. homemade leverage. Answer : E 9. The interest tax shield is a key reason why: a. the required rate of return on assets rises when debt is added to the capital structure. b. the value of an unlevered firm is equal to the value of a levered firm. c. the net cost of debt to a firm is generally less than the cost of equity. d. the cost of debt is equal to the cost of equity for a levered firm. e. firms prefer equity financing over debt financing. Answer : C 10. Which of the following factors is likely to encourage a corporation to increase the proportion of debt in its capital structure? a. b. c. d. e. Answer : A An increase in the corporate tax rate. An increase in the personal tax rate. An increase in the companys degree of operating leverage. The companys assets become less liquid. An increase in expected bankruptcy costs.

11. Which of the following statements is most correct? a. When a company increases its debt ratio, the costs of equity and debt capital both increase. Therefore, the weighted average cost of capital (WACC) must also increase. b. The capital structure that maximizes stock price is generally the capital structure that also maximizes earnings per share. c. All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio. d. Statements a and b are correct. e. Statements a and c are correct. Answer : C