1. The greater the variability of costs, the greater the business risk of the firm.

This is reflected in the: B) cost of inputs used to produce a firms output 2. The increased variability in earnings per share due to the firm's use of debt is a definition of ____. A) financial risk 3. ____ represents the permanent sources of the firm's financing. D) Capital structure 4. Perfect capital markets imply the following: A) all investors can borrow and lend at the same rate 5. Generally the ____ a firm's business risk, the ____ the amount of financial leverage that will be used in the optimal capital structure. B) greater, less 6. The use of fixed cost sources of funds, such as debt and preferred stock affect a firm's ____. B) financial risk 7. As the proportion of debt in the capital structure increases, investors require a ____ return and the value of existing debt will ____. D) higher, decrease 8. Which of the following statements is (are) true concerning the relationship between the firm's cost of equity and its capital structure (as measured by the debt ratio)? C) The exact relationship between the cost of equity and the debt ratio is difficult to determine. 9. Investors' required returns and the cost of equity capital ____ as the relative amount of debt used to finance the firm ____. A) increase, increases 10. The mix of debt, preferred stock, and common equity that minimizes the weighted cost of

capital to the firm is known as the C) optimal capital structure 11. The objective of capital structure management is to find the capital mix that leads to A) shareholder wealth maximization 12. The optimal capital structure of a firm is a function of the ____. A) business risk of the firm and the tax structure 13. With an optimal capital structure A) overall capital costs are minimized 14. Due to both financial distress and agency costs, a firm should have a capital structure that C) contains both debt and equity 15. In considering the arbitrage process in perfect capital markets with no income taxes, the market value of a firm is _________________. C) independent of its capital structure. 16. Studies of capital structure changes have found that actions that increase leverage have generally been associated with ____ stock returns and actions that decrease leverage are associated with ____ stock returns. D) positive, negative 17. What is the market value of Barings, a firm with total assets of $100 million and $30 million in perpetual debt in its capital structure. Barings' cost of equity is 15% and its cost of debt is 10%. Expected perpetual net operating income (EBIT) will be $17 million and the marginal tax rate is 40%. C) $86.0 million 18. The airline industry is extremely price competitive, as well as having huge fixed costs and very low variable costs. This is an example of: C) high operating leverage 19. What is optimal capital structure? B) It is the mix of debt, preferred stock and common equity that minimizes the weighted cost of the firms employed capital.

20. RoTek has a capital structure of $300,000 in equity and $300,000 in perpetual debt. The firm's cost of equity is 14 percent and its cost of debt is 9 percent. If the firm has an expected, perpetual net operating income of $120,000 and a marginal tax rate of 40 percent, what is the market value of RoTek? Assume all net income is paid out as dividends. A) $698,571 21. What is the present value of the tax shield to a firm that has a capital structure consisting of $100 million of perpetual debt and $180 million of equity, if the average interest rate on debt is 9%, the return on equity is 13%, and the marginal tax rate is 40%? C) $40 million 22. Calculate the market value of a firm with total assets of $105 million and $50 million of 10% perpetual debt in the capital structure. The firm's cost of equity is 14% on the $55 million in equity in the capital structure. The perpetual EBIT is expected to be $9 million and the marginal tax rate is 40%. D) $67.1 million 23. Two prominent finance researchers (Modigliani and Miller) showed that D) the value of the firm is independent of its capital structure in perfect capital markets with no income taxes 24. A survey of Fortune 500 firms indicate that they prefer internal financing (retained earnings) to external financing. This preference is known as ____. B) the pecking order theory 25. A firm accepts the risk of fixed-cost financing is to: B) increase possible returns to stockholders. 26. What is the annual tax shield to a firm that has total assets of $80 million and a net worth of $55 million, if the average interest rate on debt is 8.5%, the average return on equity is 14%, and the marginal tax rate is 35%? C) $0.744 million 27. The amount of debt in a firms optimal capital structure is often referred to as the firms: D) debt capacity

28. Agency costs B) reduce the market value of the levered firm 29. Market value of levered firm = Market value of unlevered firm ____ Present value of tax shield ____ Present value of financial distress costs ____ Present value of agency costs B) plus; minus; minus 30. One of the primary assumptions of capital structure analysis is that the level and variability of ____ is not expected to change as changes in capital structure are contemplated. A) operating income 2. What is the present value of the tax shield to a firm that has total assets of $80 million and a net worth of $55 million, if the average interest rate on perpetual debt is 8.5%, the average return on equity is 14%, and the marginal tax rate is 35%? A) $8.75 million 3. Financial leverage benefits shareholders when the D) return on assets is greater than the cost of debt 6. Modigliani and Miller show that the value of a firm is ____ capital structure given perfect capital markets and no corporate income taxes. B) independent of 7. In considering a firms capital structure, the firm should increase its ____ which will maximize its value. D) debt 12. The Modigliani-Miller theory that the value of the firm is independent of its capital structure is based on a(n) ____ process. D) arbitraging 13. Arbitrage transactions are:

A) risk-free 14. What is the annual tax shield to a firm that has a capital structure consisting of $100 million of debt and $180 million of equity, if the average interest rate on debt is 9%, the return on equity is 13%, and the marginal tax rate is 40%? B) $3.6 million 15. In determining the capital structure for an international firm, the managerial objective is to C) minimize the overall cost of capital 16. As more debt is added to the capital structure of a firm, the cost of debt capital D) initially rises slowly, then increases rapidly beyond some point 17. In analyzing the value of the firm as a function of capital structure, the present value of the tax shield benefit is offset by the present value of the expected ____, resulting in an interior optimal capital structure. D) financial distress costs and agency costs 18. The optimal capital structure is a function of ____. C) corporate income taxes, financial distress costs, and agency costs 20. Calculate the market value of a firm with total assets of $60 million and a net worth of $35 million. The firm's cost of equity is 15% and the cost of perpetual debt is 8%. The firm has a perpetual net operating income (EBIT) of $4.5 million and a marginal tax rate of 35%. D) $35.83 million 21. The amount of permanent short-term debt, long-term debt, preferred stock, and common stock used to finance a firm defines the firm's C) capital structure 22. The process of simultaneously buying and selling the same or equivalent securities in different markets to take advantage of price differences and make a profit is called: A) arbitrage

25. With financial leverage, a change in EBIT results in a change in: C) EPS 29. Calculate the market value of Lotle Group, a firm with total assets of $80 million and $30 million of perpetual debt in its capital structure. The firm's cost of equity is 14% and the cost of debt is 9%. Lotle expects annual, perpetual net operating income (EBIT) of $9 million and a marginal tax rate of 40%. C) $57 million 30. Which of the following statements is true regarding the relationship between the firm's cost of debt and its capital structure (as measured by the debt ratio)? A) The range of debt ratios where the cost of debt begins to increase rapidly varies by firm and industry, depending on the level of business risk. 3. The capital structure decision attempts to minimize ____ which maximizes the value of the firm. C) the cost of capital 13. The tax deductibility of the interest payments on corporate debt is known as: C) the tax shield 21. The tax deductibility of interest payments provides the firm with a: C) tax shield 22. Operating leverage involves the use of A) assets having fixed costs 23. The management of Graphicopy is trying to determine how much debt they should have in their capital structure. If they sell $500,000 in perpetual bonds with a 9 percent coupon, what would be the present value of the tax shield? Assume the marginal tax rate is 35%. A) $175,000 24. Holding all other things equal, as the relative amount of debt in the capital structure of the firm increases, the cost of equity capital will

A) increase 27. ____ refers to the argument that officers and managers have access to information about the expected future earnings of the firm that is not available to outside investors. A) Asymmetric information 6. The use of fixed-cost financing sources is referred to as the use of C) financial leverage 11. A firm with highly liquid assets plus unused debt capacity is said to have ____. C) financial slack 25. According to the "pecking order theory," firms prefer to issue ____ securities first and then issue ____ securities as a last resort. A) debt, equity 24. The less a firm's business risk, the ____ the amount of ____ that will be used in the optimal capital structure, holding constant all other relevant factors. D) more; financial leverage