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Exam 12: Leverage and Capital Structure

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Question 31

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The risk of the debt capital is less than that of other long-term contributors of capital because ________.

A) they have a lower priority of claim against any earnings or assets available for payment
B) they have the stockholders' personal assurance for all future interest payments
C) there is no interest rate risk as the interest rate is predetermined
D) the tax-deductibility of interest payments lowers the debt cost to a firm substantially

E) A) and B)
F) C) and D)

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Question 32

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In general,low times interest earned ratio and fixed-payment coverage ratio are associated with a high degree of financial leverage.

A) True
B) False

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Question 33

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Operating and financial constraints placed on a corporation by loan provision are ________.

A corporation has $10,000,000 of 10 percent preferred stock outstanding and a 40 percent tax rate.The amount of earnings before interest and taxes (EBIT) required to pay the preferred dividends is ________.

Whenever the percentage change in earnings per share (EPS)resulting from a given percentage change in sales is greater than the percentage change in sales,financial leverage exists.

An increase in cost (fixed cost or variable cost)tends to increase the operating breakeven point,whereas an increase in the sales price per unit will decrease the operating breakeven point.

The major shortcoming of the EBIT-EPS approach to capital structure is that ________.

Business risk is the risk to the firm of being unable to cover required financial obligations.

Generally,increases in leverage result in ________ return and ________ risk.

If a firm's variable costs per unit increase,the firm's ________.

Earnings before interest and taxes are positive above the operating breakeven point,and a loss occurs below it.

Revenue stability affects ________.

Because risk premiums increase with increases in financial leverage,maximizing EPS does not assure owners' wealth maximization.

A decrease in fixed operating costs will result in ________ in the degree of financial leverage.

With the existence of fixed operating costs,a decrease in sales will result in ________ in EBIT.

Higher financial leverage causes ________ to increase more for a given increase in ________.

Which of the following affects business risk?

The amount of leverage in a firm's capital structure-the mix of long-term debt and equity maintained by the firm-can significantly affect its value by affecting return and risk.

The asymmetric information explanation of capital structure suggests that firms will issue new equity only when the managers believe the firm's stock is overvalued; as a result,issuing new equity is considered a negative signal that will result in a decline in share price.

An increase in fixed operating and financial cost results in an increase in risk,since the firm will have to achieve a higher level of sales just to break even.