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Chapter 17: Capital Structure Determination

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1. The term "capital structure" refers to:

long-term debt, preferred stock, and common stock equity.

current assets and current liabilities.

total assets minus liabilities.

shareholders' equity.

2. A critical assumption of the net operating income (NOI) approach to valuation is:

that debt and equity levels remain unchanged.

that dividends increase at a constant rate.

that k_o remains constant regardless of changes in leverage.

that interest expense and taxes are included in the calculation.

3. The traditional approach towards the valuation of a company assumes:

that the overall capitalization rate holds constant with changes in financial leverage.

that there is an optimum capital structure.

that total risk is not altered by changes in the capital structure.

that markets are perfect.

4. Two firms that are virtually identical except for their capital structure are selling in the market at different values. According to M&M

one will be at greater risk of bankruptcy.

the firm with greater financial leverage will have the higher value.

this proves that markets cannot be efficient.

this will not continue because arbitrage will eventually cause the firms to sell at the same
value.

5. The cost of monitoring management is considered to be a (an):

bankruptcy cost.

transaction cost.

agency cost.

institutional cost.

6. What is the value of the tax shield if the value of the firm is $5 million, its value if unlevered would be $4.78 million, and the present value of bankruptcy and agency costs is $360,000?

$140,000

$220,000

$360,000

$580,000

7. According to the concept of financial signaling, management behavior results in new debt issues being regarded as " news" by investors.

good

bad

non-event

risk-neutral

8. The cost of capital for a firm -- when we allow for taxes, bankruptcy, and agency costs --

remains constant with increasing levels of financial leverage.

first declines and then ultimately rises with increasing levels of financial leverage.

increases with increasing levels of financial leverage.

decreases with increasing levels of financial leverage.

9. When sequential long-term financing is involved, the choice of debt or equity influences the future financial of the firm.

timing

flexibility

liquidity

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