Variable Cost and Capital Structure

Topics: Variable cost, Costs, Total cost Pages: 9 (1560 words) Published: March 12, 2014


1. Which of the following would increase the likelihood that a company would increase its debt ratio in its capital structure? a.An increase in costs incurred when filing for bankruptcy. b.An increase in the corporate tax rate.

c.An increase in the personal tax rate.
d.None of the statements above is correct.

ANSWER: B An increase in the corporate tax rate would mean that firms would get larger tax breaks for interest payments. Therefore, firms have an incentive to increase interest payments, in order to reduce taxes. Therefore, they will increase their debt ratios.

2. Which of the following events is likely to encourage a company to raise its target debt ratio?
a.An increase in the corporate tax rate.
b.An increase in the personal tax rate.
c.An increase in the company’s operating leverage.
d.Statements a and c are correct.

ANSWER: A An increase in the tax rate would lower the after-tax cost of debt relative to equity; therefore, this would encourage a company to raise its target debt ratio.

3. Which of the following statements is most correct?

a.Since debt financing raises the firm's financial risk, raising a company’s debt ratio will always increase the company’s WACC. b.Since debt financing is cheaper than equity financing, raising a company’s debt ratio will always reduce the company’s WACC. c.Increasing a company’s debt ratio will typically reduce the marginal cost of both debt and equity financing; however, it still may raise the company’s WACC.

d.None of the statements above is correct.

ANSWER: D

4. Which of the following statements is most correct?
a.As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. b.The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. c.The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. d.None of the statements above is correct.

ANSWER: D The optimal capital structure maximizes the firm’s stock price and minimizes the firm’s WACC.

5. Which of the following is likely to encourage a company to use more debt in its capital structure? a.An increase in the corporate tax rate.
b.An increase in the personal tax rate.
c.A decrease in the company’s degree of operating leverage. d.All of the statements above are correct.
ANSWER: D
6. Which of the following factors would affect a company’s business risk?\ a.The level of uncertainty regarding the demand for its product. b.The degree of operating leverage.
c.The amount of debt in its capital structure.
d.Statements a and b are correct.

ANSWER: D The correct answer is statement d. Statements a and b are correct. Both relate directly to the business side of the firm. Statement c, on the other hand, is related to the financial risk of the firm. Since statements a and b are correct, statement d is the correct choice.

7. The firm's capital structure refers to:
a. the way a firm invests its assets.
b. the amount of capital in the firm.
c. the amount of dividends a firm pays.
d. the mix of debt and equity used to finance the firm's assets. ANSWER: D

8. A general rule for managers to follow is to set the firm's capital structure such that: a. the firm's value is minimized.
b. the firm's value is maximized.
c. the firm's bondholders are made well off.
d. the firms suppliers of raw materials are satisfied.
ANSWER: B

9. A manager should attempt to maximize the value of the firm by: a. changing the capital structure if and only if the value of the firm increases. b. changing the capital structure if and only if the value of the firm increases to the benefits to inside management. c. changing the capital structure if and only if the value of the firm increases only to the benefits the debt holders. d. changing the capital structure if and only if the value of the firm increases although it decreases...
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