Chapter 17 - Capital Structure: Limits to the Use of Debt
17. Given realistic estimates of the probability and cost of bankruptcy, the future costs of a possible bankruptcy are borne by: A. all investors in the firm.
B. debtholders only because if default occurs interest and principal payments are not made. C. shareholders because debtholders will pay less for the debt providing less cash for the shareholders.
D. management because if the firm defaults they will lose their jobs. E. None of the above.
18. Conflicts of interest between stockholders and bondholders are known as: A. trustee costs.
B. financial distress costs. C. dealer costs. D. agency costs.
E. underwriting costs.
19. One of the indirect costs of bankruptcy is the incentive for managers to take large risks. When following this strategy:
A. the firm will rank all projects and take the project which results in the highest expected value of the firm.
B. bondholders expropriate value from stockholders by selecting high risk projects. C. stockholders expropriate value from bondholders by selecting high risk projects. D. the firm will always take the low risk project. E. Both A and B.
20. One of the indirect costs to bankruptcy is the incentive toward underinvestment. Following this strategy may result in:
A. the firm always choosing projects with the positive NPVs.
B. the firm turning down positive NPV projects that it would clearly accept in an all equity firm. C. stockholders contributing the full amount of the investment, but both stockholders and bondholders sharing in the benefits of the project. D. Both A and C. E. Both B and C.
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Chapter 17 - Capital Structure: Limits to the Use of Debt
21. Which of the following is true?
A. A firm with low anticipated profit will likely take on a high level of debt. B. A successful firm will probably take on zero debt.
C. Rational firms raise debt levels when profits are expected to decline.
D. Rational investors are likely to infer a higher firm value from a zero debt level.
E. Investors will generally view an increase in debt as a positive sign for the firm's value.
22. Studies have found that firms with high proportions of intangible assets are likely to use ____________ debt compared with firms with low proportions of intangible assets. A. more
B. the same amount of C. less
D. either more or the same amount of E. any amount of debt
23. What three factors are important to consider in determining a target debt to equity ratio? A. Taxes, asset types, and pecking order and financial slack
B. Asset types, uncertainty of operating income, and pecking order and financial slack C. Taxes, financial slack and pecking order, and uncertainty of operating income D. Taxes, asset types, and uncertainty of operating income E. None of the above.
24. An exchange may offer:
A. allow customers a 30 day money-back guarantee on the firm's product. B. allow customers a 90 day warranty on the firm's product from defects. C. allow bondholders to exchange some debt for stock.
D. allow stockholders to exchange some of their stock for debt. E. Both C and D.
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Chapter 17 - Capital Structure: Limits to the Use of Debt
25. Which of the following is not empirically true when formulating capital structure policy? A. Some firms use no debt.
B. Most corporations have low debt-asset ratios.
C. There are no differences in the capital-structure of different industries. D. Debt levels across industries vary widely.
E. Debt ratios in most countries are considerably less than 100%.
26. When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends, these will result in:
A. no action by debtholders since these are equity holder concerns.
B. positive agency costs, as bondholders impose various restrictions and covenants which will diminish firm value.
C. investments of the same risk class that the firm is in. D. undertaking scale enhancing projects.
E. lower agency costs, as shareholders have more control over the firm's assets.
27. Indirect costs of bankruptcy are born principally by: A. bondholders. B. stockholders. C. managers.
D. the federal government. E. the firm's suppliers.
28. The value of a firm in financial distress is diminished if the firm: A. is declared bankrupt and proceeds to be liquidated.
B. is declared insolvent and undergoes financial reorganization. C. is a partnership. D. Both A and C. E. Both A and B.
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Chapter 17 - Capital Structure: Limits to the Use of Debt
29. Covenants restricting the use of leasing and additional borrowings primarily protect: A. the equityholders from added risk of default.
B. the debtholders from the added risk of dilution of their claims. C. the debtholders from the transfer of assets.
D. the management from having to pay agency costs. E. None of the above.
30. If a firm issues debt but writes protective and restrictive covenants into the loan contract, then the firm's debt may be issued at a _____ interest rate compared with otherwise similar debt.
A. significantly higher B. slightly higher C. equal D. lower
E. Either A or B
31. When graphing firm value against debt levels, the debt level that maximizes the value of the firm is the level where:
A. the increase in the present value of distress costs from an additional dollar of debt is greater than the increase in the present value of the debt tax shield.
B. the increase in the present value of distress costs from an additional dollar of debt is equal to the increase in the present value of the debt tax shield.
C. the increase in the present value of distress costs from an additional dollar of debt is less than the increase of the present value of the debt tax shield. D. distress costs as well as debt tax shields are zero.
E. distress costs as well as debt tax shields are maximized.
32. When firms issue more debt, the tax shield on debt _____, the agency costs on debt (i.e., costs of financial distress) _____, and the agency costs on equity _____. A. increases; increase; increase B. decreases; decrease; decrease C. increases; increase; decrease D. decreases; decrease; increase E. increases; decrease; decrease
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