17.11: Multiple Choice

1.

Sandage Auto Parts has debt outstanding with a market value of $2 million. The company’s common stock has a book value of $3 million and a market value of $8 million. What weight is equity in Sandage’s capital structure?

1. 11%
2. 20%
3. 60%
4. 80%

2.

The capital structure of a company refers to ________.

1. whether the company purchases assets or liabilities with its equity
2. the proportion of debt and equity the company uses in financing is assets
3. the ability of the company to use its assets to generate equity for the owners
4. whether the company uses short-term assets or long-term assets to create its product

3.

Which of the following should be used when calculating the weights for a company’s capital structure?

1. Book values
2. Current market values
3. Historic accounting values
4. Par and face values

4.

Two methods for estimating a company’s cost of common stock capital are ________.

1. the historic method and the current method
2. the weighted valuation model and the beta model
3. the constant dividend growth model and the CAPM
4. the balance sheet method and the face value method

5.

Which of the following would be the most reasonable approach to calculating the cost of debt for a company?

1. Using the coupon rate on the company’s existing bonds
2. Using the interest amount reported on the income statement
3. Using the yield to maturity on the company’s existing bonds
4. Multiplying the amount of debt on the company’s balance sheet by the risk-free rate

6.

Net debt equals ________.

1. Debt/Equity
2. Debt × (1 – Tax Rate)
3. total debt minus the cash and risk-free assets the company owns
4. the yield to maturity of a company’s bonds divided by the tax rate

7.

Unlevered equity refers to ________.

1. the equity in a firm with no debt
2. a firm’s equity minus the firm’s debt
3. the equity in a firm in the absence of taxation and transaction costs
4. the portion of a firm’s capital structure that is financed by its owners

8.

In perfect capital markets, ________.

1. a company’s WACC does not change as it changes its capital structure
2. a company can lower its WACC by using more debt in its capital structure
3. a company can lower its WACC by using more equity in its capital structure
4. a company’s cost of debt capital is exactly equal to its cost of equity capital when the company uses 50% debt and 50% equity in its capital structure

9.

The interest tax shield occurs because ________.

1. interest payments are a tax-deductible expense
2. interest payments are made from after-tax income
3. investors require a lower rate of return the higher the company’s tax rate
4. investors require a lower rate of return the more debt the company incurs

10.

As a company increases the weight of debt in its capital structure, ________.

1. its cost of debt capital falls
2. the weight of equity capital also increases
3. the value of the interest tax shield decreases
4. its possibility of financial distress increases

11.

A company is said to be in financial distress if ________.

1. it is not fully exploiting the interest tax shield
2. it needs to raise capital to finance a new project
3. it has difficulty meeting its debt obligations
4. its cost of equity capital exceeds its cost of debt capital

12.

Issuing new stock ________.

1. costs the same as retaining earnings
2. will not impact a company’s WACC
3. is the most expensive source of capital because of flotation costs
4. is the cheapest source of capital because dividends do not have to be paid each year

13.

If a bond with a face value of $1,000 has a conversion ratio of 10 shares, the conversion price is ________.

1. $0.01
2. $10
3. $100
4. $1,000