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Leverage and Capital structure multiple choice questions

1) Which one of the following is correct?
-since the cost of debt is generally fixed, increasing the debt ratio tends to stabilize net income.
---When a company increases its debt ratio the costs of equity and debt both increase. Therefore the WACC must also increase.
----All else equal, an increase in the corporate tax rate would tend to encourage companies to increase their debt ratios.
---The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share.
---Since debt financing raises the firm's finanicial risk, increasing a company's debt ratio will always increase its WACC.

2) Which one of the following statements is correct?
--In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixes costs.
--Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equality.
--a firm with a relatively high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.
--If a firm's after tax cost of equality exceeded its after tax cost of debt, it can always reduce its WACC by increasing its use of debt.
--there is no reason to think that changes in the personal tax rate would affect firms capital structure decisions.

3) Which one is correct
--if the company has no debt outstanding, then its degree of total leverage equals its degree of financial leverage.
--if a firm's degree of operating leverage increases, its degree of financial leverage must also increase.
--if the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage.
--an increase in interest expense will reduce the company's degree of financial leverage.
--an increase in fixed costs will reduce the company s degree of operating leverage.

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1. All else equal, an increase in the corporate tax rate would tend to encourage companies ...

Solution Summary

Which one of the following is correct?
-since the cost of debt is generally fixed, increasing the debt ratio tends to stabilize net income.
---When a company increases its debt ratio the costs of equity and debt both increase. Therefore the WACC must also increase.
----All else equal, an increase in the corporate tax rate would tend to encourage companies to increase their debt ratios.
---The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share.
---Since debt financing raises the firm's finanicial risk, increasing a company's debt ratio will always increase its WACC.

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