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Cost of Debt, Cost of Capital, Leverage & Dividend Reinvestment

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1.9 The before-tax cost of debt for a firm which has a 40 percent marginal tax rate is 12 percent. The after-tax cost of debt is:

a. 4.8 percent
b. 6.0 percent
c. 7.2 percent
d. 12 percent

1.10 The cost of capital reflects the cost of funds:

a. over a short-run time period
b. at a given point in time
c. over a long-run time period
d. at current book values

1.11 Financial leverage measures the effect of fixed operating cost on the relationship between:

a. Sales and EBIT
b. Sales and EPS
c. EBIT and EPS
d. None of the above

1.12 Total leverage measures the effect of fixed costs on the relationship between:

e. Sales and EBIT
f. Sales and EPS
g. EBIT and EPS
h. None of the above

1.15 A decrease in fixed operating cost will result in ___________in the degree of financial leverage:

a. a decrease
b. an increase
c. no change
d. an undetermined change

1.16 ____________is the potential use of fixed financial charges to magnify the effects of changes in earnings before interest and taxes on the firm's earnings per share.

a. Financial leverage
b. Operating leverage
c. Total leverage
d. Debt service

1.17 In general, with regard to dividend payments, the contractual constraints imposed by loan agreements can include all of the following EXCEPT

a. prohibit the payment of cash dividends until a certain level of earnings has been achieved.
b. limit the percentage of earnings that can be paid out in dividends
c. limit the actual dollar amount of dividends that can be paid out
d. require the payment of a common stock dividend

1.24 ____________leverage is concerned with the relationship between sales revenues and earnings before interest and taxes.

a. Financial
b. Operating
c. Variable
d. Total

1.25 At a base sales level or $400,000, a firm has a degree of operating leverage of 2 and a degree of financial leverage of 1.5. The firm's degree of total leverage is:

a. 3.5
b. 3.0
c. .05
d. 1.3

1.26 A dividend reinvestment plan _____________on the security.

a. decreases the return
b. has no effect on the return
c. increases the return
d. has an undetermined effect

1.28 A corporation has $5,000,000 of 8 percent preferred stock outstanding and a 40 percent tax rate. The after-tax cost of the preferred stock is:

a. $400,000
b. $240,000
c. $666,667
d. $160,000

1.50 The_____________ is the firm's desired optimal mix of debt and equity financing.

a. book value
b. market value
c. cost of capital
d. target capital structure

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1.9 The before-tax cost of debt for a firm which has a 40 percent marginal tax rate is 12 percent. The after-tax cost of debt is:

a. 4.8 percent
b. 6.0 percent
c. 7.2 percent
d. 12 percent

Answer: c 7.2 percent
After tax cost = Before tax cost x (1-Tax rate) = 12 % x (1-0.4) = 7.2%

1.10 The cost of capital reflects the cost of funds:

a. over a short-run time period
b. at a given point in time
c. over a long-run time period
d. at current book values

Answer: c) over a long-run time period

1.11 Financial leverage measures the effect of fixed operating cost on the relationship between:

a. Sales and EBIT
b. Sales and EPS
c. EBIT and EPS
d. None of the above

Answer: c) EBIT and EPS

Degree of Financial Leverage = % change in EPS / % change in EBIT

1.12 Total leverage measures the effect of fixed costs on the relationship between:

a. Sales and EBIT
b. Sales and EPS
c. EBIT and EPS
d. None of the above

Answer: b) Sales and EPS

Degree of Total Leverage = % change in EPS / % change in ...

Solution Summary

Answers Multiple Choice Questions on: cost of debt, cost of capital, leverage, dividend reinvestment plan, cost of the preferred stock, optimal mix of debt and equity financing.

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Finance Problems

Which of the following component costs is expressed on an after-tax basis in the calculation of a firm's cost of capital?

a.
cost of debt

b.
cost of preferred stock

c.
cost of common equity

d.
b and c

e.
all of the above

The component cost of a firm's preferred stock consists of

a.
the current dividend yield.

b.
the expected growth rate of dividends.

c.
dividends expressed as a percent of par value.

d.
a and b

Which of the following would increase the WACC?

a.
an increase in flotation costs

b.
a decrease in tax rates

c.
a decrease in preferred dividends

d.
Both a & b

e.
All of the above

8. If a project comes with its own funding offered at a rate lower than the cost of capital, the capital budgeting analysis should be conducted using

a.
the offered rate because it is appropriate to match sources and uses of funding whenever possible.

b.
the cost of capital because to do otherwise would be unfair to departments whose projects don't happen to have separate funding

c.
the cost of capital because doing otherwise leads to irrational capital budgeting decisions

d.
an average of the offered rate and the cost of capital because that gives the best measure of the effect of the offer on the firm

Show solution and answer to this question below

15. A firm's correctly computed capital structure is 30% debt, 20% preferred stock, and 50% equity. If retained earnings of $1 million are expected, how much capital will have been raised when retained earnings are exhausted and new common equity must be issued?

a.
$1,428,571

b.
$1,000,000

c.
$2,000,000

d.
$3,333,333

Show solution and answer to this question below

If a firm's EBIT changes by 20% and it has a degree of financial leverage (DFL) of 2.0, what is the expected change in earnings per share (EPS)?

a.
20%

b.
40%

c.
50%

d.
60%

According to the MM model of capital structure, the present value of the tax shield is offset by potential __________, resulting in an optimal capital structure.

a.
bankruptcy costs

b.
interest expense

c.
operating costs

d.
a and b

Show solution and answer to this question below

Assume the following facts about a company:

Capital (000s)

EBIT (000s)
$1,000

Debt
-
Less Interest Expense
-

Equity
$3,000
EBT
$1,000

Total Capital
$3,000
Taxes @ 40%
400

Shares @ $10 = 300

Earnings after Tax
$ 600

What will be the company's new EPS if it borrows money at 10% interest and uses it to retire stock until capital is 40% debt? The stock can be purchased at its book value of $10 per share.

a.
$3.33

b.
$4.89

c.
$2.93

d.
none of the above

Show solution and answer to this question below

Khandker Motors finances 40% of its total capital with debt. The cost of debt is 11%. The firm is in the 37% tax bracket and earned an operating profit of $2.5 million dollars. If the Khandker's total capital amounts to $22 million and its book value per share is $20, what is the firm's earnings per share?

a.
$0.85

b.
$0.88

c.
$1.43

d.
$1.46

Show solution and answer to this question below

Zahn Enterprises pays $3 million annually to its bondholders and $7.5 million annual to its stockholders. The required rates of return are 9 percent and 15 percent, respectively, by the bondholders and stockholders. What is the value of Zahn Enterprises?

a.
$1.40 million

b.
$10.50 million

c.
$16.66 million

d.
$83.33 million

Shareholder needs or preferences that may influence the dividend decision include:

a.
the need for current income support oneself

b.
a preference for price appreciation because current income isn't needed

c.
a preference for capital gains over ordinary income.

d.
all of the above

Various management actions provide investors with clues as to the future prospects for the firm. Which of the following actions by management contains the most important economic information for common stock investors?

a.
A 20 percent increase in cash dividends per share.

b.
A 100 percent stock dividend

c.
A 2-for-1 stock split.

d.
a, b, and c are equally important.

Which statement related to the signaling effect of dividends is true?

a.
The signaling effect can explain why an increase in the dividend is often followed by an increase in stock price.

b.
The signaling effect is a reason a firm may follow a constant or steadily increasing dividend policy.

c.
Changes in dividends can be interpreted as a signal from management about changes in the company's future earnings.

d.
all of the above.

Show solution and answer to this question below

A firm's balance sheet discloses cash of $300,000, other assets of $700,000, liabilities of $500,000, preferred stock of $100,000, common stock of $200,000, and retained earnings of $200,000. What is the maximum cash dividend the firm can pay?

a.
$100,000

b.
$300,000

c.
$200,000

d.
$500,000

In dividend reinvestment plans, stockholders receive additional shares instead of cash dividends. Shareholders

a.
are not taxed at the time of the dividend because they received no cash

b.
must pay tax on the full value of the new shares at the time they are sold

c.
must pay tax in the year of the dividend on the value used to buy the new shares

d.
must pay tax on the dividend amount when the shares are sold.

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