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the effect to stock price as debt levels change

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What would you expect to happen to a firm's stock price as the firm changes its capital structure from zero debt to successively higher levels of debt?

Note: in order to get full points, you need to explain what happens at different debt levels and why.

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Solution Summary

The problem deals with issues under finance: Capital strucutring.

See Also This Related BrainMass Solution

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

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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