Chapter 21: Capital Structure Decisions
Multiple Choice Questions
1. Section: 21.2 Determining Capital Structure
Learning Objective: 21.2
Level of difficulty: Medium
Solution: D
Recall WACC = were + wdrd (1 - Tc)
A decrease in the tax rate, an increase in the cost of debt, and an increase in the cost of equity will increase WACC. However, since the cost of equity is usually higher than the cost of debt, WACC decreases when the weight of equity decreases.
2. Section: 21.1 Financial Leverage
Learning Objective: 21.1
Level of difficulty: Medium
Solution: C
Invested capital = short-term debt + long-term debt + shareholders’ equity
= 100,000 + 150,000 + 440,000
= 690,000
3. Section: 21.1 Financial Leverage
Learning Objective: 21.1
Level of difficulty: Easy
Solution: D
ROE represents financial risk and business risk.
4. Section: 21.1 Financial Leverage
Learning Objective: 21.1
Level of difficulty: Medium
Solution: B
ROE = ROI if a firm is 100 percent financed by equity, not debt; i.e., B = 0. ROE = ROI.
5. Section: 21.1 Financial Leverage
Learning Objective: 21.1
Level of difficulty: Medium
Solution: A
The use of debt increases the expected ROE.
6. Section: 21.1 Financial Leverage
Learning Objective: 21.1
Level of difficulty: Medium
Solution: D
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The EPS-EBIT line is steeper if there are fewer shares outstanding. Its slope = (1 – T)/#. Its intercept = –RD B (1 – T)/#. Only D is true.
7. Section: 21.1 Financial Leverage
Learning Objective: 21.1
Level of difficulty: Easy
Solution: C
There is no transaction cost.
8. Section: 21.4 The Impact of Taxes
Learning Objective: 21.4
Level of difficulty: Medium
Solution: D
WACC stays the same regardless of the debt-equity ratio in the no-tax M&M world.
9. Section: 21.4 The Impact of Taxes
Learning Objective: 21.4
Level of difficulty: Medium
Solution: C
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10. Section: 21.7 Capital Structure in Practice
Learning Objective: 21.7
Level of difficulty:...