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- Date Submitted: 03/14/2011 6:50 PM
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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:...

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