1. A high degree of variability in a firm’s earnings before interest and taxes refers to:
a) business risk
b) financial leverage
c) operating leverage
d) financial risk
2. If a firm has no operating leverage and no financial leverage, then a 10% increase in sales will have what effect on EPS?
a) EPS will increase by 10%
b) EPS will remain the same
c) EPS will increase by less than 10%
d) EPS will decrease by 10%
3. According to the moderate view of capital costs and financial leverage, as the use of debt financing increases:
a) the cost of capital continuously increases
b) there is an optimal level of debt financing
c) the cost of capital remains constant
d) the cost of capital continuously decreases
4. The primary weakness of EBIT-EPS analysis is that:
a) it double counts the cost of debt financing
b) it applies only to firms with large amounts of debt in their capital structure
c) it may only be used by firms that are profitable this year
d) it ignores the implicit cost of debt financing
5. Potential applications of the break-even model include:
a) optimizing the cash-marketable securities position of a firm
b) replacement for time-adjusted capital budgeting techniques
c) pricing policy
d) All of the above.
6. The Modigliani and Miller hypothesis does NOT work in the “real world” because:
a) interest expense is tax deductible, providing an advantage to debt financing
b) higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real costs for any corporation
c) both a and b
d) dividend payments are fixed and tax deductible for the corporation
7. A corporation with very high growth prospects and many positive NPV projects to fund may want to increase its dividend based on the:
a) very low agency costs of the corporation
b) information effect
c) tax bias against capital gains
d) residual dividend theory
8. Which of the following strategies may be used to alter a firm’s capital structure toward a higher percentage of debt compared to equity?
a) stock split
b) stock repurchase
c) stock dividend
d) maintain a low dividend payout ratio
9. AFB, Inc.’s dividend policy is to maintain a constant payout ratio. This year AFB, Inc. paid out a total of $2 million in dividends. Next year, AFB, Inc.’s sales and earnings per share are expected to increase. Dividend payments are expected to:
a) increase above $2 million only if the company issues additional shares of common stock
b) decrease below $2 million
c) increase above $2 million
d) remain at $2 million
10. Which of the following is true?
a) In industries with volatile earnings, the residual dividend policy results in the most a consistent dividend stream.
b) If the clientele effect is correct, firms should follow a constant dividend payout ratio policy.
c) In general, the higher the number of positive NPV investment opportunities for a firm, the lower the dividend payout ratio.
d) According to the informational content of dividends, an increase in dividends is always a positive signal.
11. Which of the following is always a non-cash expense?
c) income taxes
d) None of the above.
12. Which of the following is a limitation of the “percent of sales method” of preparing pro forma financial statements?
a) Inventory levels are seldom affected by changes in sales volume.
b) A firm’s investment in accounts receivable is seldom related to sales volume.
c) Not all assets and liabilities increase or decrease as a constant percent of sales.
d) The dividend payout ratio may change from one year to the next.
13. Spontaneous sources of funds refer to all of the below EXCEPT:
d) a bank loan
14. Selection of a source of short-term financing should include all of the following EXCEPT:
a) the effect of the use of credit from a particular source on the cost and availability of other sources of credit
b) the floatation costs for debentures
c) the effective cost of credit
d) the availability of financing in the amount and for the time needed
15. The terminal warehouse agreement differs from the field warehouse agreement in that:
a) the cost of the terminal warehouse agreement is lower due to the lower degree of risk
b) the warehouse procedure differs for both agreements
c) the terminal agreement transports the collateral to a public warehouse
d) the borrower of the field warehouse agreement can sell the collateral without the consent d. of the lender
16. Your company buys supplies on credit terms of 2/10 net 45. Suppose the company makes a purchase of $20,000 today. Which of the following payment options makes the most sense as a general rule?
a) pay the bill as soon as possible to keep the supplier happy
b) pay the bill on day 10 to get the discount
c) either pay the bill on day 10 to get the discount, or wait until day 45
d) pay the bill on day 45 due to the time value of money
17. Which of the following statements about financial leverage is true?
a) Financial leverage is the responsiveness of the firm’s EBIT to fluctuations in sales.
b) Financial leverage is the responsiveness of the firm’s EPS to fluctuations in EBIT.
c) Financial leverage involves the incurrence of fixed operating costs in the firm’s income stream.
d) Financial leverage reduces a firm’s risk.
18. Which of the following statements about combined (operating & financial) leverage is true?
a) Usage of both operating and financial leverage reduces a firm’s risk.
b) If a firm employs both operating and financial leverage, any percent change in sales will produce a larger percent change in earnings per share.
c) High operating leverage and high financial leverage offset one another, meaning that if sales increase by 10%, then EPS will also increase by 10%.
d) A firm that is in a capital-intensive industry should use a higher level of financial leverage than a firm that employs low levels of operating leverage.
19. The “bird-in-the-hand dividend theory” supports which view of the effect of dividend policy on company value?
a) constant dividends increase stock values
b) high dividends increase stock values
c) a firm’s dividend policy is irrelevant
d) low dividends increase stock values
20. All of the following will increase the discretionary financing needed EXCEPT:
a) decrease the dividend payout ratio
b) decrease the spontaneous financing
c) decrease the sales growth rate.
d) decrease the net profit margin
21. If a firm relies on short-term debt or current liabilities in financing its asset investments, and all other things remain the same, what can be said about the firm’s liquidity?
a) The liquidity of the firm will be unchanged.
b) The firm will be relatively more liquid.
c) The firm will be relatively less liquid.
d) The firm will be more liquid only if interest rates are below the company’s weighted average cost of capital.
22. Dakota Oil, Inc. reported that its sales and EBIT increased by 10%, but its EPS increased by 30%. The much larger change in earnings per share could be the result of:
a) high operating leverage
b) high financial leverage
c) high fixed costs of production
d) a high percentage of credit sale collections from prior years
23. Which of the following statements would be consistent with the bird-in-the-hand dividend theory?
a) Dividends are less certain than capital gains.
b) Investors are indifferent whether stock returns come from dividend income or capital gains income.
c) Wealthy investors prefer corporations to defer dividend payments because capital gains produce greater after-tax income.
d) Dividends are more certain than capital gains income.
24. The term “lumpy asset” means:
a) assets that have economies of scale but not economies of scope
b) assets that must be purchased in discrete quantities
c) the same thing as assets that exhibit scale economies
d) assets that can be purchased in incremental units
25. All of the following are potential advantages of commercial paper EXCEPT:
a) ability to borrow very large amounts
b) flexible repayment terms
c) no compensating balance requirements
d) lower interest rates than comparable sources of short-term financing
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