Question Details

Which of the following are practical difficulties associated with capital structure and degree of leverage analyses 



 .	Firm U and Firm L each have the same total assets.  Both firms also have a basic earning power of 20 percent.  Firm U is 100 percent equity financed, while Firm L is financed with 50 percent debt and 50 percent equity.  Firm L- debt has a before-tax cost of 8 percent.  Both firms have positive net income.  Which of the following statements is most correct?

a.	The two companies have the same times interest earned (TIE) ratio.
b.	Firm L has a lower ROA than Firm U.
c.	Firm L has a lower ROE than Firm U.
d.	Statements a and b are correct.
e.	Statements b and c are correct.

 .	As a general rule, the capital structure that

a.	Maximizes expected EPS also maximizes the price per share of common stock.
b.	Minimizes the interest rate on debt also maximizes the expected EPS.
c.	Minimizes the required rate on equity also maximizes the stock price.
d.	Maximizes the price per share of common stock also minimizes the weighted average cost of capital.
e.	None of the statements above is correct.


 .	Which of the following statements is most correct?

a.	Firms whose sales are very sensitive to changes in the business cycle are more likely to rely on debt financing.
b.	Firms with large tax loss carry forwards are more likely to rely on debt financing.
c.	Firms with a high operating leverage are more likely to rely on debt financing.
d.	Statements a and c are correct.
e.	None of the statements above is correct.

 .	Company A and Company B have the same total assets, operating income (EBIT), tax rate, and business risk. Company A, however, has a much higher debt ratio than Company B.  Company A- basic earning power (BEP) exceeds its cost of debt financing (kd).  Which of the following statements is most correct?

a.	Company A has a higher return on assets (ROA) than Company B.
b.	Company A has a higher times interest earned (TIE) ratio than Company B.
c.	Company A has a higher return on equity (ROE) than Company B, and its risk, as measured by the standard deviation of ROE, is also higher than Company B-.
d.	Statements b and c are correct.
e.	All of the statements above are correct.

 .	Which of the following are practical difficulties associated with capital structure and degree of leverage analyses ?

a.	It is nearly impossible to determine exactly how P/E ratios or equity capitalization rates (ks values) are affected by different degrees of financial leverage.
b.	Managers’ attitudes toward risk differ and some managers may set a target capital structure other than the one that would maximize stock price.
c.	Managers often have a responsibility to provide continuous service; they must preserve the long-run viability of the enterprise.  Thus, the goal of employing leverage to maximize short-run stock price and minimize capital cost may conflict with long-run viability.
d.	All of the statements above are correct.
e.	None of the statements above represents a serious impediment to the practical application of leverage analysis in capital structure determination.



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