Question

Question 6 Which of the following statements does correctly explain the effect of additional debt on the weighted average cost of capital (WACC)? Debtholders’ prior and “fixed” claim decreases the risk of stockholders’ “residual” claim, so the cost of stock (rs) goes down. Additional debt decreases the pre-tax of cost of debt (rd) because the decresaed risk of bankruptcy. The net effect of additional debt on WACC is to increase WACC. The net effect of additional debt on WACC is uncertain.

Question 16

If the information content, or signaling, hypothesis is correct, changes in dividend policy can be important because investors view dividend changes as signals of management’s view of the future.

True

False

Question 9

A firm sells paperback books for $5 each. The variable cost per book is $3. The fixed costs are $40,000. What’s the publisher’s breaking- even sales volume?

		8,000 books.
		10,000 books.
		20,000 books.
		40,000 books.

Answer 1

Additional debt on the weighted average cost of capital always decreases the the shareholders residual claim as debt holders will always have the fixed claim. Debt holders need to be paid first in case of liquidation of the company and the residuals of shareholders will decrease.

All other options are false as additional debt do not decrease pretax WACC and its effect is not uncertain.

Correct answer is option (A)Debtholders’ prior and “fixed” claim decreases the risk of stockholders’ “residual” claim, so the cost of stock (rs) goes down.