Question

1. Which capital structure model suggests all firms should carry as much debt as possible?

a. Pecking order theory

b. Tradeoff theory

c. Modigliani-Miller with taxes

d. Modigliani-Miller without taxes

2. Which of the following acts would suggest to investors that your firm was doing poorly?

a. Raising dividends

b. Issuing equity

c.Issuing debt

d. Financing investment using retained earnings

3. A callable bond

a. Can be sold back to the issuer at the owner’s discretion

b. Can be repurchased by the issuer at their discretion

c. Will be more expensive than a similar non callable bond

d. Protects shareholders from bondholders when the firm in in financial distress

4. A tax-free acquisition will be preferable to a taxable acquisition when:

a.The target firm has many depreciable assets on its books at below market value

b. The shareholders in the target firm are unafraid of taking a capital gain

c.The acquiring firm values the synergies more highly than the target firm

d. The shareholders in the target firm want to stay involved with the merged firm

5. In a merger, coinsurance:

a. Benefits bondholders in both firms at the expense of shareholders in both firms

b. Benefits bondholders in the acquiring firm at the expense of bondholders in the target firm

c. Benefits equity holders in the merged firm at the expense of their bondholders

d. Benefits both bondholders and shareholders in the merged firm

Answer 1

1). Modigliani-Miller model with taxes suggests that increasing leverage results in decrease in company cost of capital so companies should carry as much debt as possible. (Option c)

2). Issuing equity is usually taken to be a negative signal by investors as it is assumed that the stock is overvalued. (Option b)

3). A callable bond can be repurchased by the issuer at their discretion. (Option b)

4). A tax-free acquisition will be preferred when target shareholders want to stay involved with the merged firm as they will own stock of the merged entity. (Option d)

5). In a merger, coinsurance would benefit bondholders at the expense of shareholders. (Option a)