Chapter 13 Questions: Capital Structure and Leverage

CHAPTER 13: CAPITAL STRUCTURE AND LEVERAGE

1. A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.
a. True
b. False

ANSWER: False

2. Financial risk refers to the extra risk borne by stockholders as a result of a firm's use of debt as compared with their risk if the firm had used no debt.
a. True
b. False

ANSWER: True

3. A firm's capital structure does not affect its free cash flows as discussed in the text, because FCF reflects only operating cash flows, which are available to service debt, to pay dividends to stockholders, and for other purposes.
a. True
b. False

ANSWER: True

4. If a firm borrows money, it is using financial leverage.
a. True
b. False

ANSWER: True

5. Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.
a. True
b. False

ANSWER: True

6. The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant.
a. True
b. False

ANSWER: False

7. Provided a firm does not use an extreme amount of debt, operating leverage typically affects only EPS, while financial leverage affects both EPS and EBIT.
a. True
b. False

ANSWER: False
8. The trade-off theory states that capital structure decisions involve a tradeoff between the costs and benefits of debt financing.
a. True
b. False

ANSWER: True

9. Different borrowers have different risks of bankruptcy, and if a borrower goes bankrupt, its lenders will probably not get back the full amount of funds that they loaned. Therefore, lenders charge higher rates to borrowers judged to be more likely to go bankrupt.
a. True
b. False

ANSWER: True

10. Modigliani and Miller (MM) won Nobel Prizes for their work on capital structure theory.
a. True
b. False

ANSWER: