Chapter 2 FL 1

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

• Homemade leverage

• Dividend recapture

• The weighted average cost of capital

• Private debt placement

The proposition that the value of the firm is independent of its capital structure is called:

• The capital asset pricing model

• MM Proposition I (no taxes)

• MM Proposition II (no taxes)

• The law of one price

The proposition that the cost of equity is a positive linear function of capital structure is called:

• The capital asset pricing model

• MM Proposition I (no taxes)

• MM Proposition II (no taxes)

• The law of one price

The tax savings of the firm derived from the deductibility of interest expense is called the:

• Interest tax shield

• Depreciable basis

• Financing umbrella

• Current yield

The unlevered cost of capital is:

• The cost of capital for a firm with no equity in its capital structure

• The cost of capital for a firm with no debt in its capital structure

• The interest tax shield times pretax net income

• The cost of preferred stock for an all-equity firm

The firm's capital structure refers to the:

• Mix of current and fixed assets a firm holds

• Amount of capital invested in the firm

• Amount of dividends a firm pays

• Mix of debt and equity used to finance the firm's assets

A general rule for managers to follow is to set the firm's capital structure such that the firm's:

• Size is maximized

• Value is maximized

• Bondholders are secured

• Suppliers of raw materials are satisfied

A levered firm is a company that has:

• Accounts payable as its only liability

• Some debt in its capital structure

• An all-equity capital structure

• A tax loss carry forward

A manager should attempt to maximize the value of the firm by changing the capital structure if and only if the value of the firm increases:

• As a result of the change

• To the sole benefit of the managers

• To the sole benefit of the debtholders

• While also decreasing shareholder value

The effects of financial leverage depend on the operating earnings of the company. Based on this relationship, assume you graph the EPS and EBI for a firm, while ignoring taxes. Which one of these statements correctly states a relationship illustrated by the graph?

• Financial leverage decreases the slope of the EPS line

• Below the break-even point unlevered structures have a lower EPS for every dollar of EBI than levered structures do

• Above the break-even point the increase in EPS for unlevered structures is greater than that of levered structures for every dollar increase in EBI

• Leverage only provides value above the break-even point