TCDNNC_CHAP 14 17

The free cash flow hypothesis states:

• that firms will higher levels of free cash flow should reduce their debt levels.
• that firms with greater free cash flow should issue new equity to help minimize the wasting of resources by managers.
• that firms with greater free cash flow will pay more in dividends thereby reducing the risk of financial distress.
• that issuing debt requires interest and principal payments to be paid thereby reducing the potential of management to waste resources.
• that firms with higher levels of free cash flow should reward their managers with bonuses.

2. A firm is currently valued at $175 in a boom and $110 in a recession. The chance of either economic state occurring is 50 percent. The firm owes $120 to its debt holders. What is the value of the firm to the shareholders in a recession?

• 22.5
• 27.5
• –$10.00
• 55

. Which one of these is most related to a positive covenant?

• limiting the amount of the firm's dividends
• not issuing any additional long-term debt
• or selling any major assets without lender approval
• furnishing financial statements to the firm's lenders
• avoiding a merger while a debt remains unpaid

. If a market is strong form efficient then:

• all investments should have positive NPVs.
• company insiders have no advantage over John Q. Public investor.
• abnormal profits are obtainable by any and all investors.
• technical analysts who study past market performance have a market advantage.
• company insiders are the only investors capable of earning an abnormal profit.

The pecking order states that firms should:

• always issue debt then the market won't know when management thinks the security is overvalued.
• use internal financing first.
• issue new equity first.
• issue debt first.
• always issue equity to avoid financial distress costs.

. When [(1 – tC) × (1 – tS) = (1 – tB)], then the:

• tax shield on debt is exactly offset by higher capital gains.
• firm should hold no debt.
• tax shield on debt is exactly offset by higher levels of dividends.
• cash flow to stockholders equals the cash flow to bondholders.
• value of the levered firm is greater than the value of the unlevered firm.

Which one of the following statements is correct concerning market efficiency?

• If a market is efficient, arbitrage opportunities should be common.
• In an efficient market, some market participants will have an advantage over others.
• A firm will generally receive a fair price when it sells newly issued shares of stock.
• Markets tend to be more efficient when the frequency of price changes diminishes.
• New information will gradually be reflected in a stock's price to avoid spooking investors.

 According to theory, studying historical prices in order to identify mispriced stocks will:

• only work if the market is at least weak form efficient.
• not work if the market is at least weak form efficient.
• not work in any market regardless of the level of efficiency.
• work as long as the market is less than strong form efficient.
• work only in a strong form efficient market.

Assume the corporate tax rate is 34 percent, the personal tax rate on interest income is 15 percent, and the personal tax rate on dividends is 10 percent. If the firm earns $5 per share in taxable income and pays out 40 percent of its earnings, how much will a shareholder receive in aftertax income?

• 1.188
• 1.782
• 1.096
• 1.232
• 1.47

The optimal capital structure:

• is unaffected by changes in the financial markets.
• will be the same for all firms in the same industry.
• of a firm will vary over time as taxes and market conditions change.
• will remain constant over time unless the firm makes an acquisition.
• places more emphasis on the operations of a firm rather than the financing of a firm.