Finance Quiz

Which of the following statements is true of the capital structure of companies in Germany?

• Companies in Germany use the lowest proportion of debt of industrialized countries.

• Companies in Germany use only equity to finance their projects.

• The corporate debt raised by companies in Germany mostly consists of publicly issued bonds.

• Debt monitoring costs are high in Germany because of stringent audit requirements.

• Companies in Germany raise most of their corporate debt through bank loans.

The weighted average cost of capital of a firm represents the ____.

• minimum rate of return a firm must earn on average-risk investments to maintain its current value

• maximum rate of return a firm can expect to earn on its investments

• maximum interest rate a firm should pay on the debt it uses

• minimum dividend yield a firm must pay to its preferred stockholders

• required rate of return that should be used to evaluate capital budgeting projects that have above-average risk

In countries where capital gains are not taxed, investors should prefer to own stocks rather than debt compared to investors in countries where capital gains are taxed.

• True

• False

Which of the following is a major assumption that is embedded in the capital asset pricing model (CAPM), which is often used to estimate the cost of retained earnings, rₛ?

• All investors are well diversified.

• The firm's dividends and earnings grow at a constant rate far into the future.

• The firm's cost of equity and its cost of debt are always equal.

• The firm's cost of retained earnings must be less than its cost of preferred stock for the CAPM to provide a reasonable estimate for rₛ.

• Investors primarily purchase stocks with beta coefficients equal to zero.

For a particular firm, depending on tax rates, flotation costs, and the attitude of investors, the cost of new common equity, rₑ, can be less than, equal to, or greater than its before-tax cost of debt, rₒ.

• True

• False

The optimal capital structure is the capital structure that strikes a balance between risk and return such that the firm's stock price is maximized.

• True

• False

Everything else equal, an asset's value is _____.

• inversely related to the rate of return investors require to purchase it

• directly proportional to the cost of debt used in the capital budgeting process of the firm

• not related to the cash flows that the asset is expected to generate during its life

• inversely related to the cost of debt used in the capital budgeting process of the firm

• directly proportional to the rate of return investors require to purchase it

Symmetric information is defined as the situation in which ______.

• investors and managers have identical information about the firm's prospects

• employees and managers have identical information about the firm's prospects

• investors and creditors have identical information about the firm's prospects

• managers have different (better) information about their firm's prospects than outside investors

• employees have different (better) information about their firm's prospects than managers

The rates of return, or costs, that a firm must pay to raise funds to invest in capital budgeting projects are determined by the _____.

• marginal revenue generated by projects in which the firm invests

• investors who purchase the firm's stocks and bonds in the financial markets

• internal rate of return the firm earns on its investments

• cash flows generated by the investment in capital budgeting projects

• firm's dividend payout ratio

In the United States, equity monitoring costs are lower than most other developed countries.

• True

• False