chapter 12 finance 300

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1. Earnings before interest and taxes (EBIT) divided by times-inter-

interest charges is equal to the: est-earned (TIE)
ratio.

2. The lower the times-interest-earned ratio, the ____ higher

the probability that a firm will default on its debt.

3. The degree of financial leverage (DFL) represents EPS

the percentage change in _____ that is associated
with a given percentage change in earnings before
interest and taxes (EBIT).

4. According to the trade-off theory, why is corporate Interest charges are

debt less expensive than common stock or pre- tax deductible
ferred stock?

5. How is the business risk premium of a stock deter- It is the difference be-
mined? tween the weighted
average cost of capi-
tal when the firm is fi-
nanced with 100 per-
cent equity and the
risk-free rate.

6. A firm that has high interest payments relative to financial

other firms is said to have a high degree of _____
leverage.

7. According to which of the following theories is The trade-off theory

optimal capital structure one wherein the marginal
tax shelter benefits are equal to marginal bankrupt-
cy-related costs?

8. The ability to borrow money at a reasonable cost reserve borrowing

when good investment opportunities arise is known capacity
as _____.

9. _____ is the portion of stockholders' risk, over and financial risk

above basic business risk, that results from the
manner in which the firm is financed.
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10. The indifference point is the level of sales at which earnings per share
the _____ will be the same whether the firm uses (EPS)
debt or common stock financing.

11. At its optimal capital structure, a firm's _____ stock price

should be maximized

12. According to the signaling theory, why should a firm To obtain debt capital
use less debt than specified by the optimal capital later if necessary
structure

13. For a company, financial risk arises from the use of fixed-income securi-
_____ ties

14. Which of the following statements is true about It refers to the pres-
operating leverage of a firm ence of fixed operat-
ing costs that do not
change when the lev-
el of sales changes

15. Which of the following factors affects a firm's finan- Proportion of debt
cial risk

16. The times-interest-earned (TIE) ratio provides an how well the compa-
indication of: ny can cover its in-
terest payments with
operating income.

17. Which of the following firms has relatively high de- single-product firms
grees of business risk?

18. The extent to which fixed-income securities are financial leverage

used in a firm's capital structure is known as _____

19. The Modigliani and Miller (MM) theory assumes that symmetric
market information is ____

20. Which of the following is true of companies in Japan They use the great-
est proportion of
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debt of industrialized
countries.

21. A firm's degree of operating leverage provides in- business

formation about its _____ risk.

22. Investors prefer to invest in common stocks rather capital gains are not
than investing in debt in countries where: taxed

23. If two firms differ only in their amounts of fixed a higher degree of
business costs, the firm with the higher amount of operating leverage
fixed business costs is said to have _____.

24. Costs associated with monitoring debt are probably corporate debt in
lower in countries such as Germany and Japan be- these countries con-
cause most of the: sists of bank loans

25. Which of the following is used by firms as guidance Target capital struc-
for raising funds in the future ture

26. Which of the following is an advantage for corpora- Equity monitoring

tions that produce quarterly report costs are compara-
tively lower than oth-
er costs

27. Food processors and grocery retailers frequently low business risk
are cited as examples of industries with _____

28. Which of the following is considered a component interest payments on

of financial risk? bonds

29. If a firm increases the proportions of debt and pre- financial risk will in-
ferred stock that are contained in its capital struc- crease
ture, its _____

30. Net income = [EBIT - (Cost of debt

× Total debt)] × (1 -
Tax rate)

31. EPS =
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