Question

1. Business risk is concerned with the operations of the firm. Which of the following is not associated with (or not a part of) business risk?

a. Demand variability.

b. Sales price variability.

c. The extent to which operating costs are fixed.

d. Changes in required returns due to financing decisions.

e. The ability to change prices as costs change.

2. From the information below, select the optimal capital structure for Minnow Entertainment Company.

a. Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.

b. Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90.

c. Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20.

d. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.40.

e. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.00.

3. The firm's target capital structure is consistent with which of the following?

a. Maximum earnings per share (EPS).

b. Minimum cost of debt (kd).

c. Minimum risk.

d. Minimum cost of equity (ks).

e. Minimum weighted average cost of capital (WACC).

4. Which of the following events is likely to encourage a corporation to increase its debt ratio?

a. An increase in the corporate tax rate.

b. An increase in the personal tax rate.

c. An increase in the company's degree of operating leverage.

d. An increase in the expected cost of bankruptcy.

e. Increased uncertainty about the level of sales and output prices.

5. Which of the following is a key determinant of operating leverage?

a. Level of debt.

b. Physical location of production facilities.

c. Cost of debt.

d. Technology.

e. Capital structure.

6. The Price Company will produce 55,000 widgets next year. Variable costs will equal 40 percent of sales, while fixed costs will total $110,000. At what price must each widget be sold for the company to achieve an EBIT of $95,000?

a. $2.00

b. $4.45

c. $5.00

d. $5.37

e. $6.21

Answer 1

1.

Business risk is risk associated with variance in sales and net profit of business dies to various factors such as competition, inefficiency of employee, change in consumer taste and lots of another factor. due of these factor the demand and sale of company affect and also because of high fixed cost business risk arise.

So, change in required rate of return does not affect business risk of company.

Option (D) is correct answer.

2.

Optimal capital structure is combination of debt and equity at which stock price of company is highest. This because stock price depends on the WACC of the company. If WACC of company is highest then Stock price is lowest and if WACC is lowest then stock price is highest.

Stock price is highest at 60% debt and 40% equity and stock price is $31.20.

So, optiomal capital structure is Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20..

Option (C) is correct answer.

3.

target capital structure at which overall cost of capital (WACC) is minimum. this capital structure is also called optimal capital structure.

Option (E) is correct answer.

4.

Interest payment on debt is considered as expense for company. So, company can deduct interest expense from taxable income. So, company need to pay lesser tax because of debt capital. So, if corporate tax rate increase then increase in debt capital lead to lower tax payment.

Option (A) is correct answer.