Question

Consider two companies in a world with no taxes that are alike except in borrowing choices. Barry Corp. has no debt financing, and Crawford Corp. uses debt financing. The EBIT for both companies is $100. Barry Corp. has 40 shares and pays no interest. Crawford Corp. has 30 shares outstanding and pays $25 in interest. What is the EPS for each company?

A) Both companies have an EPS of $2.00

B) Both companies have an EPS of $2.50

C) Barry Corp. has an EPS of $2.00 and Crawford Corp. has an EPS of $2.50

D) Barry Corp. has an EPS of $2.50 and Crawford Corp. has an EPS of $2.00

If earnings reflect a return greater than the cost of debt. then ______

A) the more debt the company has sold, the worse off the shareholders are

B) the more debt the company has bought, the better off the shareholders are

C) the more debt the company has sold, the better off the shareholders are

D) the less debt the company has sold, the better off the shareholders are

Which of the statements below is TRUE regarding CAPITAL STRUCTURE?

A) Adding debt to the capital structure will always make shareholders better off.

B) Capital structure deals with the asset-side of the balance sheet.

C) Financial leverage is the degree to which a firm or individual utilizes borrowed money to make money.

D) According to the Static Theory of Capital Structure, the optimal capital structure is the one at which the company's weighted average cost of capital (WACC) is at a maximum.

Which of the statements below is TRUE regarding FINANCIAL STATEMENTS?

A) Ceteris paribus, an increase in accounts . payable represents a use of funds for the corporation.

B) Cost of Goods Sold appears on the liability side of the balance sheet.

C) Total Assets is the sum of Current Assets and Gross Fixed Assets.

D) The difference between EBIT and Taxable Income is Interest Expense.

According to the Break Even EBIT analysis, shareholders are ____ off with debt when EBIT is ____ the Break Even EBIT level.

A) better: below B) worse: above C) better: equal to D) worse: below

Answer 1

calculation of EPS

	B	C
EBIT	100	100
Less:Interest	0	25
Earnings for equity	100	75
Number of shares	40	30
EPS	2.5	2.5

B) Both companies have an EPS of $2.50

If earnings reflect a return greater than the cost of debt. then ______

C) the more debt the company has sold, the better off the shareholders are

Which of the statements below is TRUE regarding CAPITAL STRUCTURE?

C) Financial leverage is the degree to which a firm or individual utilizes borrowed money to make money.

A is not always true, B is false, it deals with the equity and liabilities side

D is false, WACC should be minimum

Which of the statements below is TRUE regarding FINANCIAL STATEMENTS?

A) Ceteris paribus, an increase in accounts . payable represents a use of funds for the corporation.

B is false

C is False, it is Current Assets and Net fixed assets

D is false, it is interest + tax

According to the Break Even EBIT analysis, shareholders are ____ off with debt when EBIT is ____ the Break Even EBIT level.

D) worse: below