10) A corporation has $5,000,000 of 10 percent bonds and $3,000,000 of 12 percent
preferred stock outstanding. The firm’s financial breakeven (assuming a 40 percent
tax rate) is
11) Operating and financial constraints placed on a corporation by loan provision are
a. agency costs to the lender.
b. interest rate costs to the firm.
c. necessary to control the risk of the firm.
d. agency costs to the firm.
12) In order to enhance the wealth of stockholders and to send positive signals to the
market, corporations generally raise funds using the following order:
a. Equity, retained earnings, debt.
b. Debt, retained earnings, equity.
c. Retained earnings, equity, debt.
d. Retained earnings, debt, equity.
Unit 4 Examination
13) According to the traditional approach to capital structure, the value of the firm will be
a. the financial leverage is maximized.
b. the weighted average cost of capital is minimized.
c. the cost of debt is minimized.
d. the dividend payout is maximized.
14) In the EBIT-EPS approach to capital structure, risk is represented by
a. shifts in the times-interest-earned ratio.
b. shifts in the cost of debt capital.
c. the slope of the capital structure line.
d. shifts in the cost of equity capital.
15) Nico Trading Company must choose its optimal capital structure. Currently, the firm
has a 20 percent debt ratio and the firm expects to generate a dividend next year of
$5.44 per share. Dividends are expected to remain at this level indefinitely. Stock-
holders currently require a 12.1 percent return on their investment. Nico is consider-
ing changing its capital structure if it would benefit shareholders. The firm estimates
that if it increases the debt ratio to 30 percent, it will increase its expected dividend
to $5.82 per share. Again, dividends are expected to remain at this new level indefi-
nitely. However, because of the added risk, the required return demanded by stock
holders will increase to 12.6 percent. Based on this information, should Nico make
c. It’s irrelevant
d. Not enough information
16) At the quarterly meeting of Tangshan Mining Corporation, held on September 10th,
the directors declared a $1.00 per share dividend for the firm’s 100,000 shares of
common stock outstanding. The net effect of declaring and paying this dividend
would be to
a. increase total assets by $100,000 and decrease stockholders equity by $100,000.
b. increase total assets by $100,000 and increase stockholders equity by $100,000.
c. decrease total assets by $100,000 and decrease stockholders equity by $100,000.
d. decrease total assets by $100,000 and increase stockholders equity by $100,000.
Unit 4 Examination
17) Tangshan Mining has common stock at par of $200,000, paid in capital in excess
of par of $400,000, and retained earnings of $280,000. In states where the firm’s
legal capital is defined as the par value of common stock, the firm could pay out
________ in cash dividends without impairing its capital.
18) Shareholder wealth considerations in the payment of dividends include all of the
a. the criminal status of the firm’s owners.
b. the tax status of the firm’s owners.
c. the investment opportunities of the firm’s owners.
d. the potential dilution of ownership on behalf of the firm’s owners.
19) Gordon’s “bird-in-the-hand” argument suggests that
a. shareholders are generally risk averse and attach less risk to current dividends.
b. dividends are irrelevant.
c. firms should have a 100 percent payout policy.
d. the market value of the firm is unaffected by dividend policy.
20) A firm that has a large percentage of ________ investors may pay out a lower percent-
age of its earnings as dividends.
d. pension fund
21) A firm has current after-tax earnings of $1,000,000 and has declared a cash dividend
of $400,000. The firm’s dividend payout ratio is
a. 4.0 percent.
b. 2.0 percent.
c. 2.5 percent.
d. 40 percent.
Unit 4 Examination
22) The advantage of using the low-regular-and-extra dividend policy is that
a. cyclical shifts in earnings may be avoided.
b. the extra dividend may become a regular event.
c. the firm avoids giving the shareholders false hopes.
d. if the firm’s earnings drop, so does the dividend payment.
23) Mr. R. owns 20,000 shares of ABC Corporation stock. The company is planning to
issue a stock dividend. Before the dividend Mr. R. owned 10 percent of the outstand-
ing stock, which had a market value of $200,000, or $10 per share. Upon receiving
the 10 percent stock dividend the value of his shares is
d. greater, but cannot be determined.
24) The accounting in a stock split will transfer funds
a. from the Retained Earnings account to the Paid in Capital account.
b. from the Common Stock and Paid in Capital accounts to the Retained Earnings ac-
c. from the Paid in Capital account to the Retained Earnings account.
d. from the Retained Earnings account to the Preferred Stock account.
e. none of the above
25) When purchasing outstanding shares of common stock a firm can utilize all of the fol-
lowing methods EXCEPT
a. a tender offer at a specified price.
b. a purchase on the open market at market prices.
c. a tender offer at varying prices.
d. by purchasing a large block on a negotiated basis.