FIN 306 CH. 13 EXAM QUESTIONS WITH VERIFIED SOLUTIONS LATEST UPDATE 2026

FIN 306 CH. 13 EXAM QUESTIONS WITH VERIFIED SOLUTIONS LATEST UPDATE 2026 1. The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as: A. M&M Proposition I. B. capital restructuring. C. homemade leverage. D. M&M Proposition II. E. financial risk management. - Answers C 2. Which one of the following statements matches M&M Proposition I? A. The cost of equity capital has a positive linear relationship with a firm's capital structure. B. The dividends paid by a firm determine the firm's value. C. The cost of equity capital varies in response to changes in a firm's capital structure. D. The value of a firm is independent of the firm's capital structure. E. The value of a firm is dependent on the firm's capital structure. - Answers D 3. Which one of the following states that a firm's cost of equity capital is a positive linear function of the firm's capital structure? A. Static theory of capital structure B. M&M Proposition I C. M&M Proposition II D. Homemade leverage theory E. WACC - Answers C 4. Which one of the following is the equity risk arising from the daily operations of a firm? A. Strategic risk B. Financial risk C. Liquidity risk D. Industry risk E. Business risk - Answers E 5. Which one of the following is the equity risk arising from the capital structure selected by a firm? A. Strategic risk B. Financial risk C. Liquidity risk D. Industry risk E. Business risk - Answers B 6. Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship? A. Static theory of interest rates B. M&M Proposition I C. Financial risk D. Interest tax shield E. Homemade leverage - Answers D 7. Which one of the following is a direct bankruptcy cost? A. Loss of customer goodwill resulting from a bankruptcy filing B. Legal and accounting fees related to a bankruptcy proceeding C. Management time spent on a bankruptcy proceeding D. Any financial distress cost E. Costs a firm spends trying to avoid bankruptcy - Answers B 8. Which one of the following terms applies to the costs incurred by a firm which is trying to avoid filing for bankruptcy? A. Indirect bankruptcy costs B. Direct bankruptcy costs C. Static theory cost D. Optimal capital structure cost E. Reorganization costs - Answers A 9. Which one of the following terms is inclusive of both direct and indirect bankruptcy costs? A. Financial distress costs B. Capital structure costs C. Financial leverage D. Homemade leverage E. Cost of capital - Answers A 10. Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt? A. M&M Proposition I, with taxes B. M&M Proposition II, with taxes C. M&M Proposition I, without taxes D. Homemade leverage proposition E. Static theory of capital structure - Answers E 11. Which one of the following best defines legal bankruptcy? A. Negotiating new payment terms with a firm's creditors B. A temporary technical insolvency C. A legal proceeding for liquidating or reorganizing a business D. The internal process of revising the capital structure of a firm E. The failure of a firm to meet its financial obligations in a timely manner - Answers C 12. Which one of the following terms refers to the termination of a firm as a going concern? A. Insolvency B. Reorganization C. Chapter 11 bankruptcy D. Prepack E. Liquidation - Answers E 13. Greenwood Motels has filed a petition for bankruptcy but hopes to continue its operations both during and after the bankruptcy process. Which one of the following terms best applies to this situation? A. Chapter 7 bankruptcy B. Liquidation C. Technical insolvency D. Accounting insolvency E. Reorganization - Answers E 14. In the process of liquidation, some types of claims receive preference over other claims. Which one of the following determines which type of claim is paid first? A. Technical insolvency definition B. Absolute priority rule C. Accounting insolvency definition D. Chapter 7 of the Federal Bankruptcy Reform Act of 1978 E. Securities and Exchange Commission - Answers B 15. Which one of the following is minimized when the value of a firm is maximized? A. Return on equity B. WACC C. Debt D. Taxes E. Bankruptcy costs - Answers B 16. Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered. Which one of the following statements is correct regarding these two firms? A. The levered firm has higher EPS than the unlevered firm at the break-even point. B. The levered firm will have higher EPS than the unlevered firm at all levels of EBIT. C. The unlevered firm will have higher EPS than the levered firm at relatively high levels of EBIT. D. The EPS for the unlevered firm will always exceed those of the levered firm. E. The unlevered firm will have higher EPS at relatively low levels of EBIT. - Answers E 17. Which one of the following statements concerning financial leverage is correct? A. Financial leverage increases profits and decreases losses. B. Financial leverage has no effect on a firm's return on equity. C. Financial leverage refers to the use of common stock. D. Financial leverage magnifies both profits and losses. E. Increasing financial leverage will always decrease the earnings per share. - Answers D 18. You are comparing two possible capital structures for a firm. The first option is an all-equity firm. The second option involves the use of $3.8 million of debt. The break-even point between these two financing options occurs when the earnings before interest and taxes (EBIT) are $428,000. Given this, you know that leverage is beneficial to the firm: A. whenever EBIT is less than $428,000. B. only when EBIT is $428,000. C. whenever EBIT exceeds $428,000. D. only if the debt is decreased by $428,000. E. only if the debt is increased by $428,000. - Answers C 19. Which one of the following statements concerning financial leverage is correct? A. The benefits of leverage are unaffected by the amount of a firm's earnings. B. The use of leverage will always increase a firm's earnings per share. C. The shareholders of a firm are exposed to less risk anytime a firm uses financial leverage. D. Changes in the capital structure of a firm will generally change the firm's earnings per share. E. Financial leverage is beneficial to a firm only when the firm has negative earnings. - Answers D 20. T.L. C. Enterprises just revised its capital structure from a debt-equity ratio of 0.30 to a debt-equity ratio of 0.45. The firm's shareholders who prefer the old capital structure should: A. sell some shares and hold the sale proceeds in cash. B. sell all of their shares and loan out the entire sale proceeds. C. do nothing. D. sell some shares and loan out the sale proceeds. E. borrow funds and purchase more shares. - Answers D 21. Which one of the following statements is the core principle of M&M Proposition I, without taxes? A. A firm's cost of equity is directly related to the firm's debt-equity ratio. B. A firm's WACC is directly related to the firm's debt-equity ratio. C. The interest tax shield increases the value of a firm. D. The capital structure of a firm is totally irrelevant. E. Levered firms have greater value than unlevered firms. - Answers D 22. Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases? A. M&M Proposition I, without taxes B. M&M Proposition II, without taxes C. M&M Proposition I, with taxes D. Static theory of capital structure E. No theory suggests this. - Answers C 23. Which one of the following is an implication of M&M Proposition II, without taxes? A. A firm's optimal capital structure is 100 percent debt. B. WACC is unaffected by the capital structure of a firm. C. WACC decreases as the debt-equity ratio increases. D. A firm's capital structure is irrelevant.