PureMeds is a highly profitable pharmaceutical company

PureMeds is a highly profitable pharmaceutical company

Subject: Business    / Finance    

Question
Question 1

PureMeds is a highly profitable pharmaceutical company that places great importance on funding research and development projects. According to finance research, the expected capital structure for PureMeds:
Answer

would show a high market-value leverage level

would show a high book-value leverage level

would contain a high long-term debt level

would contain a high total debt level

would show a low financial leverage level
4 points
Question 2

Financial leverage
Answer

Increases expect EPS and Increases EPS volatility

Increases expect EPS and Decreases EPS volatility

Decreases expect EPS and Increases EPS volatility

Decreases expect EPS and Decreases EPS volatility
4 points
Question 3

Devard, CFO of Buymore, Inc., must create a financing plan for a proposed acquisition offer. Buymore's existing shareholders would likely consider the purchase to be "good news" if:
Answer

Buymore issued new shares to finance the acquisition

current Buymore shares were accepted as payment for the acquisition

Buymore employed a debt-financed cash tender for the acquisition

Buymore offered to exchange debt holdings for equity holdings in the new corporation

the entire remaining balance of cash reserves were used for the acquisition
4 points
Question 4

According to M&M’s Proposition II the expected return on a levered firm’s equity
Answer

Falls to the debt-to-equity ratio

The levered firm’s equity expect return does not change with the debt-to-equity level

Rises with the debt-to-equity ratio

Proposition II does not address the leveraged firm’s expected return on equity
4 points
Question 5

Given an increase in personal tax rates on both dividends and interest income, companies should:
Answer

decrease retained earnings and increase leverage levels over time

increase retained earnings and decrease leverage levels over time

decrease retained earnings and decrease debt financing over time

increase dividend payments to investors and increase leverage levels over time

cannot say without knowing the values of the tax rates
4 points
Question 6

M & M Proposition II says that the WACC is not influenced by changing the mix of debt and equity because changes in leverage cause an offsetting change in the __________.
Answer

WACC

required return on equity

target leverage zones

secured debt hypothesis
4 points
Question 7

In a frictionless capital market, if the market value of a levered firm's outstanding securities differs from the market value of an otherwise identical all-equity firm's outstanding securities, M & M demonstrate that:
Answer

investors are willing to pay a premium price for shares of levered firms

investors will require "too high" an expected return on levered equity

investors are maximizing personal profits

the market value of levered equity is given by capitalizing operating income at a rate equal to the firm's WACC

an arbitrage opportunity exists
4 points
Question 8

The relationship of corporate income taxes, personal income taxes on equity investments, and personal income taxes on interest income should have a predictable change in debt ratios; which of the following predicts increasing debt ratios?
Answer

Higher corporate income taxes, higher personal taxes on equity investments, lower personal taxes on interest income

Lower corporate income taxes, higher personal taxes on equity investments, lower personal taxes on interest income

Higher corporate income taxes, lower personal taxes on equity investments, lower personal taxes on interest income

Higher corporate income taxes, higher personal taxes on equity investments, higher personal taxes on interest income
4 points
Question 9

__________ firms use almost no debt in their capital structure.
Answer

Aerospace

High-tech

Aerospace and pharmaceutical

Aerospace and retailing

Utility
4 points
Question 10

In attempting to develop a model, M & M showed that capital structure could not affect the firm value in a world with __________.
Answer

perfect markets

target leverage zones

homemade leverage

arbitrage
4 points
Question 11

Jason is suggesting that his company issue debt in order to finance an upcoming project, even though the firm has large cash reserves. He believes the market is currently underpricing his firm's stock, and would like investors to be convinced that the firm's true value is much higher. Which of the following capital structure theories provide the best explanation for Jason's suggestion?
Answer

trade-off model

pecking-order hypothesis

signaling model

managerial opportunism hypothesis

M & M capital structure model
4 points
Question 12

Which of the following presents a problem for the signaling theory of capital structure?
Answer

The theory predicts that low-quality firms should issue the most debt.

Empirically, both high-quality and low-quality firms use very similar levels of debt.

The theory is too complex for managers to understand.

Signaling models suggest that firms with high growth opportunities and intangible assets should issue very little debt.

Stock returns are almost always positive around events that increase leverage.
4 points
Question 13

Which of the following is not an assumption of the pecking-order hypothesis?
Answer

Dividends are “sticky”

Firms prefer internal financing to external financing

Firms prefer issuing safer securities to less safe securities

Financial markets are largely efficient
4 points
Question 14

Firms with sufficient __________ will not have to issue equity securities to finance investment projects and are thus able to finesse information problems between managers and investors.
Answer

agency costs

financial slack

asset substitutions

debt overhang
4 points
Question 15

Why would profitable firms borrow more?
Answer

They would not as they can rely on internally generated financing

They are more likely to benefit from tax shields

They are more likely to negotiate lower interest rates

They are more likely to actively manage their WACC
4 points
Question 16

Investors sue management for poor performance and apparent excess perquisite consumption. It will likely be relatively __________ for them to prevail, due to __________.
Answer

easy; infighting amongst managerial defendants

difficult; the fact that excess perquisite consumption is only a theoretical construct

difficult; application of the business judgment rule

easy; application of the constrained discretion rule

difficult; the likely corporate takeover of such a defendant, which will nullify any pending suits.
4 points
Question 17

The pecking order model provides a rationale for the development of __________, based on the pervasiveness of the information asymmetry between corporate managers and shareholders.
Answer

underinvestment

the business judgment rule

absolute priority rule

financial intermediaries
4 points
Question 18

Hare-Brained-Toys (HBT) and Tortoise-Toys (TT) provide returns to their bondholders of 7% and 4%, respectively. Returns to their stockholders are 12% and 9%, respectively. If the cost of capital for both firms is 8%:
Answer

HBT bondholders are requiring a return which is "too low"

TT stockholders are requiring a return which is "too high"

HBT's capital structure consists of 60% debt and 40% equity

TT employs a lower level of leverage than HBT

the market is inefficient
4 points
Question 19

The __________ problem prevents the financing of new positive-NPV projects because the benefits would accrue to existing creditors rather than to the shareholders who finance the new project.
Answer

agency cost

financial slack

asset substitutions

debt overhang
4 points
Question 20

The corporate form of organization:
Answer

provides limited liability to shareholders, thus decreasing the incentives of a company to issue new equity and decreasing corporate leverage

provides limited liability to shareholders and creates a costless bankruptcy process

provides limited liability, thereby allowing shareholders to exercise their option to default on company debt

increases the likelihood that a business will experience greater direct costs than indirect costs of bankruptcy

increases the likelihood that sales in the years after filing for bankruptcy will be higher than pre-bankruptcy sales growth forecasts would project