1. A high degree of variability in a firm’s earnings before interest and taxes refers to:
a. business risk
b. financial leverage
c. operating leverage
d. financial risk
2. If a firm has no operating leverage and no financial leverage, then a 10% increase in sales will
have what effect on EPS?
a. EPS will increase by 10%
b. EPS will remain the same
c. EPS will increase by less than 10%
d. EPS will decrease by 10%
3. According to the moderate view of capital costs and financial leverage, as the use of debt
a. the cost of capital continuously increases
b. there is an optimal level of debt financing
c. the cost of capital remains constant
d. the cost of capital continuously decreases
4. The primary weakness of EBIT-EPS analysis is that:
a. it double counts the cost of debt financing
b. it applies only to firms with large amounts of debt in their capital structure
c. it may only be used by firms that are profitable this year
d. it ignores the implicit cost of debt financing
5. Potential applications of the break-even model include:
a. optimizing the cash-marketable securities position of a firm
b. replacement for time-adjusted capital budgeting techniques
c. pricing policy
d. All of the above.
6. The Modigliani and Miller hypothesis does NOT work in the “real world” because:
a. interest expense is tax deductible, providing an advantage to debt financing
b. higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real costs
for any corporation
c. both a and b
d. dividend payments are fixed and tax deductible for the corporation
7. A corporation with very high growth prospects and many positive NPV projects to fund may
want to increase its dividend based on the:
a. very low agency costs of the corporation
b. information effect
c. tax bias against capital gains
d. residual dividend theory
8. Which of the following strategies may be used to alter a firm’s capital structure toward a higher
percentage of debt compared to equity?
a. stock split
b. stock repurchase
c. stock dividend
d. maintain a low dividend payout ratio
9. AFB, Inc.’s dividend policy is to maintain a constant payout ratio. This year AFB, Inc. paid
out a total of $2 million in dividends. Next year, AFB, Inc.’s sales and earnings per share are
expected to increase. Dividend payments are expected to:
a. increase above $2 million only if the company issues additional shares of common stock
b. decrease below $2 million
c. increase above $2 million
d. remain at $2 million
10. Which of the following is true?
a. In industries with volatile earnings, the residual dividend policy results in the most
consistent dividend stream.
b. If the clientele effect is correct, firms should follow a constant dividend payout ratio policy.
c. In general, the higher the number of positive NPV investment opportunities for a firm, the
lower the dividend payout ratio.
d. According to the informational content of dividends, an increase in dividends is always a
11. Which of the following is always a non-cash expense?
c. income taxes
d. None of the above.
12. Which of the following is a limitation of the “percent of sales method” of preparing pro forma
a. Inventory levels are seldom affected by changes in sales volume.
b. A firm’s investment in accounts receivable is seldom related to sales volume.
c. Not all assets and liabilities increase or decrease as a constant percent of sales.
d. The dividend payout ratio may change from one year to the next.