The irrelevance of capital structure in perfect capital markets helps us because:
if something is irrelevant, we can ignore it.
it applies to real-world capital markets.
it simplifies a complex subject.
it shows us which assumptions, when relaxed, may make capital structure relevant.
Question 2. 2. Two important aspects of debt financing are its tax advantages and the threat of bankruptcy. As a company shifts to more and more debt financing:
these factors reinforce one another, implying that more debt is always better.
the tax advantage always outweighs bankruptcy risk.
the threat of bankruptcy makes only very low levels of debt acceptable.
the threat of bankruptcy eventually completely offsets the tax advantage of debt.
Question 3. 3. Net present value (NPV) is best defined as:
the difference between a project's benefits and its costs.
the difference between the present value of a project's benefits and the present value of its costs.
the present value of a project's benefits.
the ratio of the present value of a project's benefits and its costs.
Question 4. 4. If depreciation expense is a noncash charge, why do we consider it when determining cash flows?
because depreciation expense reduces taxable income, so reduces the amount of taxes paid
because depreciation expense offsets part of the initial cash outlay for depreciable assets
because depreciation expense reduces net income
because depreciation expense is a method for allocating costs
The appropriate cash flows for evaluating a corporate investment decision are:
incremental additional cash flows.
marginal after-tax cash flows.
incremental after-tax cash flows.
investment after-tax cash flows.
Question 6. 6. Debt financing is called leverage because, like a lever in mechanics, it:
makes the company stronger.
magnifies the influence a company has.
has a magnifying effect on financial performance.
can lift a company out of mediocre performance.
Question 7. 7. The appropriate cash flows for evaluating a corporate investment decision are:
incremental additional cash flows.
marginal after-tax cash flows.
incremental after-tax cash flows.
investment after-tax cash flows.
Question 8. 8. The internal rate of return is:
the discount rate at which the NPV is maximized.
the discount rate used by people within the company to evaluate projects.
the rate of return that a project must exceed to be acceptable.
the discount rate that equates the present value of benefits to the present value of costs.
Question 9. 9. The most obvious leakage or capital market imperfection affecting the debt and equity choice is:
bankruptcy risk.
differential taxation of cash flows between debt and equity.
the obligatory payment of interest and discretionary payment of dividends.
the inability of bond rating agencies to perfectly foresee risk.
Question 10. 10. The key to successful capital budgeting is
choose investments that maximize a company's net income.
not exceed the budget.
choose investments that have the shortest payback period.
choose investments whose present value of expected benefits exceed the present value of their expected costs, and so are value creating