1. Biddle Publishing is currently financed with 10% debt and 90% equity. However, Biddle's CFO has proposed that the firm issue new long-term debt and repurchase some of the firm's common stock. Biddle's advisors believe the long-term debt would require a before-tax yeild of 10%, while the firms basic earning power (BEP) is 14%. The firms operating income and total assets will not be affected. The CFO has told the rest of the management team that this move he believes will increase the firms stock price. If Biddle proceeds with recapitalization, which of the following items is likely to increase?
A. Cost of Equity
B. Net Income
C. Return on Assets
D. Cost of debt
E. Basic earning power
2. Which of the following are ways that a firm can reduce cash flows in order to preven managers from wastefully spending excess cash flows?
A. Funneling excess cash flows back to shareholders through higher dividends
B. Funneling excess cash flows back to shareholders through stock repurchases
C. Minimizing the amount of debt in the firm's capital structure so that the firm can borrow money at a reasonable rate when good investment opportunities arise
D. Increasing the amount of debt in the firm's target capital structure in the hope that higher debt service requirements will force managers to be more disciplined.