1. Fixed cost sources of financing include both debt and common stock.

   True

   False

2. The desire to maintain high bond ratings will tend to increase the use of debt financing in a firm’s capital structure.

   True

   False

3. Financial risk is the basic risk inherent in the operations of a firm. It can be viewed as the volatility of a firm’s EBIT.

   True

   False

4. As a firm increases its use of debt financing, what is the impact upon the cost of equity?

   The cost of equity decreases.

   The cost of equity remains the same.

   The cost of equity increases.

   None of the above.

5. An investment banking firm has estimated the following after-tax cost of debt and cost of equity for Marquez Luxury Travel Tours.

Proportion of Debt       After-tax Cost of Debt        Cost of Equity

30%                                 3.5%                                10.5%

40%                                 3.8%                                11.3%

50%                                 5.0%                                12.9%

60%                                 7.2%                                14.5%

What is the cost of capital at Marquez’ optimal capital structure given the above information?

   8.95%

   8.40%

   8.30%

   8.15%

6. How does high business risk affect firm risk?

   Higher business risk increases the volatility of capital structure.

   Higher business risk increases the volatility of EBIT.

   Higher business risk increases the volatility of financial costs.

   Higher business risk increases the volatility of the firm’s asset structure.