1. Which of the following does NOT affect the business risk of a firm?

Variability in Sales (Price and/or Volume)

Degree of Operating Leverage     

Product Diversification

Level of Debt

2. According to the trade off model of capital structure, which is true at the optimal capital structure?

The firm’s stock price is maximized

Earnings per Share are maximized

The total value of equity is maximized

Return on Equity is maximized

3. Which is NOT a reason why the costs of debt and equity might increase at an increasing rate as the level of debt rises?

The firm’s best employees begin to leave

Managers start accepting positive NPV projects

The firm must pay higher legal and accounting costs

Assets may be sold at below market prices during liquidation

4. According to the trade off models of capital structure, as the level of debt increases, the cost of debt will _________ while the cost of equity will _________.

a. Rise; Rise

b. Fall; Fall

c. Rise; Fall

d. Fall; Rise

5. The Price Co. can make widgets for $5 and sell them for $8. If fixed costs are $100,000, then how many widgets must they sell in order to have an EBIT of $50,000?

a) 30,000            b) 50,000              c) 100,000            d) 150,000

6. Adding debt will increase the firm’s ROE as long as the cost of debt is less than their ________________.

Cost of Equity

Return on Assets

Profit Margin

Basic Earning Power

7. Why might a firm choose to use more than the optimal amount of debt?

To Avoid Risk

To Reserve Borrowing Capacity

To Signal Expected Future Gains

To maintain voting control.