1) Which of the following would increase a firm's financial leverage?

a. an increase in depreciation

b. an increase in interest expense

c. an increase in the number of shares of common stock outstanding

d. a and b

2) According to the MM model of capital structure, the present value of the tax shield is offset by potential ____, resulting in an optimal capital structure.

a. bankruptcy costs

b. interest expense

c. operating costs

d. a and b

3) Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as “W”. You have $5000 of your own money to invest and you plan on buying “WO” stock. Using homemade leverage you borrow enough in your margin account so that the payoff of your margined purchase of WO stock will be the same as a $5000 investment in W stock. The number of shares of WO stock you purchased is closest to:

a. 425

b. 1650

c. 2000

d. 825

4) The presence of a large amount of debt can encourage shareholders to take excessive risk because

a. equity holders are risk seeking by nature.

b. the costs of failure are borne largely by debt holders.

c. debt holders are risk seeking.

d. firm value increases with risk taking.

5) A DFL (degree of financial leverage) of 3.0 indicates that a 27% increase in EPS is the result of a ____ increase in EBIT.

a. 81%

b. 3%

c. 9%

d. 6%

6) Which of the following is correct?

a. Capital structure affects both financial leverage and operating leverage

b. Cost structure affects both financial leverage and operating leverage

c. Capital structure affects financial leverage and cost structure affects operating leverage.

d. Capital structure affects operating leverage and cost structure affects financial leverage.

e. None of the above is correct.