Objective questions on free cash flow, debt equity ratio, APV, NPV and dividend policy

1.   What three factors are important to consider in determining a target debt to equity ratio?

1. Taxes, asset types, and pecking order and financial slack
2. Asset types, uncertainty of operating income, and pecking order and financial slack
3. Taxes, financial slack and pecking order, and uncertainty of operating income
4. Taxes, asset types, and uncertainty of operating income
5. None of the above.

2.   The free cash flow hypothesis states:

1. that firms with greater free cash flow will pay more in dividends reducing the risk of financial distress.
2. that firms with greater free cash flow should issue new equity to force managers to minimize wasting resources and to work harder.
3. that issuing debt requires interest and principal payments reducing the potential of management to waste resources.
4. Both A and C.
5. Both B and C.

3.   The APV method is comprised of the all equity NPV of a project and the NPV of financing effects. The four side effects are:

1. tax subsidy of dividends, cost of issuing new securities, subsidy of financial distress and cost of debt financing.
2. cost of issuing new securities, cost of financial distress, tax subsidy of debt and other subsidies to debt financing.
3. cost of issuing new securities, cost of financial distress, tax subsidy of dividends and cost of debt financing.
4. subsidy of financial distress, tax subsidy of debt, cost of other debt financing and cost of issuing new securities.
5. None of the above.

4.  When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of EBIT because:

1. interest payments on the debt vary with EBIT levels.
2. interest payments on the debt stay fixed, leaving less income to be distributed over less shares.
3. interest payments on the debt stay fixed, leaving more income to be distributed over less shares.
4. interest payments on the debt stay fixed, leaving less income to be distributed over more shares.
5. interest payments on the debt stay fixed, leaving more income to be distributed over more shares.

5.  What is the most likely prediction after a firm reduces its regular dividend payment?

1. Earnings are expected to decline.
2. Investment is expected to increase.
3. Retained earnings are expected to decrease.
4. Share price is expected to fall.
5. ROE is expected to increase.

6.  Which one of the following is the prime objective of a residual dividend policy?

1. maintaining a stable dividend
2. increasing the dividend at a steady pace
3. adhering to a constant dividend payout ratio
4. decreasing the debt-equity ratio at a steady pace
5. meeting the firm\'s investment needs

7.  A stock dividend:

1. reduces both the cash balance and the equity in a firm.
2. increases the number of shares outstanding, but does not affect shareholder wealth.
3. is generally expressed as a ratio.
4. increases shareholder wealth without creating any tax liabilities by doing so.
5. is basically the same as a stock repurchase.

8.   Which of the following is a sensible reason to pay (or increase) cash dividends to shareholders?

1. Since a share price is the present value of expected future dividends, higher dividends payout increases a share price.
2. Since cash dividends are the shareholders\' wages, a firm should pay dividends to shareholders like it pays wages to workers.
3. Cash dividends are safer than future capital gains.
4. Expected return on a new project is lower than return on a diversified portfolio in the capital market.
5. Capital loss should be compensated by additional dividends.

9.   A firm commitment arrangement with an investment banker occurs when:

1. the syndicate is in place to handle the issue.
2. the spread between the buying and selling price is less than one percent.
3. the issue is solidly accepted in the market evidenced by a large price increase.
4. when the investment banker buys the securities for less than the offering price and accepts the risk of not being able to sell them.
5. when the investment banker sells as much of the security as the market can bear without a price decrease.

10.   Empirical evidence suggests that upon announcement of a new equity issue, current stock prices generally:

1. drop, perhaps because the new issue reflects management\'s view that common stock is currently overvalued.
2. remain about the same since an efficient market anticipates a new equity issue.
3. increase, perhaps because the issues are associated with positive NPV projects.
4. increase, because the market supply is always less than demand.
5. increase, because underwriters exercise their green shoe option.

11.   The six components that make up the total costs of a new issues are:

1. the spread; other direct expenses such as filing fees; indirect expenses such as management time; economies of scale; abnormal returns and the Green Shoe option.
2. the discount; other direct expenses such as filing fees; indirect expenses such as management time; due diligence costs; abnormal returns and the Green Shoe option.
3. the spread; other direct expenses such as filing fees; indirect expenses such as management time; abnormal returns; underpricing and the Green Shoe option.
4. the spread; other direct expenses such as filing fees; economies of scale; due diligence costs; abnormal returns and underpricing.
5. None of the above.