FIN 534 Final Exam 3 1. Which of the following statements is correct? 2. Grandin Inc. is evaluating its dividend policy. It has a capital budget of $625,000, and it wants to maintain a target capital structure of 60% debt and 40% equity. The company forecasts a net income of $475,000. If it follows the residual dividend policy, what is its forecasted dividend payout ratio? 3. The projected capital budget of Kandell Corporation is $1,000,000, its target capital structure is 60% debt and 40% equity, and its forecasted net income is $550,000. If the company follows a residual dividend policy, what total dividends, if any, will it pay out? 4. The capital budget of Creative Ventures Inc. is $1,000,000. The company wants to maintain a target capital structure that is 30% debt and 70% equity. The company forecasts that its net income this year will be $800,000. If the company follows a residual dividend policy, what will be its total dividend payment? 5. In the real world, dividends 6. Which of the following statements is correct? 7. If a firm adheres strictly to the residual dividend policy, the issuance of new common stock would suggest that 8. Which of the following statements is CORRECT? 9. Which of the following statements is correct? 10. If a firm adheres strictly to the residual dividend policy, then if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/total assets ratio), then the firm should pay 11. Which of the following actions will best enable a company to raise additional equity capital? 12. Poff Industries’ stock currently sells for $120 a share. You own 100 shares of the stock. The company is contemplating a 2-for-1 stock split. Which of the following best describes what your position will be after such a split takes place? 13. Consider two very different firms, M and N. Firm M is a mature firm in a mature industry. Its annual net income and net cash flows are both consistently high and stable. However, M’s growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new firm in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is correct? 14. Which of the following statements is NOT correct? 15. Which of the following statements is correct? 16. Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant? 17. Blueline Publishers is considering a recapitalization plan. It is currently 100% equity financed but under the plan it would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock. The recapitalization would not change the company’s total assets, nor would it affect the firm’s basic earning power, which is currently 15%. The CFO believes that this recapitalization would reduce the WACC and increase stock price. Which of the following would also be likely to occur if the company goes ahead with the recapitalization plan? 18. Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant? 19. Two operationally similar companies, HD and LD, have the same total assets, operating income (EBIT), tax rate, and business risk. Company HD, however, has a much higher debt ratio than LD. Also HD’s basic earning power (BEP) exceeds its cost of debt (rd). Which of the following statements is CORRECT? 20. Which of the following statements is CORRECT? 21. Firms U and L both have a basic earning power ratio of 20% and each has the same amount of assets. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm L’s debt has a before-tax cost of 8%. Both firms have positive net income. Which of the following statements is CORRECT? 22. Which of the following statements best describes the optimal capital structure? The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company’s ____. 23. Companies HD and LD have identical tax rates, total assets, and basic earning power ratios, and their basic earning power exceeds their before-tax cost of debt, rd. However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT? 24. Which of the following statements is CORRECT? 25. Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure? 26. Daylight Solutions is considering a recapitalization that would increase its debt ratio and increase its interest expense. The company would issue new bonds and use the proceeds to buy back shares of its common stock. The company’s CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share (EPS). Assuming the CFO’s estimates are correct, which of the following statements is CORRECT? 27. Which of the following statements is CORRECT? 28. Which of the following statements is CORRECT? 29. Which of the following is NOT associated with (or does not contribute to) business risk? Recall that business risk is affected by a firm’s operations. 30. Which of the following statements is CORRECT?
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