The explicit costs, such as the legal expenses, associated with corporate default are classified as _____ costs. a. flotation b. beta conversion c. direct bankruptcy d. indirect bankruptcy e. unlevered Difficulty level: Easy 2. The costs of avoiding a bankruptcy filing by a financially distressed firm are classified as _____ costs. a. flotation b. direct bankruptcy c. indirect bankruptcy d. financial solvency e. capital structure Difficulty level: Easy 3 . Indirect costs of financial distress: a. effectively limit the amount of equity a firm issues. b. serve as an incentive to increase the financial leverage of a firm. c. include direct costs such as legal and accounting fees. d. tend to increase as the debt-equity ratio decreases. e. include the costs incurred by a firm as it tries to avoid seeking bankruptcy protection. CAPITAL STRUCTURE 4 The value of a firm is maximized when the: a. cost of equity is maximized. b tax rate is zero. c. levered cost of capital is maximized. d. weighted average cost of capital is minimized. e. debt-equity ratio is minimized. Difficulty level: Easy CAPITAL STRUCTURE 5 The optimal capital structure has been achieved when the: a. debt-equity ratio is equal to 1. b. weight of equity is equal to the weight of debt. c. cost of equity is maximized given a pre-tax cost of debt. d. debt-equity ratio is such that the cost of debt exceeds the cost of equity. e. debt-equity ratio selected results in the lowest possible weighed average cost of capital. Difficulty level: Easy OPTIMAL CAPITAL STRUCTURE 6 . In a world with taxes and financial distress, when a firm is operating with the optimal capital structure: I. the debt-equity ratio will also be optimal. II. the weighted average cost of capital will be at its minimal point. III. the required return on assets will be at its maximum point. IV. the increased benefit from additional debt is equal to the increased bankruptcy costs of that debt. a. I and IV only b. II and III only c. I and II only d. II, III, and IV only e. I, II, and IV only Difficulty level: Medium AGENC Y COSTS 7 . Conflicts of interest between stockholders and bondholders are known as: a. trustee costs. b. financial distress costs. c. dealer costs. d. agency costs. e. underwriting costs. CAPM 8 . If the CAPM is used to estimate the cost of equity capital, the expected excess market return is equal to the: a. return on the stock minus the risk-free rate. b. difference between the return on the market and the risk-free rate. c. beta times the market risk premium. d. beta times the risk-free rate. e. market rate of return. CAPM 9 . Using the CAPM to calculate the cost of capital for a risky project assumes that: a. using the firm's beta is the same measure of risk as the project. b. the firm is all-equity financed. c. the financial risk is equal to business risk. d. Both A and B. e. Both A and C. Difficulty level: Medium WACC 10 . The use of WACC to select investments is acceptable when the: a. correlation of all new projects are equal. b. NPV is positive when discounted by the WACC. c. risk of the projects are equal to the risk of the firm. d. firm is well diversified and the unsystematic risk is negligible. e. None of the above. 11 . The beta of a firm is determined by which of the following firm characteristics? a. Cycles in revenues b. Operating leverage c. Financial leverage d. All of the above. e. None of the above. 12 . Jack’s Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8.5%. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is yielding 4% and the market risk premium is 8%. Jack’s tax rate is 35%. What is Jack’s weighted average cost of capital? a. 7.10 % b. 7.39 % c. 10.38 % d. 10.65 % e. 11.37 %