W4 - Online Quiz

Question 1

Multiple Choice

A firm has book values: Debt = £400m and Equity = £600m. Its market capitalisation is £1,200m and the market value of debt is £380m. What are the debt-to-capital ratios (Debt/(Debt+Equity)) using (i) book values and (ii) market values, and which statement best explains the difference?

A. Book: 40.0%; Market: 24.1%; market ratio is lower because market equity typically exceeds book equity, increasing the denominator.

B. Book: 60.0%; Market: 24.1%; market ratio is lower because book debt excludes leases.

C. Book: 40.0%; Market: 31.7%; market ratio is higher because market debt is higher than book debt.

D. Book: 24.1%; Market: 40.0%; the ratios should always be identical if accounting is correct.

Question 2

Multiple Choice

Two firms each need £100m of long-term financing. Firm A issues straight debt at a 7% coupon; Firm B issues preferred shares with a 7% stated dividend. Corporate tax rate is 25%. Ignoring issuance costs, what is the annual after-tax cost to the firm of each instrument, and what is the key reason they differ?

A. Debt: £5.25m; Preferred: £5.25m; they are identical because both are fixed payments.

B. Debt: £7.00m; Preferred: £5.25m; preferred dividends are tax deductible but interest is not.

C. Debt: £5.25m; Preferred: £7.00m; interest is tax deductible but preferred dividends are paid from after-tax income.

D. Debt: £7.00m; Preferred: £7.00m; taxes do not affect financing costs.

Question 3

Multiple Choice

A profitable firm has sufficient retained earnings to fund its planned investment, but instead announces a large seasoned equity offering (SEO) with no accompanying acquisition. Under pecking order logic, what is the most likely market interpretation and immediate price reaction, holding everything else constant?

A. Positive signal: management is confident and wants to reduce leverage; price should rise on announcement.

B. Negative signal: issuing equity is highly visible and may suggest the shares are overvalued; price often falls on announcement.

C. No signal: financing choice is irrelevant because MM says capital structure never matters; price should not move.

D. Positive signal: issuing equity commits the firm to dividends; price should rise because equity is perpetual.

Question 4

Multiple Choice

A firm reports interest-bearing debt of £500m and equity (market value) of £1,000m. It also has non-cancellable operating lease commitments with a present value of £200m and a defined-benefit pension liability PV of £300m. If an analyst treats leases and pensions as debt-equivalent obligations, what is the adjusted debt-to-capital ratio?

A. 29.4%

B. 41.2%

C. 50.0%

D. 57.1%

Question 5

Multiple Choice

A 5-year convertible bond has a price of $110 and can be converted into 2 shares (conversion ratio = 2). The underlying share price is $48. Using the definitions in the slides, what are (i) the market conversion price, (ii) the market conversion premium per share, and (iii) the market conversion premium ratio?

A. (i) $55; (ii) $7; (iii) 14.6%

B. (i) $55; (ii) $3; (iii) 6.25%

C. (i) $48; (ii) $7; (iii) 14.6%

D. (i) $110; (ii) $62; (iii) 129.2%

Question 6

Multiple Choice

Which statement is most accurate about credit ratings and priority/seniority in financial distress?

A. A bond rated BBB− by S&P is junk; senior debt typically has recovery below 30%.

B. A bond rated BBB− by S&P is investment grade; senior debt is generally ahead of subordinated debt and tends to have higher expected recovery.

C. A bond rated Ba1 by Moody’s is investment grade; subordinated debt typically has recovery above senior debt because it is riskier.

D. Credit ratings determine voting rights; higher-rated bonds give lenders more management control even without default.