CHAPTER 19

1. Increases in total long-lived assets should not ordinarily be finance by

a. long-term debt.
b. equity.
c. spontaneous increases in liabilities.
d. short-term debt.

2. A company is growing a rate of 10 percent per year. This growth required increases in accounts
receivable, inventory and plant and equipment. Under normal business financing policy this groth would
be funded by

a. the allowances for depreciation.

b. increases in current liabilities.
c. increases in shareholders' equity.
d. increases in current liabilities, long-term liabilities and shareholders' equity.

3. Private placements have many advantages over public debt issues. Which one of the following is a
disadvantage for the debtor of a privately placed debt issue?

a. Private placements go through a time-consuming process of SEC registration and approval.

b. Private placements have less flexibility and take longer to arrange.
c. The placement costs are greater than the flotation costs of a public issue.
d. The interest costs of private placements are generally higher than those of public issues.

4. Investors in long term corporate bonds are concerned about interest rate risk. This risk reflects

a. the increased probability of bankruptcy during periods of high interest rates.

b. the decrease in bond prices as interest rates rise.
c. the probability that a bond issue will be called when interest rates fall.
d. the chance that the corporation will default on the interest payments

5. Subordinates debentures are securities that

a. rank lower than or are inferior to all other bonds and to senior debt.
b. rank lower than or are inferior to the claims of ordinary shareholders.
c. are not to be used in situations in which the investments are risky.
d. are legally required to pay interest only to the degree that interest is earned each year.
e. rank lower than or are inferior to all first mortgage bonds but not to other mortgage bonds.

6. A financial instrument which promises to repay the principal at a specified date but will pay interest
only when earned is called

a. A non-participating preference share

b. A revenue bond
 c. An income bond
d. A mortgage bond

7. Which of the following does not help to explain the existence of a premium in the price of a
convertible bond?

a. The downside protection offered by the convertible that is unavailable with the stock.
b. The opportunity to participate in gains in excess of the return available to debtholders.
c. Higher transaction costs on convertibles than the cost of trading ordinary shares.
d. Restrictions on the ability of certain institutions to invest in ordinary shares.

8. A convertible debenture is used

a. As a sweetener when raising capital by debt instruments.

b. To sell ordinary shares at prices higher than those prevailing when funds are needed.
c. When low cost capital is needed during construction.
d. When capital cannot be raised by a straight debt instrument at a reasonable rate.
e. For all the reasons enumerated above.

9. The least desirable of the following forms of financing for a small corporation whose shareholders are
concerned about maintaining control over the firm is

a. a rights offering.
b. participating preference share.
c. subordinated debentures.
d. income bonds.

10. A firms floats a new stock issue and uses the proceeds from the issue to retire a bond issue which
has matured. Which one of the following statements will hold in all cases?

a. The firm has increased its operating leverage.

b. The firm has decreased its financial leverage.
c. The firm has increased its earnings per share.
d. The firm has decreased its earnings per share.

Answers:

1. D 6. C
2. D 7. C
3. D 8. E
4. B 9. D
5. A 10. B