1-Different borrowers have different risks of bankruptcy, and bankruptcy is cost

Question

1-Different borrowers have different risks of bankruptcy, and bankruptcy is costly to lenders. Therefore, lenders charge higher rates to borrowers judged to be more at risk of going bankrupt.

True

False

2-If a firm utilizes debt financing, an X% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than X.

True

False

3-Whenever a firm borrows money, it is using financial leverage.

True

False

4-The trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

True

False

5-Financial risk refers to the extra risk stockholders bear as a result of using debt as compared with the risk they would bear if no debt were used.

True

False

6-A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

True

False

Explanation / Answer

1) True
Bankruptcy costs of debt are the increased costs of financing with debt instead of equity that result from a higher probability of bankruptcy.
2) True
If a firm utilizes debt financing, a decrease in earnings before interest and taxes (EBIT) will result in a more than proportionate decrease in earnings per share
3) True
Financial leverage arises when a firm decides to finance a majority of its assets by taking on debt.
4) True
5)True
6) False
Business risk is associated with firm's operations like flctuation in demand , competition etc

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