CFA® Level 1: CFA® Level 1 Exam Preparation

CFA® Level 1 Exam Statement Analysis

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Question

Which of the following statements is correct?

Answers

A. "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage.

B. If corporate tax rates were decreased while other things were held constant, and if the Modigliani Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to increase their use of debt.

C. The optimal capital structure is the one which simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS.

D. None of these statements are true.

E. If corporate tax rates were decreased while other things were held constant, and if the Modigliani Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.

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Explanations

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A. B. C. D. E.

If corporate tax rates were decreased while other things were held constant, and if the MM tax- adjusted tradeoff theory of capital structure were correct, corporations would decrease their use of debt because the tax shelter benefit would not be as great as when tax rates are high. Business risk is the riskiness of the firm's operations if it uses no debt. The optimal capital structure does not maximize EPS, and the degree of total leverage shows how a given change in sales will affect earnings per share.

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