o borrowing might lever up the return on common equity when

o. borrowing might lever up the return on common equity when: A) the cash rom issuing debt is invested earn at a rate equal the borrowing cost B) the cash from C) the cash from issuing D) borrowing has no effect on the return on common equity. 7. Which of the following statements is of the debt cost of the debt cost of the debt tg debt is inivested cam at a rate greater than the borrowing ege ssuing debe is invested can at a rate lower than the borrowing equals A. Net operating profit margin divided by net operating asset turnover B. Return on net operating assets can be disaggregated into net operatinjg return on net operating assets profit margin and leverage C. Return on equity equals return on net operating assets less interest, net of tax D. Return on equity can be disaggregated into net operating profit margin, net operating asset turnover and leverage. 8·The residual income model defines stock price as book value plus the present value of residual income. What is the effect on stock price in a given period if the firm\'s cost of capital is greater than its return on equity? A. Cannot be determined B. No effect C. Stock price increases D. Stock price decreases 9. If a company is to successfully remain in business over the long haul, which of the following statements is most correct? A. Total cash flow from operations, measured over an extended period, must be greater than zero B. Total cash flow from investing, measured over an extended period, must be positive C. Total cash flow from financing, measured over an extended period, should be negative D. Total cash flow from financing plus total cash flow from investing, measured over an extended period, must be positive.

Solution

6B the cash from issuing debt is invested earn at a rate greater than the borrowing cost of debt. Explanation: Using debt in capital structure is called a leverage which is beneficial to increase return on equity due to its low cost than return on assets, so effectively cost of debt must be lesser than return on assets for a beneficial leverage effect. 7D Return on equity can be disaggregated into net operating profit margin, net operating asset turnover and leverge. Explanation: Return on equity is constituted using Operating profit, which is subdivided in net operating assets and leverage effect. 8D Stock price decreases. Explanation: Since residual income model uses Book value plus present value of residual income, using high cost debt that is greater than its return on equity make leverage effect negative on stock prices which reduces its residual income and present value of residula income is lowered. 9A Total cash flow from operations, measured over an extended period, must be greater than zero Explanation: For a going concern it’s a must that it generates positive cash flows from its operations since positive cash flows signifies that business is running in normal course, otherwise it will be shut down due to losses.generating positive cash flow form other than operations is not a normal course of business since busines is selling its assets or using other capitaliztion mode to generating cash for its future needs and will be shut in near future without positive operating cash flows.