Question 1

The law of conservation of value implies that

Accepted Answer

A) the return on a firm's common stock is unchanged when debt is added to its capital structure. 
B) the value of any asset is preserved regardless of the nature of the claims against it. 
C) the return on a firm's debt is unchanged when common stock is added to its capital structure. 
D) the value of an asset increases as debt is reduced. 
A) the return on a firm's common stock is unchanged when debt is added to its capital structure. 
B) the value of any asset is preserved regardless of the nature of the claims against it. 
C) the return on a firm's debt is unchanged when common stock is added to its capital structure. 
D) the value of an asset increases as debt is reduced.

Question 2

The M&M Company is financed by $10 million in debt (market value)and $40 million in equity (market value). The cost of debt is 10 percent and the cost of equity is 20 percent. Calculate the weighted average cost of capital assuming no taxes.

Accepted Answer

A) 18 percent 
B) 20 percent 
C) 10 percent 
D) 12 percent 
A) 18 percent 
B) 20 percent 
C) 10 percent 
D) 12 percent

Question 3

Generally, which of the following is true?

Accepted Answer

A) rE D A 
B) rD A E 
C) rE A D 
D) rD E A 
A) rE D A 
B) rD A E 
C) rE A D 
D) rD E A

Question 4

The firm's asset beta is usually higher than the firm's equity beta.

Accepted Answer

A) True 
 B)False

Question 5

A policy of maximizing the value of the firm is the same as a policy of minimizing the weighted average cost of capital providing that
I.the firm's investment policy is settled;
II.there are no taxes;
III.an issue of new debt does not affect the market value of existing debt

Accepted Answer

A) I only 
B) II only 
C) III only 
D) I, II, and III 
A) I only 
B) II only 
C) III only 
D) I, II, and III

Question 6

The law of conservation of value does not apply to the mix of a firm's debt securities.

Accepted Answer

A) True 
 B)False

Question 7

The principle of value additivity holds for the aggregation of assets but does not apply to the division of assets.

Accepted Answer

A) True 
 B)False

Question 8

If a firm is financed with both debt and equity, the firm's equity is known as

Accepted Answer

A) unlevered equity. 
B) levered equity. 
C) preferred equity. 
D) None of these options. 
A) unlevered equity. 
B) levered equity. 
C) preferred equity. 
D) None of these options.

Question 9

The capital structure of the firm can be defined as
I.the firm's mix of different debt securities;
II.the firm's mix of different securities used to finance assets;
III.the market imperfection that the firm's managers can exploit

Accepted Answer

A) I only 
B) II only 
C) III only 
D) I, II, and III 
A) I only 
B) II only 
C) III only 
D) I, II, and III

Question 10

According to Modigliani and Miller Proposition II, the firm's expected return on assets depends on several factors including the firm's capital structure.

Accepted Answer

A) True 
 B)False

Question 11

Describe the break-even point, as displayed on an EPS-operating income graph.

Accepted Answer

On a plot of EPS versus operating income

Question 12

According to Modigliani and Miller Proposition II, the rate of return required by debtholders linearly increases as the firm's debt-equity ratio increases.

Accepted Answer

A) True 
 B)False

Question 13

Briefly discuss some of the applications of the law of conservation of value.

Accepted Answer

The law of conservation of value can be

Question 14

A firm has zero debt in its capital structure. Its overall cost of capital is 10 percent. The firm is considering a new capital structure with 60 percent debt. The interest rate on the debt would be 8 percent. Assuming there are no taxes, its cost of equity capital with the new capital structure would be

Accepted Answer

A) 8 percent. 
B) 16 percent. 
C) 13 percent. 
D) 10 percent. 
A) 8 percent. 
B) 16 percent. 
C) 13 percent. 
D) 10 percent.

Question 15

The asset beta of a levered firm is 1.1. The beta of debt is 0.3. If the debt equity ratio is 0.5, what is the equity beta? (Assume no taxes.)

Accepted Answer

A) 1.50 
B) 1.10 
C) 0.30 
D) 0.15 
A) 1.50 
B) 1.10 
C) 0.30 
D) 0.15

Question 16

Capital structure is irrelevant if
I.capital markets are efficient;
II.each investor can borrow/lend on the same terms as the firm;
III.there are no tax benefits to debt

Accepted Answer

A) I only 
B) II only 
C) III only 
D) I, II, and III 
A) I only 
B) II only 
C) III only 
D) I, II, and III

Question 17

If an investor buys a portion (X)of an unlevered firm's equity, then his/her payoff is

Accepted Answer

A) (X)× (profits). 
B) (X)× (interest). 
C) (X)× (profits − interest). 
D) (1/X)× (profits). 
A) (X)× (profits). 
B) (X)× (interest). 
C) (X)× (profits − interest). 
D) (1/X)× (profits).

Question 18

Assume the following data for U&P Company: Debt (D)= $100 million; Equity (E)= $300 million; rD = 6%; rE = 12%; and TC = 30%. Calculate the after-tax weighted average cost of capital (WACC):

Accepted Answer

A) 10.5 percent 
B) 15.00 percent 
C) 10.05 percent 
D) 9.45 percent 
A) 10.5 percent 
B) 15.00 percent 
C) 10.05 percent 
D) 9.45 percent

Question 19

Value additivity works for
I.combining assets;
II.splitting up of assets;
III.the mix of debt securities issued by the firm

Accepted Answer

A) I only 
B) II only 
C) I and II only 
D) I, II, and III 
A) I only 
B) II only 
C) I and II only 
D) I, II, and III

Question 20

Investors require higher returns on levered equity than on equivalent unlevered equity.

Accepted Answer

A) True 
 B)False

Exam 17: Does Debt Policy Matter

The law of conservation of value implies that

The M&M Company is financed by $10 million in debt (market value)and $40 million in equity (market value). The cost of debt is 10 percent and the cost of equity is 20 percent. Calculate the weighted average cost of capital assuming no taxes.

Generally, which of the following is true?

The firm's asset beta is usually higher than the firm's equity beta.

A policy of maximizing the value of the firm is the same as a policy of minimizing the weighted average cost of capital providing that I.the firm's investment policy is settled; II.there are no taxes; III.an issue of new debt does not affect the market value of existing debt

The law of conservation of value does not apply to the mix of a firm's debt securities.

The principle of value additivity holds for the aggregation of assets but does not apply to the division of assets.

If a firm is financed with both debt and equity, the firm's equity is known as

The capital structure of the firm can be defined as I.the firm's mix of different debt securities; II.the firm's mix of different securities used to finance assets; III.the market imperfection that the firm's managers can exploit

According to Modigliani and Miller Proposition II, the firm's expected return on assets depends on several factors including the firm's capital structure.

Describe the break-even point, as displayed on an EPS-operating income graph.

According to Modigliani and Miller Proposition II, the rate of return required by debtholders linearly increases as the firm's debt-equity ratio increases.

Briefly discuss some of the applications of the law of conservation of value.

The asset beta of a levered firm is 1.1. The beta of debt is 0.3. If the debt equity ratio is 0.5, what is the equity beta? (Assume no taxes.)

Capital structure is irrelevant if I.capital markets are efficient; II.each investor can borrow/lend on the same terms as the firm; III.there are no tax benefits to debt

If an investor buys a portion (X)of an unlevered firm's equity, then his/her payoff is

Assume the following data for U&P Company: Debt (D)= $100 million; Equity (E)= $300 million; rD = 6%; rE = 12%; and TC = 30%. Calculate the after-tax weighted average cost of capital (WACC):

Value additivity works for I.combining assets; II.splitting up of assets; III.the mix of debt securities issued by the firm

Investors require higher returns on levered equity than on equivalent unlevered equity.

Introduction to Corporate Finance

How to Calculate Present Values

Valuing Bonds

The Value of Common Stocks

Net Present Value and Other Investment Criteria

Making Investment Decisions With the Net Present Value Rule

Introduction to Risk and Return

Portfolio Theory and the Capital Asset Pricing Model

Risk and the Cost of Capital

Project Analysis

How to Ensure That Projects Truly Have Positive Npvs

Agency Problems and Investment

Efficient Markets and Behavioral Finance

An Overview of Corporate Financing

How Corporations Issue Securities

Payout Policy

How Much Should a Corporation Borrow

Financing and Valuation

Understanding Options

Valuing Options

Real Options

Credit Risk and the Value of Corporate Debt

The Many Different Kinds of Debt

Leasing

Managing Risk

Managing International Risks

Financial Analysis

Financial Planning

Working Capital Management

Mergers

Corporate Restructuring

Governance and Corporate Control Around the World

Filters

Assume the following data for U&P Company: Debt (D)= $100 million; Equity (E)= $300 million; r_D = 6%; r_E = 12%; and T_C = 30%. Calculate the after-tax weighted average cost of capital (WACC):