Question 1

In the MM extension with growth, the appropriate discount rate for the tax shield is the WACC.

Accepted Answer

A) True 
 B)False  False

Question 2

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

Accepted Answer

A) True 
 B)False  False

Question 3

When a firm has risky debt, its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.

Accepted Answer

A) True 
 B)False  True

Question 4

What is the yield on Trumbull's debt?

Accepted Answer

A)  6.04% 
B)  6.36% 
C)  6.70% 
D)  7.05% 
E)  7.42% 
A)  6.04% 
B)  6.36% 
C)  6.70% 
D)  7.05% 
E)  7.42%

Question 5

Assume that the firm's gain from leverage according to the Miller model is $126,667. If the effective personal tax rate on stock income is TS = 20%, what is the implied personal tax rate on debt income?

Accepted Answer

A)  16.4% 
B)  18.2% 
C)  20.2% 
D)  22.5% 
E)  25.0% 
A)  16.4% 
B)  18.2% 
C)  20.2% 
D)  22.5% 
E)  25.0%

Question 6

Which of the following statements concerning capital structure theory is NOT CORRECT?

Accepted Answer

A)  The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt. 
B)  Under MM with zero taxes, financial leverage has no effect on a firm's value. 
C)  Under MM with corporate taxes, the value of a levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt. 
D)  Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing. 
E)  Under MM with corporate taxes, the effect of business risk is automatically incorporated because rsL is a function of rsU. 
A)  The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt. 
B)  Under MM with zero taxes, financial leverage has no effect on a firm's value. 
C)  Under MM with corporate taxes, the value of a levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt. 
D)  Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing. 
E)  Under MM with corporate taxes, the effect of business risk is automatically incorporated because rsL is a function of rsU.

Question 7

(The following data apply to Problems 26 through 28. The problems MUST be kept together.)
Gomez computer systems has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Gomez must reinvest 20% of its EBIT in net operating assets. Gomez has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%.
-According to the MM extension with growth, what is the value of Gomez's tax shield?

Accepted Answer

A)  $156,385 
B)  $164,616 
C)  $173,280 
D)  $182,400 
E)  $192,000 
A)  $156,385 
B)  $164,616 
C)  $173,280 
D)  $182,400 
E)  $192,000

Question 8

The major contribution of the Miller model is that it demonstrates that

Accepted Answer

A)  personal taxes increase the value of using corporate debt. 
B)  personal taxes decrease the value of using corporate debt. 
C)  financial distress and agency costs reduce the value of using corporate debt. 
D)  equity costs increase with financial leverage. 
E)  debt costs increase with financial leverage. 
A)  personal taxes increase the value of using corporate debt. 
B)  personal taxes decrease the value of using corporate debt. 
C)  financial distress and agency costs reduce the value of using corporate debt. 
D)  equity costs increase with financial leverage. 
E)  debt costs increase with financial leverage.

Question 9

(The following data apply to Problems 26 through 28. The problems MUST be kept together.)
Gomez computer systems has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Gomez must reinvest 20% of its EBIT in net operating assets. Gomez has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%.
-According to the MM extension with growth, what is Gomez's unlevered value?

Accepted Answer

A)  $1,296,000 
B)  $1,440,000 
C)  $1,600,000 
D)  $1,760,000 
E)  $1,936,000 
A)  $1,296,000 
B)  $1,440,000 
C)  $1,600,000 
D)  $1,760,000 
E)  $1,936,000

Question 10

In the MM extension with growth, the appropriate discount rate for the tax shield is the after-tax cost of debt.

Accepted Answer

A) True 
 B)False

Question 11

MM showed that in a world without taxes, a firm's value is not affected by its capital structure.

Accepted Answer

A) True 
 B)False

Question 12

Your firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000. It is growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is the value of your firm's tax shield, i.e., how much value does the use of debt add?

Accepted Answer

A)  $92,571 
B)  $102,857 
C)  $113,143 
D)  $124,457 
E)  $136,903 
A)  $92,571 
B)  $102,857 
C)  $113,143 
D)  $124,457 
E)  $136,903

Question 13

Firm L has debt with a market value of $200,000 and a yield of 9%. The firm's equity has a market value of $300,000, its earnings are growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what would Firm L's total value be if it had no debt?

Accepted Answer

A)  $358,421 
B)  $377,286 
C)  $397,143 
D)  $417,000 
E)  $437,850 
A)  $358,421 
B)  $377,286 
C)  $397,143 
D)  $417,000 
E)  $437,850

Question 14

In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

Accepted Answer

A) True 
 B)False

Question 15

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

Accepted Answer

A)  The tax shields should be discounted at the cost of debt. 
B)  The value of a growing tax shield is greater than the value of a constant tax shield. 
C)  For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions. 
D)  For a given D/S, the WACC is greater than the WACC under MM's original (with tax) assumptions. 
E)  The total value of the firm increases with the amount of debt. 
A)  The tax shields should be discounted at the cost of debt. 
B)  The value of a growing tax shield is greater than the value of a constant tax shield. 
C)  For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions. 
D)  For a given D/S, the WACC is greater than the WACC under MM's original (with tax) assumptions. 
E)  The total value of the firm increases with the amount of debt.

Question 16

(The following data apply to Problems 23 through 25. The problems MUST be kept together.)
The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%. Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.
-What is the value of the firm according to MM with corporate taxes?

Accepted Answer

A)  $475,875 
B)  $528,750 
C)  $587,500 
D)  $646,250 
E)  $710,875 
A)  $475,875 
B)  $528,750 
C)  $587,500 
D)  $646,250 
E)  $710,875

Question 17

In the MM extension with growth, the appropriate discount rate for the tax shield is the unlevered cost of equity.

Accepted Answer

A) True 
 B)False

Question 18

When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.

Accepted Answer

A) True 
 B)False

Question 19

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

Accepted Answer

A)  The tax shields should be discounted at the unlevered cost of equity. 
B)  The value of a growing tax shield is greater than the value of a constant tax shield. 
C)  For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions. 
D)  For a given D/S, the WACC is greater than the WACC under MM's original (with tax) assumptions. 
E)  The total value of the firm is independent of the amount of debt it uses. 
A)  The tax shields should be discounted at the unlevered cost of equity. 
B)  The value of a growing tax shield is greater than the value of a constant tax shield. 
C)  For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions. 
D)  For a given D/S, the WACC is greater than the WACC under MM's original (with tax) assumptions. 
E)  The total value of the firm is independent of the amount of debt it uses.

Question 20

(The following data apply to Problems 26 through 28. The problems MUST be kept together.)
Gomez computer systems has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Gomez must reinvest 20% of its EBIT in net operating assets. Gomez has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%.
-According to the MM extension with growth, what is Gomez's value of equity?

Accepted Answer

A)  $1,492,000 
B)  $1,529,300 
C)  $1,567,533 
D)  $1,606,721 
E)  $1,646,889 
A)  $1,492,000 
B)  $1,529,300 
C)  $1,567,533 
D)  $1,606,721 
E)  $1,646,889

In the MM extension with growth, the appropriate discount rate for the tax shield is the WACC.

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

When a firm has risky debt, its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.

What is the yield on Trumbull's debt?

Assume that the firm's gain from leverage according to the Miller model is $126,667. If the effective personal tax rate on stock income is TS = 20%, what is the implied personal tax rate on debt income?

Which of the following statements concerning capital structure theory is NOT CORRECT?

The major contribution of the Miller model is that it demonstrates that

In the MM extension with growth, the appropriate discount rate for the tax shield is the after-tax cost of debt.

MM showed that in a world without taxes, a firm's value is not affected by its capital structure.

In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

In the MM extension with growth, the appropriate discount rate for the tax shield is the unlevered cost of equity.

When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements Part 2 Fixed Income Securities

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risk, Return, and the Capital Asset Pricing Model

Stocks, Stock Valuation, and Stock Market Equilibrium

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Financial Planning and Forecasting Financial Statements

Corporate Valuation, Value-Based Management and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Working Capital Management

Multinational Financial Management

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Initial Public Offerings, Investment Banking, and Financial Restructuring

Mergers, Lbos, Divestitures, and Holding Companies

Bankruptcy, Reorganization, and Liquidation

Derivatives and Risk Management

Portfolio Theory, Asset Pricing Models, and Behavioral Finance

Real Options

Filters

Exam 26: Analysis of Capital Structure Theory

In the MM extension with growth, the appropriate discount rate for the tax shield is the WACC.

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

When a firm has risky debt, its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.

What is the yield on Trumbull's debt?

Assume that the firm's gain from leverage according to the Miller model is $126,667. If the effective personal tax rate on stock income is TS = 20%, what is the implied personal tax rate on debt income?

Which of the following statements concerning capital structure theory is NOT CORRECT?

The major contribution of the Miller model is that it demonstrates that

In the MM extension with growth, the appropriate discount rate for the tax shield is the after-tax cost of debt.

MM showed that in a world without taxes, a firm's value is not affected by its capital structure.

In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

In the MM extension with growth, the appropriate discount rate for the tax shield is the unlevered cost of equity.

When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements Part 2 Fixed Income Securities

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risk, Return, and the Capital Asset Pricing Model

Stocks, Stock Valuation, and Stock Market Equilibrium

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Financial Planning and Forecasting Financial Statements

Corporate Valuation, Value-Based Management and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Working Capital Management

Multinational Financial Management

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Initial Public Offerings, Investment Banking, and Financial Restructuring

Mergers, Lbos, Divestitures, and Holding Companies

Bankruptcy, Reorganization, and Liquidation

Derivatives and Risk Management

Portfolio Theory, Asset Pricing Models, and Behavioral Finance

Real Options

Filters