Exam 13: Does Debt Policy Matter

A firm has a debt-to-equity ratio of 1. Its (levered) cost of equity is 16%, and its cost of debt is 8%. If there were no taxes, what would be its cost of equity if the debt-to-equity ratio were zero?

An investor can undo the effect of leverage on his/her own account by: I. investing in the equity of a levered firm II. by borrowing on his/her own account III. by investing in risk-free debt like T-bills

The after-tax weighted average cost of capital (WACC) is given by: (Corporate tax rate = TC )

The beta of the firm is equal to the weighted average of the betas on its debt and equity under the assumption of no taxes.

Modigliani and Miller Proposition II states that the rate of return required by the shareholders increases, steadily, as the firm's debt-equity ratio increases.

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return. The stock price is $60 and the earnings per share are $12. The company wishes to repurchase 50% of the stock and substitutes an equal value of debt yielding 8%. Suppose that before refinancing, an investor owned 100 shares of Learn and Earn common stock. What should he do if he wishes to ensure that risk and expected return on his investment are unaffected by refinancing?

Since the expected rate of return on debt is less than the expected rate of return on equity, the weighted average cost of capital declines as more debt is issued.

According to Proposition II, the cost of equity increases as more debt is issued, but the weighted average cost of capital remains unchanged.

If an investor buys "a" proportion of an unlevered firm's (firm U) equity then his/her payoff is:

If an individual wanted to borrow with limited liability he/she should:

The law of conservation of value implies that: I. the mix of senior and subordinated debt does not affect the value of the firm II. the mix of convertible and non-convertible debt does not affect the value of the firm III. the mix of common stock and preferred stock does not affect the value of the firm

According to EPS-operating income graph, debt financing is preferred if the expected operating income is:

The equity beta of a levered firm is 1.2. The beta of debt is 0.2. The firm's market value debt to equity ratio is 0.5. What is the asset beta if the tax rate is zero?

For a levered firm, beta of equity (bE) is equal to:

Generally, which of the following is true? (b = beta)

Capital structure of the firm can be defined as: I. the firm's debt-equity ratio II. the firm's mix of different securities used to finance assets III. the market imperfection that the firm's manager can exploit

The "law of conservation of value" is not applicable to the mix of debt securities.

For a levered firm,

Minimizing the weighted average cost of capital (WACC) is the same as:

An investor can create the effect of leverage on his/her account by: I. buying equity of an unlevered firm II. by investing in risk-free debt like T-bills III. by borrowing on his/her own account