Exam 26: Analysis of Capital Structure Theory

Trumbull, Inc., has total value (debt plus equity) of $500 million and $200 million face value of 1-year zero coupon debt. The volatility ( $\sigma$ ) of Trumbull's total value is 0.60, and the risk-free rate is 5%. Assume that N(d1) = 0.9720 and N(d2) = 0.9050. -What is the value (in millions) of Trumbull's equity if it is viewed as an option?

(Multiple Choice)

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Question 21

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

(True/False)

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Question 22

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

(True/False)

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Question 23

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.

(True/False)

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Question 24

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

(Multiple Choice)

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Question 25

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

(True/False)

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Question 26

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?

(Multiple Choice)

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Question 27

Showing 21 - 27 of 27

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

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

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?

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

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risks and Rates of Return

Stocks and Their Valuation

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting

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

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not-For-Profit Businesses

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