Question 1

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. A

Question 2

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 rate of 5%, 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 Firm L's cost of equity?

Accepted Answer

A)  11.4% 
B)  12.0% 
C)  12.6% 
D)  13.3% 
E)  14.0% 
A)  11.4% 
B)  12.0% 
C)  12.6% 
D)  13.3% 
E)  14.0% E

Question 3

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. B

Question 4

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

Question 5

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 6

According to MM, in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Accepted Answer

A) True 
 B)False

Question 7

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 8

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

Accepted Answer

A) True 
 B)False

Question 9

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 10

(The following data apply to Problems 29 through 31. The problems MUST be kept together.)
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 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 11

(The following data apply to Problems 29 through 31. The problems MUST be kept together.)
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 debt if its equity is viewed as an option?

Accepted Answer

A)  $167.57 
B)  $186.19 
C)  $204.81 
D)  $225.29 
E)  $247.82 
A)  $167.57 
B)  $186.19 
C)  $204.81 
D)  $225.29 
E)  $247.82

Question 12

(The following data apply to Problems 29 through 31. The problems MUST be kept together.)
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?

Accepted Answer

A)  $228.77 
B)  $254.19 
C)  $282.43 
D)  $313.81 
E)  $345.19 
A)  $228.77 
B)  $254.19 
C)  $282.43 
D)  $313.81 
E)  $345.19

Question 13

(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 firm's cost of equity?
Answer: e
EASY

Accepted Answer

A)  21.0% 
B)  23.3% 
C)  25.9% 
D)  28.8% 
E)  32.0% 
A)  21.0% 
B)  23.3% 
C)  25.9% 
D)  28.8% 
E)  32.0%

Question 14

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 15

(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 16

The Miller model begins with the MM model with taxes and then adds personal taxes.

Accepted Answer

A) True 
 B)False

Question 17

The MM model is the same as the Miller model, but with zero corporate taxes.

Accepted Answer

A) True 
 B)False

Question 18

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

Accepted Answer

A) True 
 B)False

Question 19

(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 20

The MM model with corporate taxes is the same as the Miller model, but with zero personal taxes.

Accepted Answer

A) True 
 B)False

Exam 26: Analysis of Capital Structure Theory

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

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

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.

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

According to MM, in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

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.

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.

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

The Miller model begins with the MM model with taxes and then adds personal taxes.

The MM model is the same as the Miller model, but with zero corporate taxes.

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

The MM model with corporate taxes is the same as the Miller model, but with zero personal taxes.

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

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

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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