Question 1

The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

Accepted Answer

A) levered ﬁrms pay less taxes compared with identical unlevered ﬁrms. 
B) bondholders require higher rates of return compared with stockholders. 
C) earnings per share are no longer relevant with taxes. 
D) dividends are no longer relevant with taxes. 
E) All of the above. 
A) levered ﬁrms pay less taxes compared with identical unlevered ﬁrms. 
B) bondholders require higher rates of return compared with stockholders. 
C) earnings per share are no longer relevant with taxes. 
D) dividends are no longer relevant with taxes. 
E) All of the above.

Question 2

You own 25% of Unique Vacations SA.You have decided to retire and want to sell your shares in this closely held, all equity ﬁrm.The other shareholders have agreed to have the ﬁrm borrow €1.5 million to purchase your 1,000 shares.
What is the total value of this ﬁrm today if you ignore taxes?

Accepted Answer

A) €4.8 million 
B) €5.1 million 
C) €5.4 million 
D) €5.7 million 
E) €6.0 million 
A) €4.8 million 
B) €5.1 million 
C) €5.4 million 
D) €5.7 million 
E) €6.0 million

Question 3

A general rule for managers to follow is to set the ﬁrm's capital structure such that:

Accepted Answer

A) the ﬁrm's value is minimized. 
B) the ﬁrm's value is maximized. 
C) the ﬁrm's bondholders are made well off. 
D) the ﬁrms suppliers of raw materials are satisﬁed. 
E) the ﬁrms dividend payout is maximized. 
A) the ﬁrm's value is minimized. 
B) the ﬁrm's value is maximized. 
C) the ﬁrm's bondholders are made well off. 
D) the ﬁrms suppliers of raw materials are satisﬁed. 
E) the ﬁrms dividend payout is maximized.

Question 4

The value of the ﬁrm is maximized by taking on as much debt as possible.Show graphically how adding debt can increase value through the overall cost of capital.Explain under what conditions how this impacts the cost of capital and translates into ﬁrm value.

Accepted Answer

This is MM Proposition I and I

Question 5

A ﬁrm has a debt-to-equity ratio of 1.Its cost of equity is 16%, and its cost of debt is 8%.If the corporate tax rate is 25%, what would its cost of equity be if the debt-to-equity ratio were 0?

Accepted Answer

A) 11.11% 
B) 12.57% 
C) 13.33% 
D) 16.00% 
E) None of the above. 
A) 11.11% 
B) 12.57% 
C) 13.33% 
D) 16.00% 
E) None of the above.

Question 6

Which of the following statements are correct in relation to MM Proposition II with no taxes? I.The return on assets is equal to the weighted average cost of capital.
II)Financial risk is determined by the debt-equity ratio.
III)Financial risk determines the return on assets.
IV)The cost of equity declines when the amount of leverage used by a ﬁrm rises.

Accepted Answer

A) I and III only. 
B) II and IV only. 
C) I and II only. 
D) III and IV only. 
E) I and IV only. 
A) I and III only. 
B) II and IV only. 
C) I and II only. 
D) III and IV only. 
E) I and IV only.

Question 7

Bigelow SpA has a cost of equity of 13.56% and a pre-tax cost of debt of 7%.The required return on the assets is 11%. What is the ﬁrm's debt-equity ratio based on MM Proposition II with no taxes?

Accepted Answer

A) .60 
B) .64 
C) .72 
D) .75 
E) .80 
A) .60 
B) .64 
C) .72 
D) .75 
E) .80

Question 8

Which of the following will tend to diminish the beneﬁt of the interest tax shield given a progressive tax rate structure? I. A reduction in tax rates.
II) A large tax loss carry forward.
III) A large depreciation tax deduction.
IV) A sizeable increase in taxable income.

Accepted Answer

A) I and II only. 
B) I and III only. 
C) II and III only. 
D) I, II, and III only. 
E) I, II, III, and IV. 
A) I and II only. 
B) I and III only. 
C) II and III only. 
D) I, II, and III only. 
E) I, II, III, and IV.

Question 9

Scott's Leisure Time Sports is an unlevered ﬁrm with an after-tax net income of €86,000.The unlevered cost of capital is 10% and the tax rate is 34%.What is the value of this ﬁrm?

Accepted Answer

A) €567,600 
B) €781,818 
C) €860,000 
D) €946,000 
E) €1,152,400 
A) €567,600 
B) €781,818 
C) €860,000 
D) €946,000 
E) €1,152,400

Question 10

A ﬁrm has a debt-to-equity ratio of 1.20.If it had no debt, its cost of equity would be 15%.Its cost of debt is 10%.What is its cost of equity if there are no taxes or other imperfections?

Accepted Answer

A) 10% 
B) 15% 
C) 18% 
D) 21% 
E) None of the above. 
A) 10% 
B) 15% 
C) 18% 
D) 21% 
E) None of the above.

Question 11

A ﬁrm has a debt-to-equity ratio of 1.75.If it had no debt, its cost of equity would be 9%.Its cost of debt is 7%.What is its cost of equity if the corporate tax rate is 30%?

Accepted Answer

A) 7.73% 
B) 10.00% 
C) 11.45% 
D) 12.50% 
E) None of the above. 
A) 7.73% 
B) 10.00% 
C) 11.45% 
D) 12.50% 
E) None of the above.

Question 12

The unlevered cost of capital is:

Accepted Answer

A) the cost of capital for a ﬁrm with no equity in its capital structure. 
B) the cost of capital for a ﬁrm with no debt in its capital structure. 
C) the interest tax shield times pretax net income. 
D) the cost of preference shares for a ﬁrm with equal parts debt and ordinary equity in its capital structure. 
E) equal to the proﬁt margin for a ﬁrm with some debt in its capital structure. 
A) the cost of capital for a ﬁrm with no equity in its capital structure. 
B) the cost of capital for a ﬁrm with no debt in its capital structure. 
C) the interest tax shield times pretax net income. 
D) the cost of preference shares for a ﬁrm with equal parts debt and ordinary equity in its capital structure. 
E) equal to the proﬁt margin for a ﬁrm with some debt in its capital structure.

Question 13

The cost of capital for a ﬁrm, RWACC, in a zero tax environment is:

Accepted Answer

A) equal to the expected earnings divided by market value of the unlevered ﬁrm. 
B) equal to the rate of return for that business risk class. 
C) equal to the overall rate of return required on the levered ﬁrm. 
D) is constant regardless of the amount of leverage. 
E) All of the above. 
A) equal to the expected earnings divided by market value of the unlevered ﬁrm. 
B) equal to the rate of return for that business risk class. 
C) equal to the overall rate of return required on the levered ﬁrm. 
D) is constant regardless of the amount of leverage. 
E) All of the above.

Question 14

Gail's Dance Studio is currently an all equity ﬁrm that has 80,000 shares outstanding with a market price of €42 a share.The current cost of equity is 12% and the tax rate is 34%.Gail is considering adding €1 million of debt with a
Coupon rate of 8% to her capital structure.The debt will be sold at par value.What is the levered value of the equity?

Accepted Answer

A) €2.4 million 
B) €2.7 million 
C) €3.3 million 
D) €3.7 million 
E) €3.9 million 
A) €2.4 million 
B) €2.7 million 
C) €3.3 million 
D) €3.7 million 
E) €3.9 million

Question 15

The proposition that the value of the ﬁrm is independent of its capital structure is called:

Accepted Answer

A) the capital asset pricing model. 
B) MM Proposition I. 
C) MM Proposition II. 
D) the law of one price. 
E) the eﬃcient markets hypothesis. 
A) the capital asset pricing model. 
B) MM Proposition I. 
C) MM Proposition II. 
D) the law of one price. 
E) the eﬃcient markets hypothesis.

Question 16

The tax savings of the ﬁrm derived from the deductibility of interest expense is called the:

Accepted Answer

A) interest tax shield. 
B) depreciable basis. 
C) ﬁnancing umbrella. 
D) current yield. 
E) tax-loss carryforward savings. 
A) interest tax shield. 
B) depreciable basis. 
C) ﬁnancing umbrella. 
D) current yield. 
E) tax-loss carryforward savings.

Question 17

Montana Hills SA has expected earnings before interest and taxes of €8,100, an unlevered cost of capital of 11%, and debt with both a book and face value of €12,000.The debt has an annual 8% coupon.The tax rate is 34%.What is the
Value of the ﬁrm?

Accepted Answer

A) €48,600 
B) €50,000 
C) €52,680 
D) €56,667 
E) €60,600 
A) €48,600 
B) €50,000 
C) €52,680 
D) €56,667 
E) €60,600

Question 18

Anderson's Furniture Outlet has an unlevered cost of capital of 10%, a tax rate of 34%, and expected earnings before interest and taxes of €1,600.The company has €3,000 in bonds outstanding that have an 8% coupon and pay interest
Annually.The bonds are selling at par value.What is the cost of equity?

Accepted Answer

A) 8.67% 
B) 9.34% 
C) 9.72% 
D) 9.99% 
E) 10.46% 
A) 8.67% 
B) 9.34% 
C) 9.72% 
D) 9.99% 
E) 10.46%

Question 19

A manager should attempt to maximize the value of the ﬁrm by:

Accepted Answer

A) changing the capital structure if and only if the value of the ﬁrm increases. 
B) changing the capital structure if and only if the value of the ﬁrm increases to the beneﬁts to inside
Management. 
C) changing the capital structure if and only if the value of the ﬁrm increases only to the beneﬁts the
Debtholders. 
D) changing the capital structure if and only if the value of the ﬁrm increases although it decreases the
Stockholders' value. 
E) changing the capital structure if and only if the value of the ﬁrm increases and stockholder wealth is
Constant. 
A) changing the capital structure if and only if the value of the ﬁrm increases. 
B) changing the capital structure if and only if the value of the ﬁrm increases to the beneﬁts to inside
Management. 
C) changing the capital structure if and only if the value of the ﬁrm increases only to the beneﬁts the
Debtholders. 
D) changing the capital structure if and only if the value of the ﬁrm increases although it decreases the
Stockholders' value. 
E) changing the capital structure if and only if the value of the ﬁrm increases and stockholder wealth is
Constant.

Question 20

The proposition that the value of a levered ﬁrm is equal to the value of an unlevered ﬁrm is known as:

Accepted Answer

A) MM Proposition I with no tax. 
B) MM Proposition II with no tax. 
C) MM Proposition I with tax. 
D) MM Proposition II with tax. 
E) static theory proposition. 
A) MM Proposition I with no tax. 
B) MM Proposition II with no tax. 
C) MM Proposition I with tax. 
D) MM Proposition II with tax. 
E) static theory proposition.

Exam 15: Capital Structure: Basic Concepts

The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

A general rule for managers to follow is to set the ﬁrm's capital structure such that:

The value of the ﬁrm is maximized by taking on as much debt as possible.Show graphically how adding debt can increase value through the overall cost of capital.Explain under what conditions how this impacts the cost of capital and translates into ﬁrm value.

A ﬁrm has a debt-to-equity ratio of 1.Its cost of equity is 16%, and its cost of debt is 8%.If the corporate tax rate is 25%, what would its cost of equity be if the debt-to-equity ratio were 0?

Bigelow SpA has a cost of equity of 13.56% and a pre-tax cost of debt of 7%.The required return on the assets is 11%. What is the ﬁrm's debt-equity ratio based on MM Proposition II with no taxes?

Which of the following will tend to diminish the beneﬁt of the interest tax shield given a progressive tax rate structure? I. A reduction in tax rates. II) A large tax loss carry forward. III) A large depreciation tax deduction. IV) A sizeable increase in taxable income.

Scott's Leisure Time Sports is an unlevered ﬁrm with an after-tax net income of €86,000.The unlevered cost of capital is 10% and the tax rate is 34%.What is the value of this ﬁrm?

A ﬁrm has a debt-to-equity ratio of 1.20.If it had no debt, its cost of equity would be 15%.Its cost of debt is 10%.What is its cost of equity if there are no taxes or other imperfections?

A ﬁrm has a debt-to-equity ratio of 1.75.If it had no debt, its cost of equity would be 9%.Its cost of debt is 7%.What is its cost of equity if the corporate tax rate is 30%?

The unlevered cost of capital is:

The cost of capital for a ﬁrm, RWACC, in a zero tax environment is:

The proposition that the value of the ﬁrm is independent of its capital structure is called:

The tax savings of the ﬁrm derived from the deductibility of interest expense is called the:

Montana Hills SA has expected earnings before interest and taxes of €8,100, an unlevered cost of capital of 11%, and debt with both a book and face value of €12,000.The debt has an annual 8% coupon.The tax rate is 34%.What is the Value of the ﬁrm?

A manager should attempt to maximize the value of the ﬁrm by:

The proposition that the value of a levered ﬁrm is equal to the value of an unlevered ﬁrm is known as:

Introduction to Corporate Finance

Corporate Governance

Financial Statement Analysis

Discounted Cash Flow Valuation

Bond, Equity and Firm Valuation

Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, Real Options and Capital Budgeting

Risk and Return: Lessons From Market History

Risk and Return: the Capital Asset Pricing Model

Factor Models and the Arbitrage Pricing Theory

Risk, Cost of Capital and Capital Budgeting

Efficient Capital Markets and Behavioural Finance

Long-Term Financing: an Introduction

Capital Structure: Limits to the Use of Debt

Valuation and Capital Budgeting for the Levered Firm

Dividends and Other Payouts

Equity Financing

Debt Financing

Leasing

Options and Corporate Finance

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Financial Risk Management With Derivatives

Short-Term Finance and Planning

Short-Term Capital Management

Mergers and Acquisitions

Financial Distress

International Corporate Finance

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