Question 1

The Modigliani-Miller Proposition I without taxes states:

Accepted Answer

A)  A firm cannot change the total value of its outstanding securities by changing its capital structure proportions. 
B)  When new projects are added to the firm the firm value is the sum of the old value plus the new. 
C)  Managers can make correct corporate decisions that will satisfy all shareholders if they select projects that maximize value. 
D)  the determination of value must consider the timing and risk of the cashflows. 
A)  A firm cannot change the total value of its outstanding securities by changing its capital structure proportions. 
B)  When new projects are added to the firm the firm value is the sum of the old value plus the new. 
C)  Managers can make correct corporate decisions that will satisfy all shareholders if they select projects that maximize value. 
D)  the determination of value must consider the timing and risk of the cashflows.

Question 2

The Nantucket Nugget is unlevered and is valued at $640,000. Nantucket is currently deciding whether including debt in their capital structure would increase their value. The current of cost of equity is 12%. Under consideration is issuing $300,000 in new debt with an 8% interest rate. Nantucket would repurchase $300,000 of stock with the proceeds of the debt issue. There are currently 32,000 shares outstanding and their effective marginal tax bracket is 34%. What will Nantucket's new WACC be?

Accepted Answer

New Firm Value: $640,000 + (.34) ($300,0

Question 3

In the absence of taxes, the capital structure chosen by a firm doesn't really matter because of:

Accepted Answer

A)  taxes. 
B)  the interest tax shield. 
C)  the relationship between dividends and earnings per share. 
D)  the effects of leverage on the cost of equity. 
E)  homemade leverage. 
A)  taxes. 
B)  the interest tax shield. 
C)  the relationship between dividends and earnings per share. 
D)  the effects of leverage on the cost of equity. 
E)  homemade leverage.

Question 4

A firm has debt of $5,000, equity of $16,000, a leveraged value of $8,900, a cost of debt of 8%, a cost of equity of 12%, and a tax rate of 34%. What is the firm's weighted average cost of capital?

Accepted Answer

A)  7.29%. 
B)  7.94%. 
C)  8.87%. 
D)  10.40%. 
E)  11.05%. 
A)  7.29%. 
B)  7.94%. 
C)  8.87%. 
D)  10.40%. 
E)  11.05%.

Question 5

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)  21%. 
B)  18%. 
C)  15%. 
D)  10%. 
A)  21%. 
B)  18%. 
C)  15%. 
D)  10%.

Question 6

MM Proposition I with taxes is based on the concept that:

Accepted Answer

A)  the optimal capital structure is the one that is totally financed with equity. 
B)  the capital structure of the firm does not matter because investors can use homemade leverage. 
C)  the firm is better off with debt based on the weighted average cost of capital. 
D)  the value of the firm increases as total debt increases because of the interest tax shield. 
E)  the cost of equity increases as the debt-equity ratio of a firm increases. 
A)  the optimal capital structure is the one that is totally financed with equity. 
B)  the capital structure of the firm does not matter because investors can use homemade leverage. 
C)  the firm is better off with debt based on the weighted average cost of capital. 
D)  the value of the firm increases as total debt increases because of the interest tax shield. 
E)  the cost of equity increases as the debt-equity ratio of a firm increases.

Question 7

A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes or other imperfections, its cost of equity capital with the new capital structure would be:

Accepted Answer

A)  9%. 
B)  14%. 
C)  13%. 
D)  10%. 
A)  9%. 
B)  14%. 
C)  13%. 
D)  10%.

Question 8

The Boston Firm is unlevered with assets of $30 million and EBIT of $6 million. If the firm's tax rate is 34%, calculate both its after-tax cash flow and its value given a risk adjusted discount rate of 12%.

Accepted Answer

A)  $2,400,000; $30,000,000. 
B)  $2,400,000; $2,400,000. 
C)  $3,960,000; $33,000,000. 
D)  $3,960,000; $30,000,000. 
E)  $2,400,000; $33,000,000. 
A)  $2,400,000; $30,000,000. 
B)  $2,400,000; $2,400,000. 
C)  $3,960,000; $33,000,000. 
D)  $3,960,000; $30,000,000. 
E)  $2,400,000; $33,000,000.

Question 9

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

VU = [EBIT * (1 - Tc)] /RU = [$1,600 * (

Question 10

Financial leverage impacts the performance of the firm by:

Accepted Answer

A)  increasing the volatility of the firm's EBIT. 
B)  decreasing the volatility of the firm's EBIT. 
C)  decreasing the volatility of the firm's net income. 
D)  increasing the volatility of the firm's net income. 
A)  increasing the volatility of the firm's EBIT. 
B)  decreasing the volatility of the firm's EBIT. 
C)  decreasing the volatility of the firm's net income. 
D)  increasing the volatility of the firm's net income.

Question 11

Consider two firms, U and L, both with $50,000 in assets. Firm U is unlevered, and firm L has $20,000 of debt that pays 8% interest. Firm U has 1,000 shares outstanding, while firm L has 600 shares outstanding. Mike owns 20% of firm L and believes that leverage works in his favor. Steve tells Mike that this is an illusion, and that with the possibility of borrowing on his own account at 8% interest, he can replicate Mike's payout from firm L.
Mike tells Steve that while his analysis looks good on paper, Steve will never be able to borrow at 8%, but would have to pay a more realistic rate of 12%. If Mike is right, what will Steve's payout be?

Accepted Answer

Steve borrows $4,000 at 12% in

Question 12

A key assumption of MMs Proposition I (no taxes) is:

Accepted Answer

A)  that financial leverage increases risk. 
B)  that individuals can borrow on their own account at rates less than the firm. 
C)  that individuals must be able to borrow on their own account at rates equal to the firm. 
D)  managers are acting to maximize the value of the firm. 
A)  that financial leverage increases risk. 
B)  that individuals can borrow on their own account at rates less than the firm. 
C)  that individuals must be able to borrow on their own account at rates equal to the firm. 
D)  managers are acting to maximize the value of the firm.

Question 13

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 50%?

Accepted Answer

A)  10.0%. 
B)  10.75%. 
C)  12.50%. 
D)  7.73%. 
A)  10.0%. 
B)  10.75%. 
C)  12.50%. 
D)  7.73%.

Question 14

The interest tax shield is a key reason why:

Accepted Answer

A)  the required rate of return on assets rises when debt is added to the capital structure. 
B)  the value of an unlevered firm is equal to the value of a levered firm. 
C)  the net cost of debt to a firm is generally less than the cost of equity. 
D)  the cost of debt is equal to the cost of equity for a levered firm. 
E)  firms prefer equity financing over debt financing. 
A)  the required rate of return on assets rises when debt is added to the capital structure. 
B)  the value of an unlevered firm is equal to the value of a levered firm. 
C)  the net cost of debt to a firm is generally less than the cost of equity. 
D)  the cost of debt is equal to the cost of equity for a levered firm. 
E)  firms prefer equity financing over debt financing.

Question 15

A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If there are no taxes or other imperfections, what would be its cost of equity if the debt-to-equity ratio were 0?

Accepted Answer

A)  8%. 
B)  10%. 
C)  12%. 
D)  14%. 
E)  16%. 
A)  8%. 
B)  10%. 
C)  12%. 
D)  14%. 
E)  16%.

Question 16

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 decreases. 
B)  changing the capital structure if and only if the value of the firm increases to the benefit of the stockholders. 
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 decreases. 
B)  changing the capital structure if and only if the value of the firm increases to the benefit of the stockholders. 
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.

Exam 16: Capital Structure: Basic Concepts

The Modigliani-Miller Proposition I without taxes states:

In the absence of taxes, the capital structure chosen by a firm doesn't really matter because of:

A firm has debt of $5,000, equity of $16,000, a leveraged value of $8,900, a cost of debt of 8%, a cost of equity of 12%, and a tax rate of 34%. What is the firm's weighted average cost of capital?

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?

MM Proposition I with taxes is based on the concept that:

The Boston Firm is unlevered with assets of $30 million and EBIT of $6 million. If the firm's tax rate is 34%, calculate both its after-tax cash flow and its value given a risk adjusted discount rate of 12%.

Financial leverage impacts the performance of the firm by:

A key assumption of MMs Proposition I (no taxes) is:

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 50%?

The interest tax shield is a key reason why:

A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If there are no taxes or other imperfections, what would be its cost of equity if the debt-to-equity ratio were 0?

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

Introduction to Corporate Finance

Accounting Statements and Cash Flow

Financial Planning and Growth

Financial Markets and Net Present Value: First Principles of Finance

The Time Value of Money

How to Value Bonds and Stocks

Net Present Value and Other Investment Rules

Net Present Value and Capital Budgeting

Risk Analysis, Real Options, and Capital Budgeting

Risk and Return: Lessons From Market History

Risk and Return: the Capital Asset Pricing Model

An Alternative View of Risk and Return: the Arbitrage Pricing Theory

Risk, Return, and Capital Budgeting

Corporate Financing Decisions and Efficient Capital Markets

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

Issuing Equity Securities to the Public

Long-Term Debt

Leasing

Options and Corporate Finance: Basic Concepts

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Derivatives and Hedging Risk

Short-Term Finance and Planning

Cash Management

Credit Management

Mergers and Acquisitions

Financial Distress

International Corporate Finance

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