Question 1

The total market value (V)of the securities of a firm that has both debt (D)and equity (E)is:

Accepted Answer

A) V = D - E 
B) V = E - D 
C) V = D × E 
D) V = D + E 
A) V = D - E 
B) V = E - D 
C) V = D × E 
D) V = D + E D

Question 2

An EPS-operating income graph,for different debt ratios,shows the:
I.greater risk associated with debt financing,which is evidenced by a greater slope;
II.the break-even point where EPS of two different debt ratios are equal;
III.the minimum earnings needed to pay the debt financing for a given level of debt

Accepted Answer

A) I only 
B) II only 
C) III only 
D) I,II,and III only 
A) I only 
B) II only 
C) III only 
D) I,II,and III only D

Question 3

The law of conservation of value implies that:
I.the mix of common stock and preferred stock does not affect the value of the firm;
II.the mix of long-term and short-term debt does not affect the value of the firm;
III.the mix of secured and unsecured debt does not affect the value of the firm

Accepted Answer

A) I only 
B) II only 
C) III only 
D) I,II,and III 
A) I only 
B) II only 
C) III only 
D) I,II,and III D

Question 4

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,its cost of equity capital with the new capital structure would be:

Accepted Answer

A) 8% 
B) 16% 
C) 13% 
D) 10% 
A) 8% 
B) 16% 
C) 13% 
D) 10%

Question 5

For a levered firm where bA = beta of assets and bD = beta of debt,the return on equity (rE)is equal to:

Accepted Answer

A) rE = rA 
B) rE = rA + (D/
E) × [rA - rB] 
C) rE = rA + (D/(D + 
E) )× [rA - rB] 
D) none of the options 
A) rE = rA 
B) rE = rA + (D/
E) × [rA - rB] 
C) rE = rA + (D/(D + 
E) )× [rA - rB] 
D) none of the options

Question 6

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

Accepted Answer

A) invest in the equity of an unlevered firm. 
B) borrow on his/her own account. 
C) invest in the equity of a levered firm. 
D) invest in a risk-free asset like T-bills. 
A) invest in the equity of an unlevered firm. 
B) borrow on his/her own account. 
C) invest in the equity of a levered firm. 
D) invest in a risk-free asset like T-bills.

Question 7

Capital structure is irrelevant if:
I.capital markets are efficient;
II.each investor can borrow/lend on the same terms as the firm;
III.there are no tax benefits to debt

Accepted Answer

A) I only 
B) II only 
C) III only 
D) I,II,and III 
A) I only 
B) II only 
C) III only 
D) I,II,and III

Question 8

A firm's asset beta equals the weighted average of the betas on its debt and equity,given the assumption of no taxes.

Accepted Answer

A) True 
 B)False

Question 9

The principle of value additivity holds for the aggregation of assets but does not apply to the division of assets.

Accepted Answer

A) True 
 B)False

Question 10

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

Accepted Answer

A) True 
 B)False

Question 11

For a levered firm:

Accepted Answer

A) as earnings before interest and taxes (EBIT)increases,earnings per share (EPS)increases by the same percentage. 
B) as EBIT increases,EPS increases by a larger percentage. 
C) as EBIT increases,EPS decreases by the same percentage. 
D) as EBIT increases,EPS decreases by a larger percentage. 
A) as earnings before interest and taxes (EBIT)increases,earnings per share (EPS)increases by the same percentage. 
B) as EBIT increases,EPS increases by a larger percentage. 
C) as EBIT increases,EPS decreases by the same percentage. 
D) as EBIT increases,EPS decreases by a larger percentage.

Question 12

State and explain MM's Proposition II.

Accepted Answer

The expected rate of return on the commo

Question 13

A firm's return on assets is 12% and the cost of the firm's debt is 7%.Given a 0.7 debt to equity ratio,what is the levered cost of equity?

Accepted Answer

A) 7.0% 
B) 12.0% 
C) 13.6% 
D) 15.5% 
A) 7.0% 
B) 12.0% 
C) 13.6% 
D) 15.5%

Question 14

State the generalized version of Modigliani-Miller Proposition I.

Accepted Answer

Modigliani-Miller Proposition I states t

Question 15

Which of the following is true?

Accepted Answer

A) bD > bA > bE 
B) bE > bA > bD 
C) bA > bE > bD 
D) bA > bD > bE 
A) bD > bA > bE 
B) bE > bA > bD 
C) bA > bE > bD 
D) bA > bD > bE

Question 16

The asset beta of a levered firm is 1.1.The beta of debt is 0.3.If the debt equity ratio is 0.5,what is the equity beta? (Assume no taxes.)

Accepted Answer

A) 1.5 
B) 1.1 
C) 0.3 
D) 0.15 
A) 1.5 
B) 1.1 
C) 0.3 
D) 0.15

Question 17

According to the graph of WACC for Union Pacific,which of the following is (are)true?
I.The cost of equity is an increasing function of the debt-equity ratio.
II.The cost of debt is an increasing function of the debt-equity ratio.
III.The weighted average cost of capital (WACC)is a decreasing function of the debt-equity ratio.

Accepted Answer

A) I only 
B) I and II only 
C) III only 
D) I,II,and III 
A) I only 
B) I and II only 
C) III only 
D) I,II,and III

Question 18

The cost of capital for a firm,rWACC,in a tax-free environment is:
I.equal to the market value weighted average of the return on equity and the return on debt;
II.equal to rA,the rate of return for that business risk class;
III.equal to the overall rate of return required on the levered firm

Accepted Answer

A) I only 
B) II only 
C) III only 
D) I,II,and III 
A) I only 
B) II only 
C) III only 
D) I,II,and III

Question 19

For an all-equity firm,

Accepted Answer

A) as earnings before interest and taxes (EBIT)increases,the earnings per share (EPS)increases by the same percentage 
B) as EBIT increases,the EPS increases by a larger percentage 
C) as EBIT increases,the EPS decreases at the same rate 
D) as EBIT increases,the EPS decreases by a larger percentage 
A) as earnings before interest and taxes (EBIT)increases,the earnings per share (EPS)increases by the same percentage 
B) as EBIT increases,the EPS increases by a larger percentage 
C) as EBIT increases,the EPS decreases at the same rate 
D) as EBIT increases,the EPS decreases by a larger percentage

Question 20

The effect of financial leverage on the performance of the firm depends on the:

Accepted Answer

A) expected rate of return on equity. 
B) firm's level of operating income. 
C) current market value of the debt. 
D) rate of dividend growth. 
A) expected rate of return on equity. 
B) firm's level of operating income. 
C) current market value of the debt. 
D) rate of dividend growth.

Exam 17: Does Debt Policy Matter

The total market value (V)of the securities of a firm that has both debt (D)and equity (E)is:

The law of conservation of value implies that: I.the mix of common stock and preferred stock does not affect the value of the firm; II.the mix of long-term and short-term debt does not affect the value of the firm; III.the mix of secured and unsecured debt does not affect the value of the firm

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,its cost of equity capital with the new capital structure would be:

For a levered firm where bA = beta of assets and bD = beta of debt,the return on equity (rE)is equal to:

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

Capital structure is irrelevant if: I.capital markets are efficient; II.each investor can borrow/lend on the same terms as the firm; III.there are no tax benefits to debt

A firm's asset beta equals the weighted average of the betas on its debt and equity,given the assumption of no taxes.

The principle of value additivity holds for the aggregation of assets but does not apply to the division of assets.

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

For a levered firm:

State and explain MM's Proposition II.

A firm's return on assets is 12% and the cost of the firm's debt is 7%.Given a 0.7 debt to equity ratio,what is the levered cost of equity?

State the generalized version of Modigliani-Miller Proposition I.

Which of the following is true?

The asset beta of a levered firm is 1.1.The beta of debt is 0.3.If the debt equity ratio is 0.5,what is the equity beta? (Assume no taxes.)

The cost of capital for a firm,rWACC,in a tax-free environment is: I.equal to the market value weighted average of the return on equity and the return on debt; II.equal to rA,the rate of return for that business risk class; III.equal to the overall rate of return required on the levered firm

For an all-equity firm,

The effect of financial leverage on the performance of the firm depends on the:

Introduction to Corporate Finance

How to Calculate Present Values

Valuing Bonds

The Value of Common Stocks

Net Present Value and Other Investment Criteria

Making Investment Decisions With the Net Present Value Rule

Introduction to Risk and Return

Portfolio Theory and the Capital Asset Pricing Model

Risk and the Cost of Capital

Project Analysis

Investment, Strategy, and Economic Rents

Agency Problems, Compensation, and Performance Measurement

Efficient Markets and Behavioral Finance

An Overview of Corporate Financing

How Corporations Issue Securities

Payout Policy

How Much Should a Corporation Borrow

Financing and Valuation

Understanding Options

Valuing Options

Real Options

Credit Risk and the Value of Corporate Debt

The Many Different Kinds of Debt

Leasing

Managing Risk

Managing International Risks

Financial Analysis

Financial Planning

Working Capital Management

Mergers

Corporate Restructuring

Governance and Corporate Control Around the World

Filters

For a levered firm where b_A = beta of assets and b_D = beta of debt,the return on equity (r_E)is equal to:

The cost of capital for a firm,r_WACC,in a tax-free environment is: I.equal to the market value weighted average of the return on equity and the return on debt; II.equal to r_A,the rate of return for that business risk class; III.equal to the overall rate of return required on the levered firm