Question 1

A firm has a debt-to-equity ratio of 0.50.Its cost of debt is 10%.Its overall cost of capital is 14%.What is its cost of equity if there are no taxes?

Accepted Answer

A) 13% 
B) 16% 
C) 15% 
D) 18% 
A) 13% 
B) 16% 
C) 15% 
D) 18%

Question 2

Investors require higher returns on levered equity than on equivalent unlevered equity.

Accepted Answer

A) True 
 B)False

Question 3

When comparing levered vs.unlevered capital structures,leverage works to increase EPS for high levels of operating income because interest payments on the debt:

Accepted Answer

A) vary with EBIT levels. 
B) stay fixed,leaving less income to be distributed over fewer shares. 
C) stay fixed,leaving less income to be distributed over more shares. 
D) stay fixed,leaving more income to be distributed over fewer shares. 
A) vary with EBIT levels. 
B) stay fixed,leaving less income to be distributed over fewer shares. 
C) stay fixed,leaving less income to be distributed over more shares. 
D) stay fixed,leaving more income to be distributed over fewer shares.

Question 4

The M&M Company is financed by $4 million (market value)in debt and $6 million (market value)in equity.The cost of debt is 5% and the cost of equity is 10%.Calculate the weighted average cost of capital.(Assume no taxes.)

Accepted Answer

A) 10% 
B) 15% 
C) 8% 
D) 7% 
A) 10% 
B) 15% 
C) 8% 
D) 7%

Question 5

According to Modigliani and Miller Proposition II,since the expected rate of return on debt is less than the expected rate of return on equity,the weighted average cost of capital declines as more debt is issued.

Accepted Answer

A) True 
 B)False

Question 6

The equity beta of a levered firm is 1.2.The beta of debt is 0.2.The firm's market value debt to equity ratio is 0.5.What is the asset beta if the tax rate is zero?

Accepted Answer

A) 1.20 
B) 0.73 
C) 0.20 
D) 0.87 
A) 1.20 
B) 0.73 
C) 0.20 
D) 0.87

Question 7

Generally,which of the following is true?

Accepted Answer

A) rD > rA > rE 
B) rE > rD > rA 
C) rE > rA > rD 
D) rA > rE > rD 
A) rD > rA > rE 
B) rE > rD > rA 
C) rE > rA > rD 
D) rA > rE > rD

Question 8

The law of conservation of value does not apply to the mix of a firm's debt securities.

Accepted Answer

A) True 
 B)False

Question 9

Briefly explain how changes in the debt-equity ratio change the firm's equity beta.

Accepted Answer

There is a linear relationship between t

Question 10

Explain why,as a function of the debt-equity ratio,the cost of debt graph is concave at high levels of debt.

Accepted Answer

As a firm takes on higher leve

Question 11

State the law of conservation of value.B.The same idea holds when assets are divided.

Accepted Answer

The law of conservation of val

Question 12

If an investor buys a portion (X)of the equity of a levered firm,then his/her payoff is:

Accepted Answer

A) (X)× (profits) 
B) (X)× (interest) 
C) (X)× (profits - interest) 
D) (1/X)× (profits - interest) 
A) (X)× (profits) 
B) (X)× (interest) 
C) (X)× (profits - interest) 
D) (1/X)× (profits - interest)

Question 13

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

Accepted Answer

A) 8% 
B) 10% 
C) 12% 
D) 14% 
A) 8% 
B) 10% 
C) 12% 
D) 14%

Question 14

An investor can undo the effect of leverage on his/her own account by:
i.investing in the equity of a levered firm; II)borrowing on his/her own account; III)investing in risk-free debt like T-bills

Accepted Answer

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

Question 15

The beta of an all-equity firm is 1.2.Suppose the firm changes its capital structure to 50% debt and 50% equity using 8% debt financing.What is the equity beta of the levered firm? The beta of debt is 0.2.(Assume no taxes.)

Accepted Answer

A) 1.2 
B) 2.2 
C) 2.4 
D) 1.7 
A) 1.2 
B) 2.2 
C) 2.4 
D) 1.7

Question 16

Modigliani and Miller's Proposition I states that:

Accepted Answer

A) the market value of any firm is independent of its capital structure 
B) the market value of a firm's debt is independent of its capital structure 
C) the market value of a firm's common stock is independent of its capital structure 
D) none of the options 
A) the market value of any firm is independent of its capital structure 
B) the market value of a firm's debt is independent of its capital structure 
C) the market value of a firm's common stock is independent of its capital structure 
D) none of the options

Question 17

The after-tax weighted average cost of capital (WACC)is given by (corporate tax rate = TC):

Accepted Answer

A) WACC = (r
D) (D/V)+ (r
E) (E/V) 
B) WACC = (r
D) (D/V)+[(rE )(E/V)/(1 - T
C) ] 
C) WACC = [(r
D) (D/V)+ (r
E) (E/V)]/(1 - T
C)  
D) WACC = (r
D) (1 - T
C) (D/V)+ (r
E) (E/V) 
A) WACC = (r
D) (D/V)+ (r
E) (E/V) 
B) WACC = (r
D) (D/V)+[(rE )(E/V)/(1 - T
C) ] 
C) WACC = [(r
D) (D/V)+ (r
E) (E/V)]/(1 - T
C)  
D) WACC = (r
D) (1 - T
C) (D/V)+ (r
E) (E/V)

Question 18

MM Proposition II states that:
I.the expected return on equity is positively related to leverage;
II.the required return on equity is a linear function of the firm's debt to equity ratio;
III.the risk to equity increases with leverage

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

If a firm is financed with both debt and equity,the firm's equity is known as:

Accepted Answer

A) unlevered equity. 
B) levered equity. 
C) preferred equity. 
D) none of the options. 
A) unlevered equity. 
B) levered equity. 
C) preferred equity. 
D) none of the options.

Question 20

Health and Wealth Company is financed entirely by common stock that is priced to offer a 15% expected return.If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%,what is the expected return on the common stock after refinancing? (Ignore taxes.)

Accepted Answer

A) 18.0% 
B) 21.0% 
C) 15.0% 
D) 10.5% 
A) 18.0% 
B) 21.0% 
C) 15.0% 
D) 10.5%

Exam 17: Does Debt Policy Matter

A firm has a debt-to-equity ratio of 0.50.Its cost of debt is 10%.Its overall cost of capital is 14%.What is its cost of equity if there are no taxes?

Investors require higher returns on levered equity than on equivalent unlevered equity.

When comparing levered vs.unlevered capital structures,leverage works to increase EPS for high levels of operating income because interest payments on the debt:

The M&M Company is financed by $4 million (market value)in debt and $6 million (market value)in equity.The cost of debt is 5% and the cost of equity is 10%.Calculate the weighted average cost of capital.(Assume no taxes.)

According to Modigliani and Miller Proposition II,since the expected rate of return on debt is less than the expected rate of return on equity,the weighted average cost of capital declines as more debt is issued.

The equity beta of a levered firm is 1.2.The beta of debt is 0.2.The firm's market value debt to equity ratio is 0.5.What is the asset beta if the tax rate is zero?

Generally,which of the following is true?

The law of conservation of value does not apply to the mix of a firm's debt securities.

Briefly explain how changes in the debt-equity ratio change the firm's equity beta.

Explain why,as a function of the debt-equity ratio,the cost of debt graph is concave at high levels of debt.

State the law of conservation of value.B.The same idea holds when assets are divided.

If an investor buys a portion (X)of the equity of a levered firm,then his/her payoff is:

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

An investor can undo the effect of leverage on his/her own account by: i.investing in the equity of a levered firm; II)borrowing on his/her own account; III)investing in risk-free debt like T-bills

The beta of an all-equity firm is 1.2.Suppose the firm changes its capital structure to 50% debt and 50% equity using 8% debt financing.What is the equity beta of the levered firm? The beta of debt is 0.2.(Assume no taxes.)

Modigliani and Miller's Proposition I states that:

The after-tax weighted average cost of capital (WACC)is given by (corporate tax rate = TC):

MM Proposition II states that: I.the expected return on equity is positively related to leverage; II.the required return on equity is a linear function of the firm's debt to equity ratio; III.the risk to equity increases with leverage

If a firm is financed with both debt and equity,the firm's equity is known as:

Health and Wealth Company is financed entirely by common stock that is priced to offer a 15% expected return.If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%,what is the expected return on the common stock after refinancing? (Ignore taxes.)

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

The after-tax weighted average cost of capital (WACC)is given by (corporate tax rate = T_C):