Question 1

What circumstances violate MM's Proposition I? Briefly discuss.

Accepted Answer

MM's Proposition I is violated when the

Question 2

The firm's debt beta is usually approximately 1.0.

Accepted Answer

A) True 
 B)False

Question 3

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return.The stock price is $60 and the earnings per share are $12.If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%,what is the expected earnings per share value after refinancing?

Accepted Answer

A) $12.00 
B) $19.20 
C) $24.00 
D) $15.60 
A) $12.00 
B) $19.20 
C) $24.00 
D) $15.60

Question 4

Describe the break-even point,as displayed on an EPS-operating income graph.

Accepted Answer

On a plot of EPS versus operating income

Question 5

Modigliani and Miller's Proposition I states that the market value of any firm is independent of its capital structure.

Accepted Answer

A) True 
 B)False

Question 6

Minimizing the weighted average cost of capital (WACC)is the same as maximizing the:

Accepted Answer

A) market value of the firm. 
B) book value of the firm. 
C) profits of the firm. 
D) liquidating value of the firm. 
A) market value of the firm. 
B) book value of the firm. 
C) profits of the firm. 
D) liquidating value of the firm.

Question 7

The firm's mix of securities used to finance its assets is called the firm's capital structure.

Accepted Answer

A) True 
 B)False

Question 8

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return.The stock price is $60 and the earnings per share are $12.The company wishes to repurchase 50% of the stock and substitutes an equal value of debt yielding 8%.Suppose that before refinancing,an investor owned 100 shares of Learn and Earn common stock.What should he do if he wishes to ensure that risk and expected return on his investment are unaffected by this refinancing?

Accepted Answer

A) Borrow $3,000 and buy 50 more shares. 
B) Continue to hold 100 shares. 
C) Sell 50 shares and purchase $3,000 of 8% debt (bonds). 
D) Sell 8% of his stock and invest in bonds. 
A) Borrow $3,000 and buy 50 more shares. 
B) Continue to hold 100 shares. 
C) Sell 50 shares and purchase $3,000 of 8% debt (bonds). 
D) Sell 8% of his stock and invest in bonds.

Question 9

According to an EPS-operating income graph,debt financing is the preferred outcome in the case when expected operating income is:

Accepted Answer

A) less than the break-even income. 
B) greater than the break-even income. 
C) equal to the break-even income. 
D) not able to be determined. 
A) less than the break-even income. 
B) greater than the break-even income. 
C) equal to the break-even income. 
D) not able to be determined.

Question 10

Generally,which of the following is true?

Accepted Answer

A) rE D A 
B) rD A E 
C) rE A D 
D) rD E A 
A) rE D A 
B) rD A E 
C) rE A D 
D) rD E A

Question 11

The M&M Company is financed by $10 million in debt (market value)and $40 million in equity (market value).The cost of debt is 10% and the cost of equity is 20%.Calculate the weighted average cost of capital assuming no taxes.

Accepted Answer

A) 18% 
B) 20% 
C) 10% 
D) 12% 
A) 18% 
B) 20% 
C) 10% 
D) 12%

Question 12

According to Modigliani and Miller Proposition II,the firm's expected return on assets depends on several factors including the firm's capital structure.

Accepted Answer

A) True 
 B)False

Question 13

Assume the following data for U&P Company: Debt (D)= $100 million; Equity (E)= $300 million; rD = 6%; rE = 12%; and TC = 30%.Calculate the after-tax weighted average cost of capital (WACC):

Accepted Answer

A) 10.50% 
B) 15.00% 
C) 10.05% 
D) 9.45% 
A) 10.50% 
B) 15.00% 
C) 10.05% 
D) 9.45%

Question 14

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

Accepted Answer

A) (X)× (profits) 
B) (X)× (interest) 
C) (X)× (profits - interest) 
D) none of the options 
A) (X)× (profits) 
B) (X)× (interest) 
C) (X)× (profits - interest) 
D) none of the options

Question 15

Briefly discuss some of the applications of the law of conservation of value.

Accepted Answer

The law of conservation of value can be

Question 16

According to Modigliani and Miller Proposition II,the rate of return required by debtholders linearly increases as the firm's debt-equity ratio increases.

Accepted Answer

A) True 
 B)False

Question 17

MM's Proposition is violated when the firm,by imaginative design of its capital structure,can offer some financial service that meets the unmet needs of such a clientele.

Accepted Answer

A) True 
 B)False

Question 18

When a firm has no debt,then such a firm is known as:
i.an unlevered firm; II)a levered firm; III)an all-equity firm

Accepted Answer

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

Question 19

The law of conservation of value implies that:

Accepted Answer

A) the return on a firm's common stock is unchanged when debt is added to its capital structure. 
B) the value of any asset is preserved regardless of the nature of the claims against it. 
C) the return on a firm's debt is unchanged when common stock is added to its capital structure. 
D) the value of an asset increases as debt is reduced. 
A) the return on a firm's common stock is unchanged when debt is added to its capital structure. 
B) the value of any asset is preserved regardless of the nature of the claims against it. 
C) the return on a firm's debt is unchanged when common stock is added to its capital structure. 
D) the value of an asset increases as debt is reduced.

Question 20

A firm's equity beta is 1.2 and its debt is risk free.Given a 0.7 debt to equity ratio,what is the firm's asset beta? (Assume no taxes.)

Accepted Answer

A) 0.7 
B) 1.0 
C) 1.2 
D) 0.0 
A) 0.7 
B) 1.0 
C) 1.2 
D) 0.0

Exam 17: Does Debt Policy Matter

What circumstances violate MM's Proposition I? Briefly discuss.

The firm's debt beta is usually approximately 1.0.

Describe the break-even point,as displayed on an EPS-operating income graph.

Modigliani and Miller's Proposition I states that the market value of any firm is independent of its capital structure.

Minimizing the weighted average cost of capital (WACC)is the same as maximizing the:

The firm's mix of securities used to finance its assets is called the firm's capital structure.

According to an EPS-operating income graph,debt financing is the preferred outcome in the case when expected operating income is:

Generally,which of the following is true?

The M&M Company is financed by $10 million in debt (market value)and $40 million in equity (market value).The cost of debt is 10% and the cost of equity is 20%.Calculate the weighted average cost of capital assuming no taxes.

According to Modigliani and Miller Proposition II,the firm's expected return on assets depends on several factors including the firm's capital structure.

Assume the following data for U&P Company: Debt (D)= $100 million; Equity (E)= $300 million; rD = 6%; rE = 12%; and TC = 30%.Calculate the after-tax weighted average cost of capital (WACC):

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

Briefly discuss some of the applications of the law of conservation of value.

According to Modigliani and Miller Proposition II,the rate of return required by debtholders linearly increases as the firm's debt-equity ratio increases.

MM's Proposition is violated when the firm,by imaginative design of its capital structure,can offer some financial service that meets the unmet needs of such a clientele.

When a firm has no debt,then such a firm is known as: i.an unlevered firm; II)a levered firm; III)an all-equity firm

The law of conservation of value implies that:

A firm's equity beta is 1.2 and its debt is risk free.Given a 0.7 debt to equity ratio,what is the firm's asset beta? (Assume no 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

Assume the following data for U&P Company: Debt (D)= $100 million; Equity (E)= $300 million; r_D = 6%; r_E = 12%; and T_C = 30%.Calculate the after-tax weighted average cost of capital (WACC):