Question 1

If firm U is unlevered and firm L is levered,then which of the following is true:
I.VU = EU.
II.VL = EL + DL.
III.VL = EU + DL.

Accepted Answer

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

Question 2

Wealth and Health Company is financed entirely by common stock that is priced to offer a 15% expected return.The common stock price is $40/share.The earnings per share (EPS)is expected to be $6.If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%,what is the expected value of earnings per share after refinancing? (Ignore taxes.)

Accepted Answer

A) $6.00 
B) $7.52 
C) $7.20 
D) $6.90 
A) $6.00 
B) $7.52 
C) $7.20 
D) $6.90

Question 3

For a levered firm where bA = beta of assets and bD = beta of debt,the equity beta (bE)equals:

Accepted Answer

A) bE = bA 
B) bE = bA + (D/
E) × [bA - bD] 
C) bE = bA + (D/(D + 
E) )× [bA - bD] 
D) none of the options 
A) bE = bA 
B) bE = bA + (D/
E) × [bA - bD] 
C) bE = bA + (D/(D + 
E) )× [bA - bD] 
D) none of the options

Question 4

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

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 5

The law of conservation of value implies that:
I.the mix of senior and subordinated debt does not affect the value of the firm;
II.the mix of convertible and nonconvertible debt does not affect the value of the firm;
III.the mix of common stock and preferred stock 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

Question 6

Generally,which of the following is true? (b = beta)

Accepted Answer

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

Question 7

The firm's asset beta is usually higher than the firm's equity beta.

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 return.If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%,what is the expected return on its common stock after refinancing?

Accepted Answer

A) 32% 
B) 28% 
C) 20% 
D) 14% 
A) 32% 
B) 28% 
C) 20% 
D) 14%

Question 9

The capital structure of the firm can be defined as:
I.the firm's mix of different debt securities;
II.the firm's mix of different securities used to finance assets;
III.the market imperfection that the firm's managers can exploit

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 10

Modigliani and Miller Proposition II states that the rate of return required by shareholders increases steadily as the firm's debt-equity ratio increases.

Accepted Answer

A) True 
 B)False

Question 11

A policy of maximizing the value of the firm is the same as a policy of minimizing the weighted average cost of capital providing that:
I.the firm's investment policy is settled;
II.there are no taxes;
III.an issue of new debt does not affect the market value of existing 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 12

A firm is unlevered and has a cost of equity capital of 9%.What is the cost of equity if the firm becomes levered at a debt-equity ratio of 2? The expected cost of debt is 7%.(Assume no taxes.)

Accepted Answer

A) 15.0% 
B) 16.0% 
C) 14.5% 
D) 13.0% 
A) 15.0% 
B) 16.0% 
C) 14.5% 
D) 13.0%

Question 13

If the debt beta is zero,then the relationship between the equity beta and the asset beta is given by:

Accepted Answer

A) equity beta = 1 + [(beta of assets)/(debt-equity ratio)] 
B) equity beta = (1 - debt-equity ratio)(beta of assets) 
C) equity beta = (1 + debt-equity ratio)(beta of assets) 
D) equity beta = 1 + (debt-equity ratio/ beta of assets) 
A) equity beta = 1 + [(beta of assets)/(debt-equity ratio)] 
B) equity beta = (1 - debt-equity ratio)(beta of assets) 
C) equity beta = (1 + debt-equity ratio)(beta of assets) 
D) equity beta = 1 + (debt-equity ratio/ beta of assets)

Question 14

Value additivity works for:
i.combining assets; II)splitting up of assets; III)the mix of debt securities issued by the firm

Accepted Answer

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

Question 15

In an EPS-operating income graphical relationship,the slope of the debt line is steeper than the equity line.The debt line has a negative intercept because:

Accepted Answer

A) the break-even point is higher with debt. 
B) a fixed interest charge must be paid even at low earnings. 
C) the amount of interest per share has only a positive effect on the intercept. 
D) the higher the interest rate,the greater the slope. 
A) the break-even point is higher with debt. 
B) a fixed interest charge must be paid even at low earnings. 
C) the amount of interest per share has only a positive effect on the intercept. 
D) the higher the interest rate,the greater the slope.

Question 16

Financial leverage increases the expected return and risk of the shareholder.

Accepted Answer

A) True 
 B)False

Question 17

A firm has a debt-to-equity ratio of 1.0.If it had no debt,its cost of equity would be 12%.Its cost of debt is 9%.What is its cost of equity if there are no taxes?

Accepted Answer

A) 21% 
B) 18% 
C) 15% 
D) 16% 
A) 21% 
B) 18% 
C) 15% 
D) 16%

Question 18

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

Accepted Answer

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

Question 19

Under what conditions would a policy of maximizing the value of the firm not be the same as a policy of maximizing shareholders' wealth?

Accepted Answer

A) If the issue of debt increases the financial risk of the firm's equity 
B) If the firm issues debt for the first time 
C) If the beta of equity is positive 
D) If an issue of debt affects the market value of existing debt 
A) If the issue of debt increases the financial risk of the firm's equity 
B) If the firm issues debt for the first time 
C) If the beta of equity is positive 
D) If an issue of debt affects the market value of existing debt

Question 20

Explain the concept of value additivity.

Accepted Answer

If we have two streams of cash

Exam 17: Does Debt Policy Matter

If firm U is unlevered and firm L is levered,then which of the following is true: I.VU = EU. II.VL = EL + DL. III.VL = EU + DL.

For a levered firm where bA = beta of assets and bD = beta of debt,the equity beta (bE)equals:

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

Generally,which of the following is true? (b = beta)

The firm's asset beta is usually higher than the firm's equity beta.

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected return.If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%,what is the expected return on its common stock after refinancing?

The capital structure of the firm can be defined as: I.the firm's mix of different debt securities; II.the firm's mix of different securities used to finance assets; III.the market imperfection that the firm's managers can exploit

Modigliani and Miller Proposition II states that the rate of return required by shareholders increases steadily as the firm's debt-equity ratio increases.

A policy of maximizing the value of the firm is the same as a policy of minimizing the weighted average cost of capital providing that: I.the firm's investment policy is settled; II.there are no taxes; III.an issue of new debt does not affect the market value of existing debt

A firm is unlevered and has a cost of equity capital of 9%.What is the cost of equity if the firm becomes levered at a debt-equity ratio of 2? The expected cost of debt is 7%.(Assume no taxes.)

If the debt beta is zero,then the relationship between the equity beta and the asset beta is given by:

Value additivity works for: i.combining assets; II)splitting up of assets; III)the mix of debt securities issued by the firm

In an EPS-operating income graphical relationship,the slope of the debt line is steeper than the equity line.The debt line has a negative intercept because:

Financial leverage increases the expected return and risk of the shareholder.

A firm has a debt-to-equity ratio of 1.0.If it had no debt,its cost of equity would be 12%.Its cost of debt is 9%.What is its cost of equity if there are no taxes?

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

Under what conditions would a policy of maximizing the value of the firm not be the same as a policy of maximizing shareholders' wealth?

Explain the concept of value additivity.

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

If firm U is unlevered and firm L is levered,then which of the following is true: I.V_U = E_U. II.V_L = E_L + D_L. III.V_L = E_U + D_L.

For a levered firm where b_A = beta of assets and b_D = beta of debt,the equity beta (b_E)equals: