Question 1

The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

Accepted Answer

A) levered firms pay less taxes compared with identical unlevered firms. 
B) bondholders require higher rates of return compared with stockholders. 
C) earnings per share are no longer relevant with taxes. 
D) dividends are no longer relevant with taxes. 
E) All of the above. 
A) levered firms pay less taxes compared with identical unlevered firms. 
B) bondholders require higher rates of return compared with stockholders. 
C) earnings per share are no longer relevant with taxes. 
D) dividends are no longer relevant with taxes. 
E) All of the above.

Question 2

MM Proposition I with taxes supports the theory that:

Accepted Answer

A) there is a positive linear relationship between the amount of debt in a levered firm and its value. 
B) the value of a firm is inversely related to the amount of leverage used by the firm. 
C) the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield. 
D) a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm. 
E) a firm's weighted average cost of capital increases as the debt-equity ratio of the firm rises. 
A) there is a positive linear relationship between the amount of debt in a levered firm and its value. 
B) the value of a firm is inversely related to the amount of leverage used by the firm. 
C) the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield. 
D) a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm. 
E) a firm's weighted average cost of capital increases as the debt-equity ratio of the firm rises.

Question 3

You own 25% of Unique Vacations SA.You have decided to retire and want to sell your shares in this closely held,all equity firm.The other shareholders have agreed to have the firm borrow €1.5 million to purchase your 1,000 shares.What is the total value of this firm today if you ignore taxes?

Accepted Answer

A) €4.8 million 
B) €5.1 million 
C) €5.4 million 
D) €5.7 million 
E) €6.0 million 
A) €4.8 million 
B) €5.1 million 
C) €5.4 million 
D) €5.7 million 
E) €6.0 million

Question 4

MM Proposition I without taxes is used to illustrate:

Accepted Answer

A) the value of an unlevered firm equals that of a levered firm. 
B) that one capital structure is as good as another. 
C) leverage does not affect the value of the firm. 
D) capital structure changes have no effect stockholder's welfare. 
E) All of the above. 
A) the value of an unlevered firm equals that of a levered firm. 
B) that one capital structure is as good as another. 
C) leverage does not affect the value of the firm. 
D) capital structure changes have no effect stockholder's welfare. 
E) All of the above.

Question 5

The value of the firm is maximized by taking on as much debt as possible.Show graphically how adding debt can increase value through the overall cost of capital.Explain under what conditions how this impacts the cost of capital and translates into firm value.

Accepted Answer

See graphs pages 418 and 419.

Question 6

The proposition that the cost of equity is a positive linear function of capital structure is called:

Accepted Answer

A) the capital asset pricing model. 
B) MM Proposition I. 
C) MM Proposition II. 
D) the law of one price. 
E) the efficient markets hypothesis. 
A) the capital asset pricing model. 
B) MM Proposition I. 
C) MM Proposition II. 
D) the law of one price. 
E) the efficient markets hypothesis.

Question 7

Backwoods Lumber AB has a debt-equity ratio of .80.The firm's required return on assets is 12% and its cost of equity is 15.68%.What is the pre-tax cost of debt based on MM Proposition II with no taxes?

Accepted Answer

A) 6.76% 
B) 7.00% 
C) 7.25% 
D) 7.40% 
E) 7.50% 
A) 6.76% 
B) 7.00% 
C) 7.25% 
D) 7.40% 
E) 7.50%

Question 8

A key assumption of MM's Proposition I without 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. 
E) All of the above. 
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. 
E) All of the above.

Question 9

The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:

Accepted Answer

A) MM Proposition I with no tax. 
B) MM Proposition II with no tax. 
C) MM Proposition I with tax. 
D) MM Proposition II with tax. 
E) static theory proposition. 
A) MM Proposition I with no tax. 
B) MM Proposition II with no tax. 
C) MM Proposition I with tax. 
D) MM Proposition II with tax. 
E) static theory proposition.

Question 10

If a firm is unlevered and has a cost of equity capital 12%,what would its cost of equity be if its debt-equity ratio became 2? The expected cost of debt is 8%.

Accepted Answer

A) 14.0% 
B) 14.67% 
C) 16.0% 
D) 20.0% 
E) None of the above. 
A) 14.0% 
B) 14.67% 
C) 16.0% 
D) 20.0% 
E) None of the above.

Question 11

The proposition that the value of the firm is independent of its capital structure is called:

Accepted Answer

A) the capital asset pricing model. 
B) MM Proposition I. 
C) MM Proposition II. 
D) the law of one price. 
E) the efficient markets hypothesis. 
A) the capital asset pricing model. 
B) MM Proposition I. 
C) MM Proposition II. 
D) the law of one price. 
E) the efficient markets hypothesis.

Question 12

A general rule for managers to follow is to set the firm's capital structure such that:

Accepted Answer

A) the firm's value is minimized. 
B) the firm's value is maximized. 
C) the firm's bondholders are made well off. 
D) the firms suppliers of raw materials are satisfied. 
E) the firms dividend payout is maximized. 
A) the firm's value is minimized. 
B) the firm's value is maximized. 
C) the firm's bondholders are made well off. 
D) the firms suppliers of raw materials are satisfied. 
E) the firms dividend payout is maximized.

Question 13

The effect of financial leverage depends on the operating earnings of the company.Which of the following is not true?

Accepted Answer

A) Below the indifference or break-even point in EBIT the non-levered structure is superior. 
B) Financial leverage increases the slope of the EPS line. 
C) Above the indifference or break-even point the increase in EPS for all equity plans is less than debt-equity plans. 
D) Above the indifference or break-even point the increase in EPS for all equity plans is greater than debt-equity plans. 
E) The rate of return on operating assets is unaffected by leverage. 
A) Below the indifference or break-even point in EBIT the non-levered structure is superior. 
B) Financial leverage increases the slope of the EPS line. 
C) Above the indifference or break-even point the increase in EPS for all equity plans is less than debt-equity plans. 
D) Above the indifference or break-even point the increase in EPS for all equity plans is greater than debt-equity plans. 
E) The rate of return on operating assets is unaffected by leverage.

Question 14

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 increases. 
B) changing the capital structure if and only if the value of the firm increases to the benefits to inside management. 
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 increases. 
B) changing the capital structure if and only if the value of the firm increases to the benefits to inside management. 
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.

Question 15

A firm has a debt-to-equity ratio of 1.75.If it had no debt,its cost of equity would be 14%.Its cost of debt is 10%.What is its cost of equity if the corporate tax rate is 50%?

Accepted Answer

A) 14.0% 
B) 16.0% 
C) 17.5% 
D) 21.0% 
E) None of the above. 
A) 14.0% 
B) 16.0% 
C) 17.5% 
D) 21.0% 
E) None of the above.

Question 16

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 17

Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure?
I.a reduction in tax rates
II.a large tax loss carryforward
III.a large depreciation tax deduction
IV.a sizeable increase in taxable income

Accepted Answer

A) I and II only. 
B) I and III only. 
C) II and III only. 
D) I,II,and III only. 
E) I,II,III,and IV. 
A) I and II only. 
B) I and III only. 
C) II and III only. 
D) I,II,and III only. 
E) I,II,III,and IV.

Question 18

The weighted average cost of capital is invariant to the use of leverage under MM conditions of no taxes.Graph the relationship of the weighted average cost of capital and leverage; be sure to include the cost of equity and debt.Explain why this relationship holds.

Accepted Answer

See graph page 409. In a world without t

Question 19

A levered firm is a company that has:

Accepted Answer

A) Accounts Payable as the only liability on the balance sheet. 
B) has some debt in the capital structure. 
C) has all equity in the capital structure. 
D) All of the above. 
E) None of the above. 
A) Accounts Payable as the only liability on the balance sheet. 
B) has some debt in the capital structure. 
C) has all equity in the capital structure. 
D) All of the above. 
E) None of the above.

Question 20

Bigelow SpA has a cost of equity of 13.56% and a pre-tax cost of debt of 7%.The required return on the assets is 11%.What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

Accepted Answer

A) .60 
B) .64 
C) .72 
D) .75 
E) .80 
A) .60 
B) .64 
C) .72 
D) .75 
E) .80

Exam 15: Capital Structure: Basic Concepts

The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

MM Proposition I with taxes supports the theory that:

You own 25% of Unique Vacations SA.You have decided to retire and want to sell your shares in this closely held,all equity firm.The other shareholders have agreed to have the firm borrow €1.5 million to purchase your 1,000 shares.What is the total value of this firm today if you ignore taxes?

MM Proposition I without taxes is used to illustrate:

The value of the firm is maximized by taking on as much debt as possible.Show graphically how adding debt can increase value through the overall cost of capital.Explain under what conditions how this impacts the cost of capital and translates into firm value.

The proposition that the cost of equity is a positive linear function of capital structure is called:

Backwoods Lumber AB has a debt-equity ratio of .80.The firm's required return on assets is 12% and its cost of equity is 15.68%.What is the pre-tax cost of debt based on MM Proposition II with no taxes?

A key assumption of MM's Proposition I without taxes is:

The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:

If a firm is unlevered and has a cost of equity capital 12%,what would its cost of equity be if its debt-equity ratio became 2? The expected cost of debt is 8%.

The proposition that the value of the firm is independent of its capital structure is called:

A general rule for managers to follow is to set the firm's capital structure such that:

The effect of financial leverage depends on the operating earnings of the company.Which of the following is not true?

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

A firm has a debt-to-equity ratio of 1.75.If it had no debt,its cost of equity would be 14%.Its cost of debt is 10%.What is its cost of equity if the corporate tax rate is 50%?

The capital structure chosen by a firm doesn't really matter because of:

Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure? I.a reduction in tax rates II.a large tax loss carryforward III.a large depreciation tax deduction IV.a sizeable increase in taxable income

The weighted average cost of capital is invariant to the use of leverage under MM conditions of no taxes.Graph the relationship of the weighted average cost of capital and leverage; be sure to include the cost of equity and debt.Explain why this relationship holds.

A levered firm is a company that has:

Bigelow SpA has a cost of equity of 13.56% and a pre-tax cost of debt of 7%.The required return on the assets is 11%.What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

Introduction to Corporate Finance

Corporate Governance

Financial Statement Analysis and Long-Term Planning

Discounted Cash Flow Valuation

How to Value Bonds and Shares

Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, Real Options, and Capital Budgeting

Risk and Return: Lessons From Market History

Return and Risk: The Capital Asset Pricing Model Capm

Factor Models and the Arbitrage Pricing Theory

Risk, cost of Capital, 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

Dividend and Other Payouts

Equity Financing

Debt Financing

Leasing and Off-Balance-Sheet Financing

Options and Corporate Finance

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Financial Risk Management With Derivatives

Short-Term Finance and Planning

Cash Management

Credit Management

Mergers and Acquisitions

Financial Distress

International Corporate Finance

Filters