Question 1

Which of the following statements is false?

Accepted Answer

A)  Modigliani and Miller's conclusion verified the common view, which stated that even with perfect capital markets, leverage would affect a firm's value. 
B)  We can evaluate the relationship between risk and return more formally by computing the sensitivity of each security's return to the systematic risk of the economy. 
C)  Investors in levered equity require a higher expected return to compensate for its increased risk. 
D)  Leverage increases the risk of equity even when there is no risk that the firm will default. 
A)  Modigliani and Miller's conclusion verified the common view, which stated that even with perfect capital markets, leverage would affect a firm's value. 
B)  We can evaluate the relationship between risk and return more formally by computing the sensitivity of each security's return to the systematic risk of the economy. 
C)  Investors in levered equity require a higher expected return to compensate for its increased risk. 
D)  Leverage increases the risk of equity even when there is no risk that the firm will default.

Question 2

Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.
-Suppose that to raise the funds for the initial investment,the project is sold to investors as an all-equity firm.The equity holders will receive the cash flows of the project in one year.The market value of the unlevered equity for this project is closest to:

Accepted Answer

A)  $94,100 
B)  $90,000 
C)  $86,250 
D)  $98,600 
A)  $94,100 
B)  $90,000 
C)  $86,250 
D)  $98,600

Question 3

Use the information for the question(s) below.
Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%.
-Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as With.You have $5000 of your own money to invest and you plan on buying With stock.Using homemade (un)leverage you invest enough at the risk-free rate so that the payoff of your account will be the same as a $5000 investment in Without stock.The number of shares of With stock you purchased is closest to:

Accepted Answer

A)  100 
B)  425 
C)  1650 
D)  825 
A)  100 
B)  425 
C)  1650 
D)  825

Question 4

Use the information for the question(s) below.
Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00.
-Following the borrowing of $12 million and the subsequent share repurchase,the equity cost of capital for RC is closest to:

Accepted Answer

A)  12% 
B)  9% 
C)  11% 
D)  10% 
A)  12% 
B)  9% 
C)  11% 
D)  10%

Question 5

The example of Canadian Jet Set Airline's expansion by issuing new equity proves that

Accepted Answer

A)  any gain or loss associated with the transaction will result from the expected return of the investments the firm makes with the funds raised. 
B)  any gain or loss associated with the transaction will result from the realized return of the investments the firm makes with the funds raised. 
C)  any gain or loss associated with the transaction will result from the required return of the investments the firm makes with the funds raised. 
D)  any gain or loss associated with the transaction will result from the NPV of the investments the firm makes with the funds raised. 
A)  any gain or loss associated with the transaction will result from the expected return of the investments the firm makes with the funds raised. 
B)  any gain or loss associated with the transaction will result from the realized return of the investments the firm makes with the funds raised. 
C)  any gain or loss associated with the transaction will result from the required return of the investments the firm makes with the funds raised. 
D)  any gain or loss associated with the transaction will result from the NPV of the investments the firm makes with the funds raised.

Question 6

Which of the following equations would NOT be appropriate to use in a firm with risky debt?

Accepted Answer

A)  βE = βU +   (βU - β
D)  
B)  βU = βE+   (βU - β
D)  
C)  βE = βU +   βU 
D)  βU =   βE +   βD 
A)  βE = βU +   (βU - β
D)  
B)  βU = βE+   (βU - β
D)  
C)  βE = βU +   βU 
D)  βU =   βE +   βD

Question 7

Consider the following equation: E + D = U = A
The E in this equation represents

Accepted Answer

A)  the value of the firm's equity. 
B)  the value of the firm's debt. 
C)  the value of the firm's unlevered equity. 
D)  the market value of the firm's assets. 
A)  the value of the firm's equity. 
B)  the value of the firm's debt. 
C)  the value of the firm's unlevered equity. 
D)  the market value of the firm's assets.

Question 8

Use the information for the question(s) below.
Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00.
-Prior to any borrowing and share repurchase,RC's EPS is closest to:

Accepted Answer

A)  $0.60 
B)  $1.00 
C)  $1.20 
D)  $0.50 
A)  $0.60 
B)  $1.00 
C)  $1.20 
D)  $0.50

Question 9

Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.
-Two separate firms are considering investing in this project.Firm Unlevered plans to fund the entire $80,000 investment using equity,while Firm Levered plans to borrow $45,000 at the risk-free rate and use equity to finance the remainder of the initial investment.Calculate the expected returns for both the levered and unlevered firm.

Accepted Answer

@#IMG-DLM& PV(equity cash flows)= @#IMG-DLM& = $90,000
C/F (

Question 10

Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.
-Suppose that to raise the funds for the initial investment the firm borrows $45,000 at the risk free rate and issues new equity to cover the remainder.In this situation,calculate the value of the firm's levered equity from the project.What is the cost of capital for the firm's levered equity?

Accepted Answer

PV(equity cash flows)= @#IMG-DLM& = $90,

Question 11

Use the information for the question(s) below.
Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%.
-According to MM Proposition 1,the stock price for With is closest to:

Accepted Answer

A)  $8.00 
B)  $24.00 
C)  $6.00 
D)  $12.00 
A)  $8.00 
B)  $24.00 
C)  $6.00 
D)  $12.00

Question 12

When firm borrows at the ________ cost of capital for debt,its equity cost of capital ________.

Accepted Answer

A)  low; rises 
B)  high; rises 
C)  low; decreases 
D)  high; decreases 
A)  low; rises 
B)  high; rises 
C)  low; decreases 
D)  high; decreases

Question 13

Use the information for the question(s) below.
Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00.
-Prior to any borrowing and share repurchase,the equity cost of capital for RC is closest to:

Accepted Answer

A)  20% 
B)  10% 
C)  12% 
D)  9% 
A)  20% 
B)  10% 
C)  12% 
D)  9%

Question 14

Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.
-Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate,then the cost of capital for the firm's levered equity is closest to:

Accepted Answer

A)  45% 
B)  25% 
C)  15% 
D)  95% 
A)  45% 
B)  25% 
C)  15% 
D)  95%

Question 15

Which of the following is NOT one of Modigliani and Miller's set of conditions referred to as perfect capital markets?

Accepted Answer

A)  All investors hold the efficient portfolio of assets. 
B)  There are no taxes, transaction costs, or issuance costs associated with security trading. 
C)  A firm's financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them. 
D)  Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows. 
A)  All investors hold the efficient portfolio of assets. 
B)  There are no taxes, transaction costs, or issuance costs associated with security trading. 
C)  A firm's financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them. 
D)  Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows.

Question 16

Which of the following statements is false?

Accepted Answer

A)  The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its capital structure. 
B)  The most common choices are financing through equity alone and financing through a combination of debt and equity. 
C)  The project's NPV represents the value to the new investors of the firm created by the project. 
D)  When corporations raise funds from outside investors, they must choose which type of security to issue. 
A)  The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its capital structure. 
B)  The most common choices are financing through equity alone and financing through a combination of debt and equity. 
C)  The project's NPV represents the value to the new investors of the firm created by the project. 
D)  When corporations raise funds from outside investors, they must choose which type of security to issue.

Question 17

Which of the following statements is false?

Accepted Answer

A)  Leverage decreases the risk of the equity of a firm. 
B)  Because the cash flows of the debt and equity sum to the cash flows of the project, by the Law of One Price the combined values of debt and equity must be equal to the cash flows of the project. 
C)  Franco Modigliani and Merton Miller argued that with perfect capital markets, the total value of a firm should not depend on its capital structure. 
D)  It is inappropriate to discount the cash flows of levered equity at the same discount rate that we use for unlevered equity. 
A)  Leverage decreases the risk of the equity of a firm. 
B)  Because the cash flows of the debt and equity sum to the cash flows of the project, by the Law of One Price the combined values of debt and equity must be equal to the cash flows of the project. 
C)  Franco Modigliani and Merton Miller argued that with perfect capital markets, the total value of a firm should not depend on its capital structure. 
D)  It is inappropriate to discount the cash flows of levered equity at the same discount rate that we use for unlevered equity.

Question 18

The following equation: X =   rE +   rD
Can be used to calculate all of the following EXCEPT:

Accepted Answer

A)  The cost of capital for the firm's assets 
B)  The levered cost of equity 
C)  The unlevered cost of equity 
D)  The weighted average cost of capital 
A)  The cost of capital for the firm's assets 
B)  The levered cost of equity 
C)  The unlevered cost of equity 
D)  The weighted average cost of capital

Question 19

Use the information for the question(s) below.
You are evaluating a new project and need an estimate for your project's beta. You have identified the following information about three firms with comparable projects:  
-The unlevered beta for Blinkin is closest to:

Accepted Answer

A)  0.95 
B)  1.10 
C)  1.00 
D)  0.90 
A)  0.95 
B)  1.10 
C)  1.00 
D)  0.90

Question 20

Which of the following statements is false?

Accepted Answer

A)  If we can identify a comparison firm whose assets have the same risk as the project being evaluated, and if the comparison firm is levered, then we can use its equity cost of capital as the cost of capital for the project. 
B)  We can calculate the cost of capital of the firm's assets by computing the weighted average of the firm's equity and debt cost of capital, which we refer to as the firm's weighted average cost of capital (WAC
C) . 
C)  The portfolio of a firm's equity and debt replicates the returns we would earn if the firm were unlevered. 
D)  When evaluating any potential investment project, we must use a discount rate that is appropriate given the risk of the project's free cash flow. 
A)  If we can identify a comparison firm whose assets have the same risk as the project being evaluated, and if the comparison firm is levered, then we can use its equity cost of capital as the cost of capital for the project. 
B)  We can calculate the cost of capital of the firm's assets by computing the weighted average of the firm's equity and debt cost of capital, which we refer to as the firm's weighted average cost of capital (WAC
C) . 
C)  The portfolio of a firm's equity and debt replicates the returns we would earn if the firm were unlevered. 
D)  When evaluating any potential investment project, we must use a discount rate that is appropriate given the risk of the project's free cash flow.

Exam 14: Capital Structure in a Perfect Market

Which of the following statements is false?

The example of Canadian Jet Set Airline's expansion by issuing new equity proves that

Which of the following equations would NOT be appropriate to use in a firm with risky debt?

Consider the following equation: E + D = U = A The E in this equation represents

When firm borrows at the ________ cost of capital for debt,its equity cost of capital ________.

Which of the following is NOT one of Modigliani and Miller's set of conditions referred to as perfect capital markets?

Which of the following statements is false?

Which of the following statements is false?

The following equation: X = rE + rD Can be used to calculate all of the following EXCEPT:

Use the information for the question(s) below. You are evaluating a new project and need an estimate for your project's beta. You have identified the following information about three firms with comparable projects: -The unlevered beta for Blinkin is closest to:

Which of the following statements is false?

The Corporation

Introduction to Financial Statement Analysis

Arbitrage and Financial Decision Making

The Time Value of Money

Interest Rates

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Bonds

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behaviour and Capital Market Efficiency

Debt and Taxes

Financial Distress, managerial Incentives, and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Real Options

The Mechanics of Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters

When firm borrows at the cost of capital for debt,its equity cost of capital .

The following equation: X = r_E + r_D Can be used to calculate all of the following EXCEPT: