Question 1

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 2

Suppose that Rearden Metal currently has no debt and has an equity cost of capital of 12%.Rearden is considering borrowing funds at a cost of 6% and using these funds to repurchase existing shares of stock.Assume perfect capital markets.If Taggart borrows until they achieved a debt -to-equity ratio of 50%,then Rearden's levered cost of equity would be closest to:

Accepted Answer

A)  10.0% 
B)  12.0% 
C)  15.0% 
D)  16.0% 
A)  10.0% 
B)  12.0% 
C)  15.0% 
D)  16.0%

Question 3

Use the information for the question(s) below.
Consider two firms: firm Without has no debt, and firm With has debt of $10,000 on which it pays interest of 5% per year. Both companies have identical projects that generate free cash flows of $1000 or $2000 each year. Suppose that there are no taxes, and after paying any interest on debt, both companies use all remaining cash free cash flows to pay dividends each year.
-Suppose you own 10% of the equity of Without.What is another portfolio you could hold that would provide you with the same exact cash flows?

Accepted Answer

The cash flows for a 10% ownership stake

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.
-Which of the following statements is false?

Accepted Answer

A)  Since the publication of their original paper, Modigliani and Miller's ideas have greatly influenced finance research and practice. 
B)  Proposition I was one of the first arguments to show that the Law of One Price could have strong implications for security prices and firm values in a competitive market; it marks the beginning of the modern theory of corporate finance. 
C)  The conservation of value principle extends far beyond questions of debt versus equity or even capital structure. 
D)  The conservation of value principle for financial markets states that with perfect capital markets, financial transactions neither add nor destroy value, but instead represent a repackaging of risk (and therefore return). 
A)  Since the publication of their original paper, Modigliani and Miller's ideas have greatly influenced finance research and practice. 
B)  Proposition I was one of the first arguments to show that the Law of One Price could have strong implications for security prices and firm values in a competitive market; it marks the beginning of the modern theory of corporate finance. 
C)  The conservation of value principle extends far beyond questions of debt versus equity or even capital structure. 
D)  The conservation of value principle for financial markets states that with perfect capital markets, financial transactions neither add nor destroy value, but instead represent a repackaging of risk (and therefore return).

Question 5

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

Accepted Answer

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

Question 6

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& @#IMG-DLM& C/F (weak economy)= $90,000(unlevered)

Question 7

Equity in a firm with no debt is called

Accepted Answer

A)  levered equity. 
B)  unlevered equity. 
C)  riskless equity. 
D)  risky equity. 
A)  levered equity. 
B)  unlevered equity. 
C)  riskless equity. 
D)  risky equity.

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.
-Show mathematically that the stock price of RC won't change following the debt issuance and share repurchase.

Accepted Answer

EPS = (EBIT)/ Shares outstanding = ($6M)

Question 9

Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors, and has already announced the stock repurchase plan. Currently Luther is an all equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share.
-Assume that in addition to 1.25 billion common shares outstanding,Luther has stock options given to employees valued at $2 billion.After the repurchase how many shares will Luther have outstanding?

Accepted Answer

A)  1.0 billion 
B)  1.2 billion 
C)  0.75 billion 
D)  1.1 billion 
A)  1.0 billion 
B)  1.2 billion 
C)  0.75 billion 
D)  1.1 billion

Question 10

Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors, and has already announced the stock repurchase plan. Currently Luther is an all equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share.
-After the repurchase how many shares will Luther have outstanding?

Accepted Answer

A)  0.75 billion 
B)  1.0 billion 
C)  1.1 billion 
D)  1.2 billion 
A)  0.75 billion 
B)  1.0 billion 
C)  1.1 billion 
D)  1.2 billion

Question 11

Suppose the risk-free interest rate is 4%.If Nielson borrows $150 million today at this rate and uses the proceeds to pay an immediate cash dividend,then according to MM,the market value of its equity just alter the dividend is paid would be closest to:

Accepted Answer

A)  $0 million 
B)  $150 million 
C)  $250 million 
D)  $400 million 
A)  $0 million 
B)  $150 million 
C)  $250 million 
D)  $400 million

Question 12

Which of the following statements is false?

Accepted Answer

A)  The levered equity return equals the unlevered return, plus an extra "kick" due to leverage. 
B)  By holding a portfolio of the firm's equity and its debt, we can replicate the cash flows from holding its levered equity. 
C)  The cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a premium that is proportional to the market value debt-equity ratio. 
D)  If a firm is unlevered, all of the free cash flows generated by its assets are available to be paid out to its equity holders. 
A)  The levered equity return equals the unlevered return, plus an extra "kick" due to leverage. 
B)  By holding a portfolio of the firm's equity and its debt, we can replicate the cash flows from holding its levered equity. 
C)  The cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a premium that is proportional to the market value debt-equity ratio. 
D)  If a firm is unlevered, all of the free cash flows generated by its assets are available to be paid out to its equity holders.

Question 13

Use the following information to answer the question(s) below.
Galt Industries has 50 million shares outstanding and a market capitalization of $1.25 billion. It also has $750 million in debt outstanding. Galt Industries has decided to delever the firm by issuing new equity and completely repaying all the outstanding debt. Assume perfect capital markets.
-Suppose you are a shareholder in Galt industries holding 600 shares,and you disagree with this decision to delever the firm.You can undo the effect of this decision by:

Accepted Answer

A)  Borrow $6,000 and buy 240 shares of stock 
B)  Sell 240 shares of stock and lend $6,000 
C)  Borrow $9,000 and buy 360 shares of stock 
D)  Sell 360 shares of stock and lend $9,000 
A)  Borrow $6,000 and buy 240 shares of stock 
B)  Sell 240 shares of stock and lend $6,000 
C)  Borrow $9,000 and buy 360 shares of stock 
D)  Sell 360 shares of stock and lend $9,000

Question 14

Use the following information to answer the question(s) below.
d'Anconia Copper is an all-equity firm with 60 million shares outstanding, which are currently trading at $20 per share. Last month, d'Anconia announced that it will change its capital structure by issuing $300 million in debt. The $200 million raised by this issue, plus another $200 million in cash that d'Anconia already has, will be used to repurchase existing shares of stock. Assume that capital markets are perfect.
-At the conclusion of this transaction,the number of shares that d'Anconia Copper will have outstanding is closest to:

Accepted Answer

A)  5 million 
B)  15 million 
C)  20 million 
D)  40 million 
A)  5 million 
B)  15 million 
C)  20 million 
D)  40 million

Question 15

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%.
-The NPV for this project is closest to:

Accepted Answer

A)  $6,250 
B)  $14,100 
C)  $10,000 
D)  $18,600 
A)  $6,250 
B)  $14,100 
C)  $10,000 
D)  $18,600

Question 16

Following the borrowing of $12 and subsequent share repurchase,the equity cost of capital for RC is closest to:

Accepted Answer

A)  12% 
B)  9% 
C)  11.0% 
D)  10% 
A)  12% 
B)  9% 
C)  11.0% 
D)  10%

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

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

Equity in a firm with no debt is called

Suppose the risk-free interest rate is 4%.If Nielson borrows $150 million today at this rate and uses the proceeds to pay an immediate cash dividend,then according to MM,the market value of its equity just alter the dividend is paid would be closest to:

Which of the following statements is false?

Following the borrowing of $12 and subsequent share repurchase,the equity cost of capital for RC is closest to:

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

The Capital Asset Pricing Model

Investor Behavior 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

Exam 14: Capital Structure in a Perfect Market

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

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

Equity in a firm with no debt is called

Suppose the risk-free interest rate is 4%.If Nielson borrows $150 million today at this rate and uses the proceeds to pay an immediate cash dividend,then according to MM,the market value of its equity just alter the dividend is paid would be closest to:

Which of the following statements is false?

Following the borrowing of $12 and subsequent share repurchase,the equity cost of capital for RC is closest to:

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

The Capital Asset Pricing Model

Investor Behavior 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