Question 1

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 2

Use the information for the question(s) below.
Luther Industries has no debt, a total equity capitalization of $20 billion, and a beta of 1.8. Included in Luther's assets are $4 billion in cash and risk-free securities.
-Considering the fact that Luther's cash is risk-free,Luther's unlevered beta is closest to:

Accepted Answer

A)  1.90 
B)  2.25 
C)  1.50 
D)  1.45 
A)  1.90 
B)  2.25 
C)  1.50 
D)  1.45

Question 3

When investors use leverage in their own portfolios to adjust the leverage choice made by the firm,we say that they are using ________.

Accepted Answer

A)  homemade leverage 
B)  operating leverage 
C)  financial leverage 
D)  total leverage 
A)  homemade leverage 
B)  operating leverage 
C)  financial leverage 
D)  total leverage

Question 4

With perfect capital markets,what is the market value of Luther's equity after the share repurchase?

Accepted Answer

A)  $15 billion 
B)  $10 billion 
C)  $25 billion 
D)  $20 billion 
A)  $15 billion 
B)  $10 billion 
C)  $25 billion 
D)  $20 billion

Question 5

Use the information for the question(s) below.
Luther Industries has no debt, a total equity capitalization of $20 billion, and a beta of 1.8. Included in Luther's assets are $4 billion in cash and risk-free securities.
-What is Luther's enterprise value?

Accepted Answer

A)  $16 billion 
B)  $10.5 billion 
C)  $24 billion 
D)  $20 billion 
A)  $16 billion 
B)  $10.5 billion 
C)  $24 billion 
D)  $20 billion

Question 6

Which of the following statements is false?

Accepted Answer

A)  Holding cash has the opposite effect of leverage on risk and return. 
B)  We use the market value of the firm's net debt when computing its WACC and unlevered beta to measure the cost of capital and market risk of the firm's business assets. 
C)  Since the WACC does not change with the use of leverage, the value of the firm's free cash flow evaluated using the WACC does not change, and so the enterprise value of the firm does not depend on its financing choices. 
D)  Even if the firm's capital structure is more complex, the WACC is calculated by computing the weighted average cost of only the firm's debt and equity. 
A)  Holding cash has the opposite effect of leverage on risk and return. 
B)  We use the market value of the firm's net debt when computing its WACC and unlevered beta to measure the cost of capital and market risk of the firm's business assets. 
C)  Since the WACC does not change with the use of leverage, the value of the firm's free cash flow evaluated using the WACC does not change, and so the enterprise value of the firm does not depend on its financing choices. 
D)  Even if the firm's capital structure is more complex, the WACC is calculated by computing the weighted average cost of only the firm's debt and equity.

Question 7

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 8

Which of the following statements is false?

Accepted Answer

A)  The Law of One Price implies that leverage will affect the total value of the firm under perfect capital market conditions. 
B)  In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the firm's assets. 
C)  With perfect capital markets, leverage merely changes the allocation of cash flows between debt and equity, without altering the total cash flows of the firm. 
D)  In a perfect capital market, the total value of a firm is equal to the market value of the total cash flows generated by its assets and is not affected by its choice of capital structure. 
A)  The Law of One Price implies that leverage will affect the total value of the firm under perfect capital market conditions. 
B)  In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the firm's assets. 
C)  With perfect capital markets, leverage merely changes the allocation of cash flows between debt and equity, without altering the total cash flows of the firm. 
D)  In a perfect capital market, the total value of a firm is equal to the market value of the total cash flows generated by its assets and is not affected by its choice of capital structure.

Question 9

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 10

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 11

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 12

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 13

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 14

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.Construct a table detailing the percentage returns to the equity holders of both the levered and unlevered firms for both the weak and strong economy.

Accepted Answer

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

Question 15

Consider the following equation: βU =   βE +   βD
The term βD in the equation is

Accepted Answer

A)  the same as the beta of the firm's assets. 
B)  the required return on the firm's equity. 
C)  the proportion of the firm financed with equity. 
D)  equal to zero if the firm's debt is riskless. 
A)  the same as the beta of the firm's assets. 
B)  the required return on the firm's equity. 
C)  the proportion of the firm financed with equity. 
D)  equal to zero if the firm's debt is riskless.

Question 16

Which of the following statements is false?

Accepted Answer

A)  As long as the firm's choice of securities does not change the cash flows generated by its assets, the capital structure decision will not change the total value of the firm or the amount of capital it can raise. 
B)  If securities are fairly priced, then buying or selling securities has an NPV of zero and, therefore, should not change the value of a firm. 
C)  The future repayments that the firm must make on its debt are equal in value to the amount of the loan it receives up front. 
D)  An investor who would like more leverage than the firm has chosen can lend and add leverage to his or her own portfolio. 
A)  As long as the firm's choice of securities does not change the cash flows generated by its assets, the capital structure decision will not change the total value of the firm or the amount of capital it can raise. 
B)  If securities are fairly priced, then buying or selling securities has an NPV of zero and, therefore, should not change the value of a firm. 
C)  The future repayments that the firm must make on its debt are equal in value to the amount of the loan it receives up front. 
D)  An investor who would like more leverage than the firm has chosen can lend and add leverage to his or her own portfolio.

Question 17

In a perfect capital market,the total value of a firm is ________ the market value of the total cash flows generated by its assets and is not affected by its choice of capital structure.

Accepted Answer

A)  greater than 
B)  smaller than 
C)  equal to 
D)  not related to 
A)  greater than 
B)  smaller than 
C)  equal to 
D)  not related to

Question 18

Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate,then the value of the firm's levered equity from the project is closest to:

Accepted Answer

A)  $0 
B)  $10,000 
C)  $6,000 
D)  $8,600 
A)  $0 
B)  $10,000 
C)  $6,000 
D)  $8,600

Question 19

The cost of capital of levered equity is ________ the cost of capital of unlevered equity plus a premium that is proportional to the market value debt-equity ratio.

Accepted Answer

A)  greater than 
B)  smaller than 
C)  equal to 
D)  not related to 
A)  greater than 
B)  smaller than 
C)  equal to 
D)  not related to

Question 20

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

Exam 17: Capital Structure in a Perfect Market

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

When investors use leverage in their own portfolios to adjust the leverage choice made by the firm,we say that they are using ________.

With perfect capital markets,what is the market value of Luther's equity after the share repurchase?

Use the information for the question(s) below. Luther Industries has no debt, a total equity capitalization of $20 billion, and a beta of 1.8. Included in Luther's assets are $4 billion in cash and risk-free securities. -What is Luther's enterprise value?

Which of the following statements is false?

Which of the following statements is false?

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

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

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

Which of the following statements is false?

Consider the following equation: βU = βE + βD The term βD in the equation is

Which of the following statements is false?

In a perfect capital market,the total value of a firm is ________ the market value of the total cash flows generated by its assets and is not affected by its choice of capital structure.

Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate,then the value of the firm's levered equity from the project is closest to:

The cost of capital of levered equity is ________ the cost of capital of unlevered equity plus a premium that is proportional to the market value debt-equity ratio.

The Corporation

Introduction to Financial Statement Analysis

Arbitrage and Financial Decision Making

The Time Value of Money

Interest Rates

Valuing Bonds

Valuing Stocks

Investment Decision Rules

Fundamentals of Capital Budgeting

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

Financial Options

Option Valuation

Real Options

Debt and Taxes

Financial Distress, managerial Incentives, and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modelling: a Case Study

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:

Consider the following equation: β_U = β_E + β_D The term β_D in the equation is