Question 1

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

Accepted Answer

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

Question 2

Equity in a firm with debt is called:

Accepted Answer

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

Question 3

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 4

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 $40,000 at the risk free rate and issues new equity to cover the remainder. In this situation, the value of the firm's levered equity from the project is closest to:

Accepted Answer

A)  $0 
B)  $50,000 
C)  $90,000 
D)  $40,000 
A)  $0 
B)  $50,000 
C)  $90,000 
D)  $40,000

Question 5

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 value of a share of d'Anconia Copper will be closest to:

Accepted Answer

A)  $18.33 
B)  $20.00 
C)  $25.00 
D)  $27.50 
A)  $18.33 
B)  $20.00 
C)  $25.00 
D)  $27.50

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%.
-Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free rate and issues new equity to cover the remainder. In this situation, the cost of capital for the firm's levered equity is closest to:

Accepted Answer

A)  23% 
B)  25% 
C)  15% 
D)  18% 
A)  23% 
B)  25% 
C)  15% 
D)  18%

Question 7

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&_TB2720_00 PV(equity cash flows) = @#IMG-DLM&_TB27

Question 8

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 9

Consider the following equation: βU =   βE +   βD
The term βU 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 10

Use the following information to answer the question(s) below.
Nielson Motors is currently an all equity financed firm. It expects to generate EBIT of $20 million over the next year. Currently Nielson has 8 million shares outstanding and its stock is trading at $20.00 per share. Nielson is considering changing its capital structure by borrowing $50 million at an interest rate of 8% and using the proceeds to repurchase shares. Assume perfect capital markets.
-Which of the following statements is FALSE?

Accepted Answer

A)  The money taken in by the firm as a result of the share issue exactly offsets the dilution of the shares. 
B)  Most analysts prefer to use performance measures and valuation multiples that are based on the firm's earnings before interest has been deducted. 
C)  Because the firm's earnings per share and price-earnings ratio are affected by leverage implies that we can always reliably compare these measures across firms with different capital structures. 
D)  In general, as long as the firm sells the new shares of equity at a fair price, there will be no gain or loss to shareholders associated with the equity issue itself. 
A)  The money taken in by the firm as a result of the share issue exactly offsets the dilution of the shares. 
B)  Most analysts prefer to use performance measures and valuation multiples that are based on the firm's earnings before interest has been deducted. 
C)  Because the firm's earnings per share and price-earnings ratio are affected by leverage implies that we can always reliably compare these measures across firms with different capital structures. 
D)  In general, as long as the firm sells the new shares of equity at a fair price, there will be no gain or loss to shareholders associated with the equity issue itself.

Question 11

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 12

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.
-What is the conservation of value principle?

Accepted Answer

With perfect capital markets,

Question 13

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 14

Use the following information to answer the question(s) below.
Nielson Motors (NM) has no debt. Its assets will be worth $600 million in one year if the economy is strong, but only $300 million if the economy is weak. Both events are equally likely. The market value today of Nielson's assets is $400 million.
-The expected return for Nielson Motors stock without leverage is closest to:

Accepted Answer

A)  -25.0% 
B)  -17.5% 
C)  -12.5% 
D)  12.5% 
A)  -25.0% 
B)  -17.5% 
C)  -12.5% 
D)  12.5%

Question 15

Which of the following statements is FALSE?

Accepted Answer

A)  While debt itself may be cheap, it increases the risk and therefore the cost of capital of the firm's equity. 
B)  Although debt does not have a lower cost of capital than equity, we can consider this cost in isolation. 
C)  We can use Modigliani and Miller's first proposition to derive an explicit relationship between leverage and the equity cost of capital. 
D)  The total market value of the firm's securities is equal to the market value of its assets, whether the firm is unlevered or levered. 
A)  While debt itself may be cheap, it increases the risk and therefore the cost of capital of the firm's equity. 
B)  Although debt does not have a lower cost of capital than equity, we can consider this cost in isolation. 
C)  We can use Modigliani and Miller's first proposition to derive an explicit relationship between leverage and the equity cost of capital. 
D)  The total market value of the firm's securities is equal to the market value of its assets, whether the firm is unlevered or levered.

Question 16

Which of the following statements is FALSE?

Accepted Answer

A)  The unlevered beta measures the market risk of the firm's business activities, ignoring any additional risk due to leverage. 
B)  If a firm holds $1 in cash and has $1 of risk-free debt, then the interest earned on the cash will equal the interest paid on the debt. The cash flows from each source cancel each other, just as if the firm held no cash and no debt. 
C)  The unlevered beta measures the market risk of the firm without leverage, which is equivalent to the beta of the firm's assets. 
D)  When a firm changes its capital structure without changing its investments, its levered beta will remain unaltered, however, its asset beta will change to reflect the effect of the capital structure change on its risk. 
A)  The unlevered beta measures the market risk of the firm's business activities, ignoring any additional risk due to leverage. 
B)  If a firm holds $1 in cash and has $1 of risk-free debt, then the interest earned on the cash will equal the interest paid on the debt. The cash flows from each source cancel each other, just as if the firm held no cash and no debt. 
C)  The unlevered beta measures the market risk of the firm without leverage, which is equivalent to the beta of the firm's assets. 
D)  When a firm changes its capital structure without changing its investments, its levered beta will remain unaltered, however, its asset beta will change to reflect the effect of the capital structure change on its risk.

Question 17

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 18

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 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 19

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 20

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, how much do you need to invest at the risk-free rate so that the payoff of your account will be the same as a $5000 investment in Without stock?

Accepted Answer

A)  $5000 
B)  $0 
C)  $2,500 
D)  $4,000 
A)  $5000 
B)  $0 
C)  $2,500 
D)  $4,000

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

Equity in a firm with debt is called:

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

Which of the following statements is FALSE?

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

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

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

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

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

Equity in a firm with debt is called:

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

Which of the following statements is FALSE?

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

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

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

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters

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

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

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