Question 1

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 value of the firm's levered equity from the project is closest to:

Accepted Answer

A)  $0.
B)  $10,000.
C)  $6000.
D)  $8600. B

Question 2

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.
-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 D

Question 3

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 you borrow $30,000 in financing the project.According to MM proposition II,the firm's equity cost of capital will be closest to:

Accepted Answer

A)  21%.
B)  15%.
C)  20%.
D)  25%. C

Question 4

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.

Question 5

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)  borrowing $6000 and buying 240 shares of stock.
B)  selling 240 shares of stock and lending $6000.
C)  borrowing $9000 and buying 360 shares of stock.
D)  selling 360 shares of stock and lending $9000.

Question 6

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

The answer of Two separate firms are considering investing in...

Question 7

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

The answer of Use the information for the question(s)below.
Consider a...

Question 8

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.

Question 9

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.

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.
-With perfect capital markets,what is the market price per share of Luther's stock after the share repurchase?

Accepted Answer

A)  $25
B)  $24
C)  $15
D)  $20

Question 11

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 subsequent share repurchase,the number of shares that RC will have outstanding is closest to:

Accepted Answer

A)  4.0 million.
B)  6.0 million.
C)  4.9 million.
D)  4.5 million.

Question 12

Equity in a firm with debt is called:

Accepted Answer

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

Question 13

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 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 cash flows?

Accepted Answer

The answer of Use the information for the question(s)below.
Consider two...

Question 14

Louie's Truck Repair has assets with a market value of $8000.The company has three types of securities: equity,$2500 of debt,and 100 warrants that are fairly priced at $20 each.What is the value of Louie's equity?

Accepted Answer

A)  $5430
B)  $12,500
C)  $10,500
D)  $3500

Question 15

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.
-Nielson's EPS if they choose not to change their capital structure is closest to:

Accepted Answer

A)  $2.00.
B)  $2.30.
C)  $2.50.
D)  $2.90.

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.

Question 17

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 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.

Question 18

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 Lincoln is closest to:

Accepted Answer

A)  0.95.
B)  1.00.
C)  1.05.
D)  0.90.

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 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%.

Question 20

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.

Exam 14: Capital Structure in a Perfect Market

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

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

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

Equity in a firm with debt is called:

Louie's Truck Repair has assets with a market value of $8000.The company has three types of securities: equity,$2500 of debt,and 100 warrants that are fairly priced at $20 each.What is the value of Louie's equity?

Which of the following statements is FALSE?

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 Lincoln is closest to:

Which of the following statements is FALSE?