Question 1

The M&M Company is financed by $4 million (market value) in debt and $6 million (market value) in equity. The cost of debt is 5% and the cost of equity is 10%. Calculate the weighted average cost of capital. (Assume no taxes.)

Accepted Answer

A)  10% 
B)  15% 
C)  8% 
D)  None of the above

Question 2

The M & M Company is financed by $10 million in debt (market value) and $40 million in equity (market value). The cost of debt is 10% and the cost of equity is 20%. Calculate the weighted average cost of capital assuming no taxes.

Accepted Answer

A)  18% 
B)  20% 
C)  10% 
D)  None of the above

Question 3

MM's proposition is violated when the firm, by imaginative design of its capital structure, can offer some financial service that meets the need of such a clientele.

Accepted Answer

A) True 
 B)False

Question 4

Which of the following is true?

Accepted Answer

A)  bD > bA > bE 
B)  bE > bA > bD 
C)  bA > bE > bD 
D)  None of the above is true

Question 5

A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes its cost of equity capital with the new capital structure would be:

Accepted Answer

A)  8% 
B)  16% 
C)  13% 
D)  10% 
E)  None of the above
RE = 10 + (60/40)(10 - 8) = 10 + 3 = 13

Question 6

The firm's asset beta is usually higher than the firm's equity beta.

Accepted Answer

A) True 
 B)False

Question 7

A firm has a debt-to-equity ratio of 1.0. If it had no debt, its cost of equity would be 12%. Its cost of debt is 9%. What is its cost of equity if there are no taxes?

Accepted Answer

A)  21% 
B)  18% 
C)  15% 
D)  16%

Question 8

Value additivity does not hold good when assets are split up.

Accepted Answer

A) True 
 B)False

Question 9

If a firm is financed with both debt and equity, the firm's equity is known as:

Accepted Answer

A)  unlevered equity 
B)  levered equity 
C)  preferred equity 
D)  none of the above

Question 10

The asset beta of a levered firm is 1.1. The beta of debt is 0.3. If the debt equity ratio is 0.5, what is the equity beta? (Assume no taxes.)

Accepted Answer

A)  1.5 
B)  1.1 
C)  0.3 
D)  None of the above

Question 11

A firm's return on assets is estimated to be 12% and the cost of the firm's debt is 7%. Given a .7 debt to equity ratio, what is the levered cost of equity?

Accepted Answer

A)  7% 
B)  12% 
C)  13.6% 
D)  15.5%

Question 12

Health and Wealth Company is financed entirely by common stock that is priced to offer a 15% expected return. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected return on the common stock after refinancing? (Ignore taxes.)

Accepted Answer

A)  18% 
B)  21% 
C)  15% 
D)  None of the above

Question 13

When a firm has no debt, then such a firm is known as: 
I. an unlevered firm
II. a levered firm
III. an all-equity firm

Accepted Answer

A)  I only 
B)  II only 
C)  III only 
D)  I and III only

Question 14

Under what circumstances would MM's proposition is violated? Briefly discuss.

Accepted Answer

The answer of Under what circumstances would MM's proposition is...

Question 15

A firm has a debt-to-equity ratio of 0.50. Its cost of debt is 10%. Its overall cost of capital is 14%. What is its cost of equity if there are no taxes?

Accepted Answer

A)  13% 
B)  16% 
C)  15% 
D)  18%

Question 16

The effect of financial leverage on the performance of the firm depends on:

Accepted Answer

A)  The rate of return on equity 
B)  The firm's level of operating income 
C)  The current market value of the debt 
D)  The rate of dividend growth

Question 17

An EPS-Operating Income graph shows the trade-off between financing plans and: 
I. Greater risk associated with debt financing, which is evidenced by the greater slope 
II. Their break-even point
III. The minimum earnings needed to pay the debt financing for a given level of debt

Accepted Answer

A)  I only 
B)  II only 
C)  III only 
D)  I, II, and III only

Question 18

Discuss a successful example of corporations trying to add value through innovative financing.

Accepted Answer

The answer of Discuss a successful example of corporations trying...

Question 19

For an all equity firm,

Accepted Answer

A)  As earnings before interest and taxes (EBIT) increases, the earnings per share (EPS) increases by the same percent 
B)  As EBIT increases, the EPS increases by a larger percent 
C)  As EBIT increases, the EPS decreases 
D)  None of the above

Question 20

Modigliani and Miller Proposition I states that the market value of any firm is independent of its capital structure.

Accepted Answer

A) True 
 B)False

Exam 13: Does Debt Policy Matter

The M&M Company is financed by $4 million (market value) in debt and $6 million (market value) in equity. The cost of debt is 5% and the cost of equity is 10%. Calculate the weighted average cost of capital. (Assume no taxes.)

The M & M Company is financed by $10 million in debt (market value) and $40 million in equity (market value) . The cost of debt is 10% and the cost of equity is 20%. Calculate the weighted average cost of capital assuming no taxes.

MM's proposition is violated when the firm, by imaginative design of its capital structure, can offer some financial service that meets the need of such a clientele.

Which of the following is true?

A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes its cost of equity capital with the new capital structure would be:

The firm's asset beta is usually higher than the firm's equity beta.

A firm has a debt-to-equity ratio of 1.0. If it had no debt, its cost of equity would be 12%. Its cost of debt is 9%. What is its cost of equity if there are no taxes?

Value additivity does not hold good when assets are split up.

If a firm is financed with both debt and equity, the firm's equity is known as:

The asset beta of a levered firm is 1.1. The beta of debt is 0.3. If the debt equity ratio is 0.5, what is the equity beta? (Assume no taxes.)

A firm's return on assets is estimated to be 12% and the cost of the firm's debt is 7%. Given a .7 debt to equity ratio, what is the levered cost of equity?

Health and Wealth Company is financed entirely by common stock that is priced to offer a 15% expected return. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected return on the common stock after refinancing? (Ignore taxes.)

When a firm has no debt, then such a firm is known as: I. an unlevered firm II. a levered firm III. an all-equity firm

Under what circumstances would MM's proposition is violated? Briefly discuss.

A firm has a debt-to-equity ratio of 0.50. Its cost of debt is 10%. Its overall cost of capital is 14%. What is its cost of equity if there are no taxes?

The effect of financial leverage on the performance of the firm depends on:

An EPS-Operating Income graph shows the trade-off between financing plans and: I. Greater risk associated with debt financing, which is evidenced by the greater slope II. Their break-even point III. The minimum earnings needed to pay the debt financing for a given level of debt

Discuss a successful example of corporations trying to add value through innovative financing.

For an all equity firm,

Modigliani and Miller Proposition I states that the market value of any firm is independent of its capital structure.