Question 1

MM showed that in a world without taxes, a firm's value is not affected by its capital structure.

Accepted Answer

A) True 
 B)False  True

Question 2

The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%.	Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.
-Assume that the firm's gain from leverage according to the Miller model is
$126,667. If the effective personal tax rate on stock income is TS = 20%, what is the implied personal tax rate on debt income?

Accepted Answer

A)   16.4%
B)   18.2%
C)   20.2%
D)   22.5%
E)   25.0% E

Question 3

Which of the following statements concerning capital structure theory is NOT CORRECT?

Accepted Answer

A)  	The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt.
B)  	Under MM with zero taxes, financial leverage has no effect on a firm’s value.
C)  	Under MM with corporate taxes, the value of a levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt.
D)  	Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing.
E)  	Under MM with corporate taxes, the effect of business risk is automatically incorporated because rsL is a function of rsU. D

Question 4

In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

Accepted Answer

A) True 
 B)False

Question 5

MM showed that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

Accepted Answer

A) True 
 B)False

Question 6

The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%.	Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.
-What is the firm's cost of equity?

Accepted Answer

A)   21.0%
B)   23.3%
C)   25.9%
D)   28.8%
E)   32.0%

Question 7

The Miller model begins with the MM model with taxes and then adds personal taxes.

Accepted Answer

A) True 
 B)False

Question 8

Gomez computer systems has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Gomez must reinvest 20% of its EBIT in net operating assets. Gomez has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%.
-According to the MM extension with growth, what is Gomez's value of equity?

Accepted Answer

A)   $1,492,000
B)   $1,529,300
C)   $1,567,533
D)   $1,606,721
E)   $1,646,889

Question 9

In the MM extension with growth, the appropriate discount rate for the tax shield is the after-tax cost of debt.

Accepted Answer

A) True 
 B)False

Question 10

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

Accepted Answer

A) True 
 B)False

Question 11

The major contribution of the Miller model is that it demonstrates that

Accepted Answer

A)   personal taxes increase the value of using corporate debt.
B)   personal taxes decrease the value of using corporate debt.
C)   financial distress and agency costs reduce the value of using corporate debt.
D)   equity costs increase with financial leverage.
E)   debt costs increase with financial leverage.

Question 12

The MM model with corporate taxes is the same as the Miller model, but with zero personal taxes.

Accepted Answer

A) True 
 B)False

Question 13

According to MM, in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Accepted Answer

A) True 
 B)False

Question 14

When a firm has risky debt, its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.

Accepted Answer

A) True 
 B)False

Question 15

The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%.	Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.
-What is the value of the firm according to MM with corporate taxes?

Accepted Answer

A)   $475,875
B)   $528,750
C)   $587,500
D)   $646,250
E)   $710,875

Question 16

Gomez computer systems has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Gomez must reinvest 20% of its EBIT in net operating assets. Gomez has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%.
-According to the MM extension with growth, what is the value of Gomez's tax shield?

Accepted Answer

A)   $156,385
B)   $164,616
C)   $173,280
D)   $182,400
E)   $192,000

Question 17

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

Accepted Answer

A)   The tax shields should be discounted at the unlevered cost of equity.
B)   The value of a growing tax shield is greater than the value of a constant tax shield.
C)   For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax)  assumptions.
D)   For a given D/S, the WACC is greater than the WACC under MM's original (with tax)  assumptions.
E)   The total value of the firm is independent of the amount of debt it uses.

Question 18

Trumbull, Inc., has total value (debt plus equity) of $500 million and $200 million face value of 1-year zero coupon debt. The volatility ($\sigma$) of Trumbull's total value is 0.60, and the risk-free rate is 5%. Assume that N(d1) = 0.9720 and N(d2) = 0.9050.
-What is the value (in millions) of Trumbull's debt if its equity is viewed as an option?

Accepted Answer

A)   $167.57
B)   $186.19
C)   $204.81
D)   $225.29
E)   $247.82

Question 19

The MM model is the same as the Miller model, but with zero corporate taxes.

Accepted Answer

A) True 
 B)False

Question 20

Firm L has debt with a market value of $200,000 and a yield of 9%. The firm's equity has a market value of $300,000, its earnings are growing at a rate of 5%, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is Firm L's cost of equity?

Accepted Answer

A)   11.4%
B)   12.0%
C)   12.6%
D)   13.3%
E)   14.0%

Exam 26: Analysis of Capital Structure Theory

MM showed that in a world without taxes, a firm's value is not affected by its capital structure.

Which of the following statements concerning capital structure theory is NOT CORRECT?

In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

MM showed that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%. Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. -What is the firm's cost of equity?

The Miller model begins with the MM model with taxes and then adds personal taxes.

In the MM extension with growth, the appropriate discount rate for the tax shield is the after-tax cost of debt.

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

The major contribution of the Miller model is that it demonstrates that

The MM model with corporate taxes is the same as the Miller model, but with zero personal taxes.

According to MM, in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

When a firm has risky debt, its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.

The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%. Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. -What is the value of the firm according to MM with corporate taxes?

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

The MM model is the same as the Miller model, but with zero corporate taxes.