Question 1

Modigliani and Miller (M&M)Proposition II states:

Accepted Answer

A) the cost of equity does not change when a firm takes on a greater proportion of debt. 
B) the cost of equity increases when a firm takes on a greater proportion of debt. 
C) the cost of debt increases when a firm takes on a greater proportion of equity. 
D) the cost of equity decreases when a firm takes on a greater proportion of debt.

Question 2

A firm's risk level will fluctuate as its ________ changes.

Accepted Answer

A) financial leverage 
B) debt-to-equity 
C) degree of financial leverage 
D) All of the above.

Question 3

The author cites a global study by Servaes and Tufano from 2006 which shows ________ as the dividend policy preferred by the vast majority (76%)of the firms surveyed.

Accepted Answer

A) a specific percentage amount 
B) a specific target amount 
C) a specific growth amount 
D) no specific policy

Question 4

A firm's capital structure combines all forms of financing on which the firm relies including:

Accepted Answer

A) preferred shares. 
B) common equity. 
C) long-term debt. 
D) All of the above.

Question 5

$\begin{array}{c}
\begin{array}{|l|}
\hline \
\hline \
 \hline \text {Anticipated operating income }\
 \hline \text {Interest}\ 
  \hline \text {Earnings before tax}\ 
  \hline \text {Tax at 30 \% }\ 
  \hline \text {Earnings after tax}\
\hline \
 \hline \text {Combined debt and equity income }\
 \text {(interest plus earnings after tax)}\
 \hline   
\end{array}
\begin{array}{l|}
  \hline \text {ALL EQUTTY}\ 
 \hline \
 \hline  \$ 1,000,000 \
\hline\underline{\quad\quad}\ 
 \hline\$1,00,000\
 \hline\underline{\$300,000}\
 \hline \$ 700,000 \
 \hline\
 \hline\
\$700,000\
 \hline
\end{array}
\begin{array}{l|}
 \hline \text {EQUITY AND DEBT}\
\hline\
\hline\$ 1,000,000 \
\hline\underline{\$ 200,000} \
\hline\$ 800,000 \
\hline\underline{\$-}\
\hline\$\
\hline\
\hline\
\$\
\hline
\end{array}
\end{array}$
-In a world with taxes,M&M's second proposition defines the expected return on equity as:

Accepted Answer

A) Ke = Ku + (Ku - Kd)(1 - t)( $\frac { D } { E }$ ) 
B) Ke = Ku + (Ku + Kd)(1 - t)( $\frac { D } { E }$ ) 
C) Ke = Ku + (Ku - Kd)(1 + t)( $\frac { D } { E }$ ) 
D) Ke = Ku - (Ku - Kd)(1 - t)( $\frac { D } { E }$ )

Question 6

The beauty of the Modigliani and Miller model is that if you relax the restrictive assumptions,it still demonstrates that capital structure does not impact the value of the firm.

Accepted Answer

A) True 
 B)False

Question 7

A firm's capital structure combines all forms of long-term financing on which the firm relies EXCEPT:

Accepted Answer

A) long-term debt. 
B) common equity. 
C) inventory. 
D) preferred shares.

Question 8

The major real-world benefit of debt is that interest payments are a tax-deductible expense.

Accepted Answer

A) True 
 B)False

Question 9

Flyover Airlines Inc.has a cost of equity equal to 24.67%.If the firm is financed with 40% debt and 60% equity and has an average cost of capital of 18%,what is the cost of debt? Assume perfect capital markets.

Accepted Answer

A) 8.00% 
B) 6.67% 
C) 10.00% 
D) 12.33%

Question 10

Under conditions of perfect capital markets,M&M insist that the value of the levered firm is greater than the value of the unlevered firm.

Accepted Answer

A) True 
 B)False

Question 11

Modigliani and Miller each won a Nobel prize in economics in at least in part because of their work with capital structure.

Accepted Answer

A) True 
 B)False

Question 12

________ refers to the difficulties experienced by firms as they attempt to meet financial commitments to their creditors.

Accepted Answer

A) Financial distress 
B) Capital structure 
C) Capital budgeting 
D) Working capital management

Question 13

Which type of firm described is likely to have a high dividend payout ratio policy?

Accepted Answer

A) A younger firm with uncertain income but significant growth opportunities. 
B) An older firm with steady earnings but few growth opportunities.. 
C) An older firm with irregular income and significant growth opportunities. 
D) A younger firm with significant income and super normal positive growth opportunities.

Question 14

Spectronix Inc.operates in a world of perfect capital markets,has no debt,and has a required rate of return on equity of 10%.An executive manager has suggested that borrowing money to buy back outstanding stock is a good idea because it would replace equity financing with less expensive debt financing,thus increasing the value of the firm.Assume the firm issues new debt with a required return of of 5% to repurchase 30% of the outstanding stock.What is the cost of equity at the conclusion of this transaction?

Accepted Answer

A) 21.67% 
B) 12.14% 
C) 16.43% 
D) 45.00%

Question 15

Which of the following statements regarding a share repurchase is NOT true?

Accepted Answer

A) Share repurchases occur most commonly as open market repurchases. 
B) The firm typically buys its shares just like any investor would purchase stocks listed on a stock exchange. 
C) A firm often announces its intention to repurchase a certain number of its shares,say over the upcoming year. 
D) In most cases,a firm may agree to repurchase shares from a major shareholder at a negotiated price.

Question 16

Assume an M&M world with taxes where the corporate tax rate is 25%,the before tax required return on debt is 8%,the required return on the unlevered firm is 12%,and the firm is financed 20% with debt and 80% with equity.What is the required return on equity?

Accepted Answer

A) 12.75% 
B) 15.00% 
C) 13.25% 
D) 11.25%

Question 17

In M&M Proposition II the cost of equity changes with changes in the amount of debt financing.Which of the following is the correct formula for Proposition II?

Accepted Answer

A) Ke = Ku + (Ku - Kd)/ ( $\frac { D } { E }$ ) 
B) Ke = Ku + (Ku - Kd)( $\frac { D } { E }$ ) 
C) Ke = Ku + (Ku + Kd)( $\frac { D } { E }$ ) 
D) Ke = Ku + (Ku + Kd)/ ( $\frac { D } { E }$ )

Question 18

Which of the following statements is NOT correct? Under conditions of perfect capital markets:

Accepted Answer

A) investors do not pay taxes,but firms do. 
B) firms do not pay taxes,but investors do. 
C) capital structure matters because it can change the value of the firm. 
D) capital structure does not matter because it cannot change the value of the firm.

Question 19

Under conditions of perfect capital markets,M&M suggest that the average cost of capital for the firm will increase with the addition of debt.

Accepted Answer

A) True 
 B)False

Question 20

Figure 11.1: Selected information for Silicon Solutions Inc.
$\begin{array}{|l|l|l} 
\hline& \text { ALL EQUITY } & \text { EQUTTY AND DEBT } \ 
\hline & & \
\hline \text { Number of shares } & 1,000,000 & 750,000 \
\hline \text { Price per share } & \$ 10 & \$ 10 \
\hline \text { Market value of shares } & \$ 10,000,000 & \$ 7,500,000 \
\hline \text { Market value of debt } & - & \$ 2,500,000 \
\hline & & \
\hline \text { Anticipated operating income } & \$ 1,000,000 & \$ 1,000,000 \
\hline \text { Interest } & - & \$ 150,000 \
\hline \text { Earnings (after interest) } & \$ 1,000,000 & \$ 850,000 \
\hline \text { Earnings per share } & \$ 1.00 & \$ 1.13 \
\hline \text { Return on shares } & & \
\text { Average cost of capital } & & \
\text { Return on debt } & & \
\hline
\end{array}$
-According to Modigliani and Miller (M&M),in a world of perfect capital markets,what will be the expected equity return (or cost of equity)for a firm that has a cost of capital of 14 percent,a cost of debt of 8 percent,debt valued at $3.0 million,and equity valued at $4.0 million? What would happen to the cost of equity as the amount of debt increased? What would happen to the cost of debt if the amount of debt was increased?

Accepted Answer

The answer of Figure 11.1: Selected information for Silicon Solutions...

Exam 11: Understanding Financing and Payout Decisions

Modigliani and Miller (M&M) Proposition II states:

A firm's risk level will fluctuate as its ________ changes.

The author cites a global study by Servaes and Tufano from 2006 which shows ________ as the dividend policy preferred by the vast majority (76%) of the firms surveyed.

A firm's capital structure combines all forms of financing on which the firm relies including:

The beauty of the Modigliani and Miller model is that if you relax the restrictive assumptions,it still demonstrates that capital structure does not impact the value of the firm.

A firm's capital structure combines all forms of long-term financing on which the firm relies EXCEPT:

The major real-world benefit of debt is that interest payments are a tax-deductible expense.

Flyover Airlines Inc.has a cost of equity equal to 24.67%.If the firm is financed with 40% debt and 60% equity and has an average cost of capital of 18%,what is the cost of debt? Assume perfect capital markets.

Under conditions of perfect capital markets,M&M insist that the value of the levered firm is greater than the value of the unlevered firm.

Modigliani and Miller each won a Nobel prize in economics in at least in part because of their work with capital structure.

________ refers to the difficulties experienced by firms as they attempt to meet financial commitments to their creditors.

Which type of firm described is likely to have a high dividend payout ratio policy?

Which of the following statements regarding a share repurchase is NOT true?

Assume an M&M world with taxes where the corporate tax rate is 25%,the before tax required return on debt is 8%,the required return on the unlevered firm is 12%,and the firm is financed 20% with debt and 80% with equity.What is the required return on equity?

In M&M Proposition II the cost of equity changes with changes in the amount of debt financing.Which of the following is the correct formula for Proposition II?

Which of the following statements is NOT correct? Under conditions of perfect capital markets:

Under conditions of perfect capital markets,M&M suggest that the average cost of capital for the firm will increase with the addition of debt.