Deck 21: Dynamic Capital Structures

Question 1

The market value of Firm L's debt is $200,000 and its yield is 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?

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

Answer 1

14.0%

Question 2

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

Answer 2

False

Question 3

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

Answer 3

True

Question 4

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

Question 5

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

Question 6

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

Question 7

Other things held constant,an increase in financial leverage will increase a firm's market (or systematic)risk as measured by its beta coefficient.

Question 8

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.

Question 9

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

Question 10

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

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

Question 11

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

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

Question 12

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

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

Question 13

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

Question 14

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

Question 15

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

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

Question 16

In the MM extension with growth,the appropriate discount rate for the tax shield is the unlevered cost of equity.

Question 17

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

Question 18

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

A) Under MM with zero taxes, financial leverage has no effect on a firm's value.
B) 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.
C) Under MM with corporate taxes, r_s increases with leverage, and this increase exactly offsets the tax benefits of debt financing.
D) Under MM with corporate taxes, the effect of business risk is automatically incorporated because r_sL is a function of r_sU.
E) The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt.

Question 19

In the MM extension with growth,the appropriate discount rate for the tax shield is the WACC.

Question 20

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.

Question 21

The market value of Firm L's debt is $200,000 and its yield is 9%.The firm's equity has a market value of $300,000,its earnings are growing at a 5% rate,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 would Firm L's total value be if it had no debt?

A) $358,421
B) $377,286
C) $397,143
D) $417,000
E) $437,850

Question 22

A local firm has debt worth $200,000,with a yield of 9%,and equity worth $300,000.It is growing at a 5% rate,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 the value of your firm's tax shield,i.e.,how much value does the use of debt add?

A) $92,571
B) $102,857
C) $113,143
D) $124,457
E) $136,903