Question 1

When investors use leverage in their own portfolios to adjust the leverage choice made by the firm, it is referred to as ________.

Accepted Answer

A)   outside debt
B)   retained earnings
C)   homemade leverage
D)   payout ratioE) A) and D)
F) None of the above

Question 2

What are indirect costs of financial distress?

Accepted Answer

Indirect costs of financial di...

Question 3

What are some implications of market imperfections?

Accepted Answer

Market imperfections such as c...

Question 4

Equity-debt holder conflicts are more likely to arise if the risk of financial distress is high.

Accepted Answer

A) True 
 B)False

Question 5

What is the capital structure of a firm?

Accepted Answer

The relative proport...

Question 6

Managers should consider ________ for external financing when agency costs are significant.

Accepted Answer

A)   long-term debt
B)   retained earnings
C)   internal equity
D)   short-term debtE) A) and D)
F) B) and C)

Question 7

Market timing means that managers may sell ________ when they believe the stock is over-valued and rely on ________ when the stock is undervalued.

Accepted Answer

A)   debt, shares
B)   debt, preferred stock
C)   new shares, debt
D)   debt, debtE) A) and B)
F) None of the above

Question 8

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 billionE) B) and D)
F) B) and C)

Question 9

Which of the following statements is FALSE?

Accepted Answer

A)   While debt itself may be cheap, it increases the risk and therefore the cost of capital of the firm's equity.
B)   Although debt does not have a lower cost of capital than equity, we can consider this cost in isolation.
C)   We can use MM Proposition I to derive an explicit relationship between leverage and the equity cost of capital.
D)   The total market value of the firm's securities is equal to the market value of its assets, whether the firm is unlevered or levered.E) All of the above
F) B) and D)

Question 10

A firm requires an investment of $18,000 and will return $25,000 after one year. If the firm borrows $10,000 at 6%, what is the return on levered equity?

Accepted Answer

A)   80%
B)   64%
C)   96%
D)   112%E) A) and B)
F) B) and C)

Question 11

Which of the following statements is FALSE?

Accepted Answer

A)   Investors can alter the leverage choice of a firm to suit their personal tastes either by borrowing and reducing leverage or by holding bonds and adding more leverage.
B)   As per MM proposition II, 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 debt-equity ratio.
C)   The MM propositions imply that the true role of a firm's financial policy is to deal with financial market imperfections such as taxes and transaction costs.
D)   In practice, we will find that capital structure can have an effect on a firm's value.E) All of the above
F) B) and C)

Question 12

Which of the following statements is FALSE?

Accepted Answer

A)   As long as a firm's choice of securities does not change the cash flows generated by its assets, the capital structure decision will not change the total value of the firm or the amount of capital it can raise.
B)   If securities are fairly priced, then buying or selling securities has a net present value (NPV)  of zero and, therefore, should not change the value of a firm.
C)   The future repayments that the firm must make on its debt are equal in value to the amount of the loan it receives up front.
D)   An investor who would like more leverage than the firm has chosen can lend and add leverage to his or her own portfolio.E) A) and B)
F) None of the above

Question 13

To reduce agency costs, issuing debt instead of equity provides incentives for managers to run a firm efficiently because ________.

Accepted Answer

A)   debt increases the funds available to managers to run the firm
B)   ownership of managers may remain more concentrated
C)   managers may take actions that benefit shareholders but harm creditors and lower the value of the firm
D)   shareholders prefer to decline new projects to save cash, even if their NPVs are positiveE) B) and C)
F) C) and D)

Question 14

Suppose a project financed via an issue of debt requires five annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 7%, what is the value of the interest rate tax shield?

Accepted Answer

A)   $20.66 million
B)   $31.00 million
C)   $25.83 million
D)   $51.66 millionE) B) and C)
F) C) and D)

Question 15

Use the information for the question(s)  below.
Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at an interest rate of 5%.
-Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as Firm X. You have $5,000 of your own money to invest and you plan on buying Firm X stock. Using homemade (un) leverage, how much do you need to invest at the risk-free rate so that the payoff of your account will be the same as a $5,000 investment in Firm Y stock?

Accepted Answer

A)   $5,000
B)   $0
C)   $2,500
D)   $4,000E) A) and B)
F) B) and C)

Question 16

Managers should make use of the interest tax shield if a firm has ________.

Accepted Answer

A)   consistent taxable income
B)   volatility in taxable income
C)   consistent dividend payments
D)   low tax ratesE) B) and C)
F) A) and D)

Question 17

A project will give a one-time cash flow of $22,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?

Accepted Answer

A)   $20,000
B)   $16,000
C)   $24,000
D)   more information neededE) A) and C)
F) A) and B)

Question 18

Equity in a firm with no debt is called unlevered equity.

Accepted Answer

A) True 
 B)False

Question 19

MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets.

Accepted Answer

A)   earnings after taxes
B)   earnings after interest
C)   cash flows after taxes
D)   free cash flowsE) All of the above
F) A) and C)

Question 20

Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options given to employees valued at $2 billion. After the repurchase how many shares will Luther have outstanding?

Accepted Answer

A)   1.15 billion
B)   1.2 billion
C)   0.75 billion
D)   1.1 billionE) None of the above
F) All of the above

Exam 16: Capital Structure

Managers should make use of the interest tax shield if a firm has ________.

Correct Answer
verified

A project will give a one-time cash flow of $22,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?

Correct Answer
verified

What are indirect costs of financial distress?

Correct Answer
verified
Indirect costs of financial di...
View Answer

Equity-debt holder conflicts are more likely to arise if the risk of financial distress is high.

Correct Answer
verified

Which of the following statements is FALSE?

Correct Answer
verified

Equity in a firm with no debt is called unlevered equity.

Correct Answer
verified

MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets.

Correct Answer
verified

Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options given to employees valued at $2 billion. After the repurchase how many shares will Luther have outstanding?

Correct Answer
verified

Suppose a project financed via an issue of debt requires five annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 7%, what is the value of the interest rate tax shield?

Correct Answer
verified

Correct Answer
verified

A firm requires an investment of $18,000 and will return $25,000 after one year. If the firm borrows $10,000 at 6%, what is the return on levered equity?

Correct Answer
verified

To reduce agency costs, issuing debt instead of equity provides incentives for managers to run a firm efficiently because ________.

Correct Answer
verified

Which of the following statements is FALSE?

Correct Answer
verified

Market timing means that managers may sell when they believe the stock is over-valued and rely on when the stock is undervalued.

Correct Answer
verified

With perfect capital markets, what is the market value of Luther's equity after the share repurchase?

Correct Answer
verified

When investors use leverage in their own portfolios to adjust the leverage choice made by the firm, it is referred to as ________.

Correct Answer
verified

Managers should consider ________ for external financing when agency costs are significant.

Correct Answer
verified

What are some implications of market imperfections?

Correct Answer
verified
Market imperfections such as c...
View Answer

What is the capital structure of a firm?

Correct Answer
verified
The relative proport...
View Answer

Which of the following statements is FALSE?

Correct Answer
verified

Exam 16: Capital Structure

Managers should make use of the interest tax shield if a firm has ________.

Correct AnswerverifiedShow Answer

A project will give a one-time cash flow of $22,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?

Correct AnswerverifiedShow Answer

What are indirect costs of financial distress?

Correct AnswerverifiedIndirect costs of financial di...View AnswerShow Answer

Equity-debt holder conflicts are more likely to arise if the risk of financial distress is high.

Correct AnswerverifiedShow Answer

Which of the following statements is FALSE?

Correct AnswerverifiedShow Answer

Equity in a firm with no debt is called unlevered equity.

Correct AnswerverifiedShow Answer

MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets.

Correct AnswerverifiedShow Answer

Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options given to employees valued at $2 billion. After the repurchase how many shares will Luther have outstanding?

Correct AnswerverifiedShow Answer

Suppose a project financed via an issue of debt requires five annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 7%, what is the value of the interest rate tax shield?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

A firm requires an investment of $18,000 and will return $25,000 after one year. If the firm borrows $10,000 at 6%, what is the return on levered equity?

Correct AnswerverifiedShow Answer

To reduce agency costs, issuing debt instead of equity provides incentives for managers to run a firm efficiently because ________.

Correct AnswerverifiedShow Answer

Which of the following statements is FALSE?

Correct AnswerverifiedShow Answer

Market timing means that managers may sell ________ when they believe the stock is over-valued and rely on ________ when the stock is undervalued.

Correct AnswerverifiedShow Answer

With perfect capital markets, what is the market value of Luther's equity after the share repurchase?

Correct AnswerverifiedShow Answer

When investors use leverage in their own portfolios to adjust the leverage choice made by the firm, it is referred to as ________.

Correct AnswerverifiedShow Answer

Managers should consider ________ for external financing when agency costs are significant.

Correct AnswerverifiedShow Answer

What are some implications of market imperfections?

Correct AnswerverifiedMarket imperfections such as c...View AnswerShow Answer

What is the capital structure of a firm?

Correct AnswerverifiedThe relative proport...View AnswerShow Answer

Which of the following statements is FALSE?

Correct AnswerverifiedShow Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
Indirect costs of financial di...
View Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Market timing means that managers may sell when they believe the stock is over-valued and rely on when the stock is undervalued.

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
Market imperfections such as c...
View Answer

Correct Answer
verified
The relative proport...
View Answer

Correct Answer
verified