Exam 17: Does Debt Policy Matter

MM Proposition II states that I.the expected return on equity is positively related to leverage; II.the required return on equity is a linear function of the firm's debt to equity ratio; III.the risk to equity increases with leverage

The beta of an all-equity firm is 1.2. Suppose the firm changes its capital structure to 50 percent debt and 50 percent equity using 8 percent debt financing. What is the equity beta of the levered firm? The beta of debt is 0.2. (Assume no taxes.)

Financial leverage increases the expected return and risk of the shareholder.

Modigliani and Miller's Proposition I states that

Under what conditions would a policy of maximizing the value of the firm not be the same as a policy of maximizing shareholders' wealth?

For an all-equity firm,

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

If firm U is unlevered and firm L is levered, then which of the following is true? I.V_U = E_U. II.V_L = E_L + D_L. III.V_L = E_U + D_L.

According to the graph of WACC for Union Pacific, which of the following is (are)true? I.The cost of equity is an increasing function of the debt-equity ratio. II.The cost of debt is an increasing function of the debt-equity ratio. III.The weighted average cost of capital (WACC)is a decreasing function of the debt-equity ratio.

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20 percent expected return. If the company repurchases 50 percent of the stock and substitutes an equal value of debt yielding 8 percent, what is the expected return on its common stock after refinancing?

An investor can create the effect of leverage on his/her account by I.buying equity of a levered firm; II.investing in risk-free debt like T-bills; III.borrowing on his/her own account

State the generalized version of Modigliani-Miller Proposition I.

Briefly explain how changes in the debt-equity ratio change the firm's equity beta.

The firm's mix of securities used to finance its assets is called the firm's capital structure.

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

Generally, which of the following is true?

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

When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of operating income because interest payments on the debt