Question 1

If a firm's expected return on equity equals its expected return on assets, then the:

Accepted Answer

A) Expected return on debt exceeds the expected return on assets 
B) Likelihood of financial distress is high 
C) Firm has too much debt 
D) Firm has no debt in its capital structure 
A) Expected return on debt exceeds the expected return on assets 
B) Likelihood of financial distress is high 
C) Firm has too much debt 
D) Firm has no debt in its capital structure

Question 2

Restructuring a firm involves changing the:

Accepted Answer

A) Mix of liabilities and equity 
B) Dividend payout ratio 
C) Managerial personnel 
D) Interest rate on debt 
A) Mix of liabilities and equity 
B) Dividend payout ratio 
C) Managerial personnel 
D) Interest rate on debt

Question 3

When a corporation issues permanent debt, the value of all its securities:

Accepted Answer

A) Increases by the present value of the tax shield 
B) Decreases by the present value of the tax shield 
C) Increases by the annual interest tax shield 
D) Decreases by the annual interest tax shield 
A) Increases by the present value of the tax shield 
B) Decreases by the present value of the tax shield 
C) Increases by the annual interest tax shield 
D) Decreases by the annual interest tax shield

Question 4

Explain MM Proposition II under conditions of corporate taxes and risk-free debt.How does the analysis change when debt can be risky?

Accepted Answer

Under MM Proposition II, the expected re

Question 5

The pecking-order theory of capital structure suggests the following order of financing:

Accepted Answer

A) Internal financing, debt issue, equity issue 
B) Internal financing, equity issue, debt issue 
C) Debt issue, equity issue, internal financing 
D) Equity issue, internal financing, debt issue 
A) Internal financing, debt issue, equity issue 
B) Internal financing, equity issue, debt issue 
C) Debt issue, equity issue, internal financing 
D) Equity issue, internal financing, debt issue

Question 6

What is the change in value for a firm with $1 million in equity, $1 million in permanent debt at a 10% interest rate, and a 35% tax rate if MM I is modified to recognize corporate taxes?

Accepted Answer

A) Value increases by $35,000 
B) Value increases by $100,000 
C) Value increases by $350,000 
D) Value increases by $700,000 PV of interest tax shield = Tc x D
= )35 x $1,000,000
= $350,000
Value of levered firm = value of all-equity financed + present value of tax shield 
A) Value increases by $35,000 
B) Value increases by $100,000 
C) Value increases by $350,000 
D) Value increases by $700,000 PV of interest tax shield = Tc x D
= )35 x $1,000,000
= $350,000
Value of levered firm = value of all-equity financed + present value of tax shield

Question 7

Under MM II assumptions, the expected return on equity is equal to the expected return on assets for a levered firm.

Accepted Answer

A) True 
 B)False

Question 8

A firm has an expected return on equity of 15% and an after-tax cost of debt of 10%.What debt-equity ratio should be used in order to keep the WACC at 11%?

Accepted Answer

A) 1.00 
B) 2.00 
C) 3.00 
D) 4.00 
A) 1.00 
B) 2.00 
C) 3.00 
D) 4.00

Question 9

What is the present value of the tax shields for a firm that anticipates a perpetual debt level of $10 million at an interest rate of 7% and a tax rate of 35%?

Accepted Answer

A) $245,000 
B) $700,000 
C) $3,500,000 
D) $10,000,000 PV tax shield = 
A) $245,000 
B) $700,000 
C) $3,500,000 
D) $10,000,000 PV tax shield =

Question 10

The present value of a perpetual tax shield increases as the firm's tax rate _____ and the amount of principal _____.

Accepted Answer

A) Increases; increases 
B) Increases; decreases 
C) Decreases; decreases 
D) Decreases; increases 
A) Increases; increases 
B) Increases; decreases 
C) Decreases; decreases 
D) Decreases; increases

Question 11

What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt, which totals 30% of assets?

Accepted Answer

A) 16.14% 
B) 17.00% 
C) 19.00% 
D) 25.67% Expected return on equity = Expected return on assets + 
A) 16.14% 
B) 17.00% 
C) 19.00% 
D) 25.67% Expected return on equity = Expected return on assets +

Question 12

A firm has an expected return on equity of 16% and an after-tax cost of debt of 8%.What debt-equity ratio should be used in order to keep the WACC at 12%?

Accepted Answer

A) .50 
B) .75 
C) 1.00 
D) 1.50 Let x = debt/asset ratio.Then
)12 = .08x + (1-x).16
= )08x + .16 - .16x
)08x/.08 = .04/.08
X = .50 
A) .50 
B) .75 
C) 1.00 
D) 1.50 Let x = debt/asset ratio.Then
)12 = .08x + (1-x).16
= )08x + .16 - .16x
)08x/.08 = .04/.08
X = .50

Question 13

Ignoring taxes, a firm's weighted-average cost of capital is equal to:

Accepted Answer

A) Its expected return on assets 
B) Its expected return on equity 
C) The sum of expected return on equity and expected return on debt 
D) Its expected return on assets times the debt-equity ratio 
A) Its expected return on assets 
B) Its expected return on equity 
C) The sum of expected return on equity and expected return on debt 
D) Its expected return on assets times the debt-equity ratio

Question 14

When debt is risky under MM II:

Accepted Answer

A) Bond holders shift more of the risk to equity holders 
B) Equity holders shift more of the risk to bond holders 
C) The value of the interest tax shield is at its highest 
D) There is more overall risk in the firm 
A) Bond holders shift more of the risk to equity holders 
B) Equity holders shift more of the risk to bond holders 
C) The value of the interest tax shield is at its highest 
D) There is more overall risk in the firm

Question 15

Under the assumptions necessary for MM I, if investors can borrow or lend at the same terms as the firm, they will:

Accepted Answer

A) Invest in debt only and ignore equity investments 
B) Not be willing to pay more for a restructured firm 
C) Require a higher rate of return on equity 
D) Accept a lower rate of return on equity 
A) Invest in debt only and ignore equity investments 
B) Not be willing to pay more for a restructured firm 
C) Require a higher rate of return on equity 
D) Accept a lower rate of return on equity

Question 16

Debt financing affects neither the operating risk nor the business risk of the firm.

Accepted Answer

A) True 
 B)False

Question 17

What is the proportion of equity financing for a firm that expects a 15% return on equity, a 10% return on assets, and an 8% return on debt? Ignore taxes.

Accepted Answer

A) 25% 
B) 29% 
C) 75% 
D) 71% 
A) 25% 
B) 29% 
C) 75% 
D) 71%

Question 18

When financial disaster is looming, management may borrow to invest in projects having a negative expected NPV because:

Accepted Answer

A) The firm's beta is now negative 
B) Taxes are no longer a concern 
C) The interest tax shield will cover the loan costs 
D) The lender bears all the risk 
A) The firm's beta is now negative 
B) Taxes are no longer a concern 
C) The interest tax shield will cover the loan costs 
D) The lender bears all the risk

Question 19

What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.

Accepted Answer

A) 6.50% 
B) 9.90% 
C) 10.67% 
D) 11.14% WACC = rdebt + requity
14% = rdebt(.60) + 19%(.40)
14% = .6rdebt + 7.6% 
A) 6.50% 
B) 9.90% 
C) 10.67% 
D) 11.14% WACC = rdebt + requity
14% = rdebt(.60) + 19%(.40)
14% = .6rdebt + 7.6%

Question 20

The WACC is used to value:

Accepted Answer

A) Projects with any risk 
B) Projects with the same risk as the firm's current business 
C) Projects with the same risk as the firm's debt 
D) Projects with the same risk as the firm's equity 
A) Projects with any risk 
B) Projects with the same risk as the firm's current business 
C) Projects with the same risk as the firm's debt 
D) Projects with the same risk as the firm's equity

Exam 16: Debt Policy

If a firm's expected return on equity equals its expected return on assets, then the:

Restructuring a firm involves changing the:

When a corporation issues permanent debt, the value of all its securities:

Explain MM Proposition II under conditions of corporate taxes and risk-free debt.How does the analysis change when debt can be risky?

The pecking-order theory of capital structure suggests the following order of financing:

What is the change in value for a firm with $1 million in equity, $1 million in permanent debt at a 10% interest rate, and a 35% tax rate if MM I is modified to recognize corporate taxes?

Under MM II assumptions, the expected return on equity is equal to the expected return on assets for a levered firm.

A firm has an expected return on equity of 15% and an after-tax cost of debt of 10%.What debt-equity ratio should be used in order to keep the WACC at 11%?

What is the present value of the tax shields for a firm that anticipates a perpetual debt level of $10 million at an interest rate of 7% and a tax rate of 35%?

The present value of a perpetual tax shield increases as the firm's tax rate _____ and the amount of principal _____.

What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt, which totals 30% of assets?

A firm has an expected return on equity of 16% and an after-tax cost of debt of 8%.What debt-equity ratio should be used in order to keep the WACC at 12%?

Ignoring taxes, a firm's weighted-average cost of capital is equal to:

When debt is risky under MM II:

Under the assumptions necessary for MM I, if investors can borrow or lend at the same terms as the firm, they will:

Debt financing affects neither the operating risk nor the business risk of the firm.

What is the proportion of equity financing for a firm that expects a 15% return on equity, a 10% return on assets, and an 8% return on debt? Ignore taxes.

When financial disaster is looming, management may borrow to invest in projects having a negative expected NPV because:

What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.

The WACC is used to value:

Goals and Governance of the Firm

Financial Markets and Institutions

Accounting and Finance

Measuring Corporate Performance

The Time Value of Money

Valuing Bonds

Valuing Stocks

Net Present Value and Other Investment Criteria

Using Discounted Cash-Flow Analysis to Make Investment Decisions

Project Analysis

Introduction to Risk, Return, and the Opportunity Cost of Capital

Risk, Return, and Capital Budgeting

The Weighted-Average Cost of Capital and Company Valuation

Introduction to Corporate Financing and Governance

Venture Capital, Ipos, and Seasoned Offerings

Payout Policy

Long-Term Financial Planning

Short-Term Financial Planning

Working Capital Management

Mergers, Acquisitions, and Corporate Control

International Financial Management

Options

Risk Management

Conclusion

What We Do and Do Not Know About Finance

Filters

The present value of a perpetual tax shield increases as the firm's tax rate _ and the amount of principal _.