Question 1

MM's proposition I,or the debt-irrelevance proposition,states that the value of a firm is unaffected by its capital structure.

Accepted Answer

A) True 
 B)False

Question 2

A decrease in the possible range of percentage stock returns can be achieved by:

Accepted Answer

A)  a decrease in the firm's financial leverage. 
B)  an increase in the firm's asset risk. 
C)  an increase in the firm's business risk. 
D)  a decrease in the firm's debt beta. 
A)  a decrease in the firm's financial leverage. 
B)  an increase in the firm's asset risk. 
C)  an increase in the firm's business risk. 
D)  a decrease in the firm's debt beta.

Question 3

According to MM II,if the expected return on assets decreases,what happens to the expected return on equity?

Accepted Answer

A)  Depends on the firm's capital structure 
B)  Decreases 
C)  Stays constant 
D)  Increases 
A)  Depends on the firm's capital structure 
B)  Decreases 
C)  Stays constant 
D)  Increases

Question 4

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 5

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 
A)  $245,000 
B)  $700,000 
C)  $3,500,000 
D)  $10,000,000

Question 6

Debt finance does not affect the operating risk but it does add financial risk.

Accepted Answer

A) True 
 B)False

Question 7

When debt is risky under MM II:

Accepted Answer

A)  bondholders shift more of the risk to equityholders. 
B)  equityholders shift more of the risk to bondholders. 
C)  the value of the interest tax shield is at its highest. 
D)  there is more overall risk in the firm. 
A)  bondholders shift more of the risk to equityholders. 
B)  equityholders shift more of the risk to bondholders. 
C)  the value of the interest tax shield is at its highest. 
D)  there is more overall risk in the firm.

Question 8

Financial slack means having ready access to cash or debt financing.

Accepted Answer

A) True 
 B)False

Question 9

What is the return on equity for a firm with 15% return on assets,10% return on debt,and a .75 debt-equity ratio?

Accepted Answer

A)  18.75% 
B)  20.00% 
C)  23.75% 
D)  26.25% 
A)  18.75% 
B)  20.00% 
C)  23.75% 
D)  26.25%

Question 10

Does firm value increase when more debt is used?

Accepted Answer

Not necessarily.Modigliani and Miller's

Question 11

MM proposition I states that a firm's value is unaffected by its:

Accepted Answer

A)  required rate of return on equity. 
B)  operating income, in the absence of taxes. 
C)  interest rate paid on debt. 
D)  mixture of debt and equity. 
A)  required rate of return on equity. 
B)  operating income, in the absence of taxes. 
C)  interest rate paid on debt. 
D)  mixture of debt and equity.

Question 12

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 ret

Question 13

What is meant by investors being able "to undo" the effects of corporate restructuring? Investors:

Accepted Answer

A)  repay their portion of the firm's debt. 
B)  purchase securities only in unlevered firms. 
C)  will pay more for unlevered shares. 
D)  borrow in their name and replicate the effects of restructuring. 
A)  repay their portion of the firm's debt. 
B)  purchase securities only in unlevered firms. 
C)  will pay more for unlevered shares. 
D)  borrow in their name and replicate the effects of restructuring.

Question 14

Which of the following is a safe assumption for a firm in which the PV of the tax shield is approximately equal to the costs of financial distress?

Accepted Answer

A)  The tax shield has been calculated incorrectly. 
B)  The firm is too heavily levered financially. 
C)  The firm has reached its optimal debt level. 
D)  The firm appears to have low risk of financial distress. 
A)  The tax shield has been calculated incorrectly. 
B)  The firm is too heavily levered financially. 
C)  The firm has reached its optimal debt level. 
D)  The firm appears to have low risk of financial distress.

Question 15

What is the amount of the annual interest tax shield for a firm with $3 million in debt that pays 12% interest if the firm is in the 35% tax bracket?

Accepted Answer

A)  $126,000 
B)  $234,000 
C)  $360,000 
D)  $1,050,000 
A)  $126,000 
B)  $234,000 
C)  $360,000 
D)  $1,050,000

Question 16

When there are no taxes and capital markets function well,the market value of a company does not depend on its capital structure.

Accepted Answer

A) True 
 B)False

Question 17

The present value of the costs of financial distress increases with increases in the debt ratio because the:

Accepted Answer

A)  expected return on assets increases. 
B)  present value of the interest tax shield is greater. 
C)  equity tax shield is depleted. 
D)  probability of default and/or bankruptcy is greater. 
A)  expected return on assets increases. 
B)  present value of the interest tax shield is greater. 
C)  equity tax shield is depleted. 
D)  probability of default and/or bankruptcy is greater.

Question 18

Which of the following statements is false regarding MM's proposition I?

Accepted Answer

A)  Firm value is unaffected by its capital structure. 
B)  It is also called the debt irrelevance proposition. 
C)  Shareholders should care about the firm's debt policy. 
D)  After restructuring, the firm's value should be the same as it was prior to restructuring. 
A)  Firm value is unaffected by its capital structure. 
B)  It is also called the debt irrelevance proposition. 
C)  Shareholders should care about the firm's debt policy. 
D)  After restructuring, the firm's value should be the same as it was prior to restructuring.

Question 19

A firm is currently expected to develop $2 EPS when operating income equals $4 million and interest expense equals $2 million.How low can operating income drop before EPS are reduced by half,to $1? Ignore taxes.

Accepted Answer

A)  Operating income drops to $3.5 million. 
B)  Operating income drops to $3.0 million. 
C)  Operating income drops to $2.5 million. 
D)  Operating income drops to $2.0 million. 
A)  Operating income drops to $3.5 million. 
B)  Operating income drops to $3.0 million. 
C)  Operating income drops to $2.5 million. 
D)  Operating income drops to $2.0 million.

Question 20

Firms facing financial distress may pass up positive-NPV projects rather than commit new equity because:

Accepted Answer

A)  they prefer to finance with debt. 
B)  the benefits may be shared with the bondholders. 
C)  no cash is available for dividends. 
D)  there is no interest tax shield associated with equity. 
A)  they prefer to finance with debt. 
B)  the benefits may be shared with the bondholders. 
C)  no cash is available for dividends. 
D)  there is no interest tax shield associated with equity.

Exam 16: Debt Policy

MM's proposition I,or the debt-irrelevance proposition,states that the value of a firm is unaffected by its capital structure.

A decrease in the possible range of percentage stock returns can be achieved by:

According to MM II,if the expected return on assets decreases,what happens to the expected return on equity?

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

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%?

Debt finance does not affect the operating risk but it does add financial risk.

When debt is risky under MM II:

Financial slack means having ready access to cash or debt financing.

What is the return on equity for a firm with 15% return on assets,10% return on debt,and a .75 debt-equity ratio?

Does firm value increase when more debt is used?

MM proposition I states that a firm's value is unaffected by its:

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

What is meant by investors being able "to undo" the effects of corporate restructuring? Investors:

Which of the following is a safe assumption for a firm in which the PV of the tax shield is approximately equal to the costs of financial distress?

What is the amount of the annual interest tax shield for a firm with $3 million in debt that pays 12% interest if the firm is in the 35% tax bracket?

When there are no taxes and capital markets function well,the market value of a company does not depend on its capital structure.

The present value of the costs of financial distress increases with increases in the debt ratio because the:

Which of the following statements is false regarding MM's proposition I?

A firm is currently expected to develop $2 EPS when operating income equals $4 million and interest expense equals $2 million.How low can operating income drop before EPS are reduced by half,to $1? Ignore taxes.

Firms facing financial distress may pass up positive-NPV projects rather than commit new equity because:

Goals and Governance of the Corporation

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

How Corporations Raise Venture Capital and Issue Securities

Payout Policy

Long-Term Financial Planning

Short-Term Financial Planning

Risk, Return, and Capital Budgeting

Mergers, Acquisitions, and Corporate Control

International Financial Management

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Risk Management

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