Question 1

Consider the following equation: βU =   βE +   βD
The term   in the equation is

Accepted Answer

A)  the required return on the firm's equity. 
B)  the same as the beta of the firm's assets. 
C)  equal to zero if the firm's debt is riskless. 
D)  the proportion of the firm financed with equity. 
A)  the required return on the firm's equity. 
B)  the same as the beta of the firm's assets. 
C)  equal to zero if the firm's debt is riskless. 
D)  the proportion of the firm financed with equity.

Question 2

Consider the following equation: βU =   βE +   βD
The term βU in the equation is?

Accepted Answer

A)  the same as the beta of the firm's assets. 
B)  the required return on the firm's equity. 
C)  the proportion of the firm financed with equity. 
D)  equal to zero if the firm's debt is riskless. 
A)  the same as the beta of the firm's assets. 
B)  the required return on the firm's equity. 
C)  the proportion of the firm financed with equity. 
D)  equal to zero if the firm's debt is riskless.

Question 3

With perfect capital markets,what is the market price per share of Luther's stock after the share repurchase?

Accepted Answer

A)  $25 
B)  $24 
C)  $15 
D)  $20 
A)  $25 
B)  $24 
C)  $15 
D)  $20

Question 4

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 Modigliani and Miller's first proposition 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. 
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 Modigliani and Miller's first proposition 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.

Question 5

Use the information for the question(s) below.
Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00.
-Prior to any borrowing and share repurchase,RC's EPS is closest to:

Accepted Answer

A)  $0.60 
B)  $1.00 
C)  $1.20 
D)  $0.50 
A)  $0.60 
B)  $1.00 
C)  $1.20 
D)  $0.50

Question 6

With perfect capital markets,a firm's WACC is ________ its capital structure and is ________ its equity cost of capital if it is unlevered,which matches the cost of capital of its assets.

Accepted Answer

A)  independent of; equal to 
B)  dependent on; equal to 
C)  independent of; greater than 
D)  independent of; smaller than 
A)  independent of; equal to 
B)  dependent on; equal to 
C)  independent of; greater than 
D)  independent of; smaller than

Question 7

Use the information for the question(s) below.
You are evaluating a new project and need an estimate for your project's beta. You have identified the following information about three firms with comparable projects:
  
-The unlevered beta for Nod is closest to:

Accepted Answer

A)  1.00 
B)  0.90 
C)  0.95 
D)  1.10 
A)  1.00 
B)  0.90 
C)  0.95 
D)  1.10

Question 8

Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors, and has already announced the stock repurchase plan. Currently Luther is an all equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share.
-The market value of Luther's non-cash assets is closest to:

Accepted Answer

A)  $20 billion 
B)  $19 billion 
C)  $25 billion 
D)  $24 billion 
A)  $20 billion 
B)  $19 billion 
C)  $25 billion 
D)  $24 billion

Question 9

Which of the following is NOT one of Modigliani and Miller's set of conditions referred to as perfect capital markets?

Accepted Answer

A)  All investors hold the efficient portfolio of assets. 
B)  There are no taxes, transaction costs, or issuance costs associated with security trading. 
C)  A firm's financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them. 
D)  Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows. 
A)  All investors hold the efficient portfolio of assets. 
B)  There are no taxes, transaction costs, or issuance costs associated with security trading. 
C)  A firm's financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them. 
D)  Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows.

Question 10

Use the information for the question(s) below.
Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars 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 With.You have $5,000 of your own money to invest and you plan on buying With stock.Using homemade (un)leverage you invest enough at the risk-free rate so that the payoff of your account will be the same as a $5,000 investment in Without stock.The number of shares of With stock you purchased is closest to:

Accepted Answer

A)  100 
B)  425 
C)  1,650 
D)  825 
A)  100 
B)  425 
C)  1,650 
D)  825

Question 11

Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.
-Suppose that you borrow only $45,000 in financing the project.According to MM proposition II,calculate the firm's equity cost of capital.

Accepted Answer

PV(equity cash flows - unlever

Question 12

Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free rate and issues new equity to cover the remainder.In this situation,the cost of capital for the firm's levered equity is closest to:

Accepted Answer

A)  23% 
B)  25% 
C)  15% 
D)  18% 
A)  23% 
B)  25% 
C)  15% 
D)  18%

Question 13

When corporations raise funds from outside investors,they must choose which type of security to issue.The most common choices are financing through

Accepted Answer

A)  equity alone. 
B)  debt alone. 
C)  a combination of debt and equity. 
D)  Both A and C 
A)  equity alone. 
B)  debt alone. 
C)  a combination of debt and equity. 
D)  Both A and C

Question 14

Use the information for the question(s) below.
Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00.
-Which of the following statements is false?

Accepted Answer

A)  Since the publication of their original paper, Modigliani and Miller's ideas have had only limited influence on finance research and practice. 
B)  Proposition I was one of the first arguments to show that the Law of One Price could have strong implications for security prices and firm values in a competitive market; it marks the beginning of the modern theory of corporate finance. 
C)  The conservation of value principle extends far beyond questions of debt versus equity or even capital structure. 
D)  The conservation of value principle for financial markets states that with perfect capital markets, financial transactions neither add nor destroy value, but instead represent a repackaging of risk (and therefore return). 
A)  Since the publication of their original paper, Modigliani and Miller's ideas have had only limited influence on finance research and practice. 
B)  Proposition I was one of the first arguments to show that the Law of One Price could have strong implications for security prices and firm values in a competitive market; it marks the beginning of the modern theory of corporate finance. 
C)  The conservation of value principle extends far beyond questions of debt versus equity or even capital structure. 
D)  The conservation of value principle for financial markets states that with perfect capital markets, financial transactions neither add nor destroy value, but instead represent a repackaging of risk (and therefore return).

Question 15

Which of the following statements is false?

Accepted Answer

A)  With no debt, the WACC is equal to the unlevered equity cost of capital. 
B)  With perfect capital markets, a firm's WACC is dependent on its capital structure and is equal to its equity cost of capital only if the firm is unlevered. 
C)  As the firm borrows at the low cost of capital for debt, its equity cost of capital rises, but the net effect is that the firm's WACC is unchanged. 
D)  Although debt has a lower cost of capital than equity, leverage does not lower a firm's WACC. 
A)  With no debt, the WACC is equal to the unlevered equity cost of capital. 
B)  With perfect capital markets, a firm's WACC is dependent on its capital structure and is equal to its equity cost of capital only if the firm is unlevered. 
C)  As the firm borrows at the low cost of capital for debt, its equity cost of capital rises, but the net effect is that the firm's WACC is unchanged. 
D)  Although debt has a lower cost of capital than equity, leverage does not lower a firm's WACC.

Question 16

Use the information for the question(s) below.
Rockwood Enterprises is currently an all equity firm and has just announced plans to expand their current business. In order to fund this expansion, Rockwood will need to raise $100 million in new capital. After the expansion, Rockwood is expected to produce earnings before interest and taxes of $50 million per year in perpetuity. Rockwood has already announced the planned expansion, but has not yet determined how best to fund the expansion. Rockwood currently has 16 million shares outstanding and following the expansion announcement these shares are trading at $25 per share. Rockwood has the ability to borrow at a rate of 5% or to issue new equity at $25 per share.
-If Rockwood finances their expansion by issuing new stock,what will Rockwood's cost of equity capital be?

Accepted Answer

A)  12% 
B)  15% 
C)  8% 
D)  10% 
A)  12% 
B)  15% 
C)  8% 
D)  10%

Question 17

With perfect capital markets,leverage has ________ effect on firm value or the firm's overall cost of capital.

Accepted Answer

A)  zero 
B)  a positive 
C)  a negative 
D)  an unpredictable 
A)  zero 
B)  a positive 
C)  a negative 
D)  an unpredictable

Question 18

Use the information for the question(s) below.
Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00.
-Following the borrowing of $12 million and the subsequent share repurchase,the expected earnings per share for RC is closest to:

Accepted Answer

A)  $1.32 
B)  $1.44 
C)  $1.40 
D)  $1.20 
A)  $1.32 
B)  $1.44 
C)  $1.40 
D)  $1.20

Question 19

Use the information for the question(s) below.
Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00.
-Prior to any borrowing and share repurchase,the equity cost of capital for RC is closest to:

Accepted Answer

A)  20% 
B)  10% 
C)  12% 
D)  9% 
A)  20% 
B)  10% 
C)  12% 
D)  9%

Question 20

Which of the following statements is false?

Accepted Answer

A)  The money taken in by the firm as a result of the share issue exactly offsets the dilution of the shares. 
B)  Most analysts prefer to use performance measures and valuation multiples that are based on the firm's earnings before interest has been deducted. 
C)  The fact that the firm's earnings per share and price-earnings ratio are affected by leverage implies that we can always reliably compare these measures across firms with different capital structures. 
D)  In general, as long as the firm sells the new shares of equity at a fair price, there will be no gain or loss to shareholders associated with the equity issue itself. 
A)  The money taken in by the firm as a result of the share issue exactly offsets the dilution of the shares. 
B)  Most analysts prefer to use performance measures and valuation multiples that are based on the firm's earnings before interest has been deducted. 
C)  The fact that the firm's earnings per share and price-earnings ratio are affected by leverage implies that we can always reliably compare these measures across firms with different capital structures. 
D)  In general, as long as the firm sells the new shares of equity at a fair price, there will be no gain or loss to shareholders associated with the equity issue itself.

Exam 17: Capital Structure in a Perfect Market

Consider the following equation: βU = βE + βD The term in the equation is

Consider the following equation: βU = βE + βD The term βU in the equation is?

With perfect capital markets,what is the market price per share of Luther's stock after the share repurchase?

Which of the following statements is false?

With perfect capital markets,a firm's WACC is ________ its capital structure and is ________ its equity cost of capital if it is unlevered,which matches the cost of capital of its assets.

Use the information for the question(s) below. You are evaluating a new project and need an estimate for your project's beta. You have identified the following information about three firms with comparable projects: -The unlevered beta for Nod is closest to:

Which of the following is NOT one of Modigliani and Miller's set of conditions referred to as perfect capital markets?

Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free rate and issues new equity to cover the remainder.In this situation,the cost of capital for the firm's levered equity is closest to:

When corporations raise funds from outside investors,they must choose which type of security to issue.The most common choices are financing through

Which of the following statements is false?

With perfect capital markets,leverage has ________ effect on firm value or the firm's overall cost of capital.

Which of the following statements is false?

The Corporation

Introduction to Financial Statement Analysis

Arbitrage and Financial Decision Making

The Time Value of Money

Interest Rates

Valuing Bonds

Valuing Stocks

Investment Decision Rules

Fundamentals of Capital Budgeting

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behaviour and Capital Market Efficiency

Financial Options

Option Valuation

Real Options

Debt and Taxes

Financial Distress, managerial Incentives, and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modelling: a Case Study

The Mechanics of Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters

Consider the following equation: β_U = β_E + β_D The term in the equation is

Consider the following equation: β_U = β_E + β_D The term β_U in the equation is?

With perfect capital markets,a firm's WACC is its capital structure and is its equity cost of capital if it is unlevered,which matches the cost of capital of its assets.