Question 1

The direct costs of bankruptcy are estimated to be far greater, as a percent of assets, than the indirect costs of bankruptcy.

Accepted Answer

A) True 
 B)False

Question 2

Which of the following statements is FALSE assuming a perfect market?

Accepted Answer

A)  The unlevered beta measures the market risk of a firm's business activities, ignoring any additional risk due to leverage. 
B)  If a firm holds $1 in cash and has $1 of risk-free debt, then the interest earned on the cash will equal the interest paid on the debt. The cash flows from each source cancel each other, just as if the firm held no cash and no debt. 
C)  The unlevered beta measures the market risk of a firm without leverage, which is equivalent to the beta of the firm's assets. 
D)  As the amount of debt decreases, the debt becomes riskier because there is a chance the firm will default. 
A)  The unlevered beta measures the market risk of a firm's business activities, ignoring any additional risk due to leverage. 
B)  If a firm holds $1 in cash and has $1 of risk-free debt, then the interest earned on the cash will equal the interest paid on the debt. The cash flows from each source cancel each other, just as if the firm held no cash and no debt. 
C)  The unlevered beta measures the market risk of a firm without leverage, which is equivalent to the beta of the firm's assets. 
D)  As the amount of debt decreases, the debt becomes riskier because there is a chance the firm will default.

Question 3

According to researchers Modigliani and Miller, with perfect capital markets, the total value of a firm should not depend on its capital structure.

Accepted Answer

A) True 
 B)False

Question 4

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. What is the value of the company if the demand is as expected?

Accepted Answer

A)  $23,148.15 
B)  $32,407.40 
C)  $41,666.67 
D)  Cannot be determined with the information given. 
A)  $23,148.15 
B)  $32,407.40 
C)  $41,666.67 
D)  Cannot be determined with the information given.

Question 5

Which of the following statements is FALSE?

Accepted Answer

A)  The levered equity return equals the unlevered return plus an extra "kick" due to leverage. 
B)  By holding a portfolio of a firm's equity and its debt, we can replicate the cash flows from holding its levered equity. 
C)  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 market value debt-equity ratio. 
D)  If a firm is unlevered, all of the free cash flows generated by its assets are available to be paid out to its equity holders. 
A)  The levered equity return equals the unlevered return plus an extra "kick" due to leverage. 
B)  By holding a portfolio of a firm's equity and its debt, we can replicate the cash flows from holding its levered equity. 
C)  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 market value debt-equity ratio. 
D)  If a firm is unlevered, all of the free cash flows generated by its assets are available to be paid out to its equity holders.

Question 6

The E in the equation above represents ________.

Accepted Answer

A)  the value of the firm's equity 
B)  the value of the firm's debt 
C)  the value of the firm's unlevered equity 
D)  the market value of the firm's assets 
A)  the value of the firm's equity 
B)  the value of the firm's debt 
C)  the value of the firm's unlevered equity 
D)  the market value of the firm's assets

Question 7

A firm has a market value of equity of $40,000. It borrows $8000 at 7%. If the unlevered cost of equity is 16%, what is the firm's cost of equity capital?

Accepted Answer

A)  8.9% 
B)  21.4% 
C)  17.8% 
D)  24.9% 
A)  8.9% 
B)  21.4% 
C)  17.8% 
D)  24.9%

Question 8

Firms in industries such as real estate tend to have ________ distress costs because of a large proportion of tangible assets.

Accepted Answer

A)  high 
B)  low 
C)  unexpected 
D)  varying 
A)  high 
B)  low 
C)  unexpected 
D)  varying

Question 9

Which of the following statements is FALSE?

Accepted Answer

A)  When a firm borrows significant money to repurchase shares or pay a large cash dividend, the transaction is called a leveraged recapitalization. 
B)  MM Proposition I applies to capital structure decisions made at any time during the life of a firm. 
C)  By choosing positive-NPV projects that are worth more than their initial investment, a firm can enhance its value. 
D)  The choice of capital structure does not change the value of a firm if the cost of equity is higher than the cost of debt. 
A)  When a firm borrows significant money to repurchase shares or pay a large cash dividend, the transaction is called a leveraged recapitalization. 
B)  MM Proposition I applies to capital structure decisions made at any time during the life of a firm. 
C)  By choosing positive-NPV projects that are worth more than their initial investment, a firm can enhance its value. 
D)  The choice of capital structure does not change the value of a firm if the cost of equity is higher than the cost of debt.

Question 10

One of the factors that determine the present value (PV) of financial distress costs is ________.

Accepted Answer

A)  costs of unpaid interest arrears 
B)  loss of dividend payments 
C)  probability of financial distress 
D)  employee compensation 
A)  costs of unpaid interest arrears 
B)  loss of dividend payments 
C)  probability of financial distress 
D)  employee compensation

Question 11

A project will give a one-time cash flow of $22,000 after one year. If the project risk requires a return of 11%, what is the levered value of the firm with perfect capital markets?

Accepted Answer

A)  $15,855.86 
B)  $19,819.82 
C)  $23,783.78 
D)  more information needed 
A)  $15,855.86 
B)  $19,819.82 
C)  $23,783.78 
D)  more information needed

Question 12

As the level of debt increases the tax benefits of debt increase until ________.

Accepted Answer

A)  interest costs exceed dividend payments 
B)  tax shield benefit exceeds distress costs 
C)  raw material costs exceed dividend payments 
D)  employee costs exceed interest expense 
A)  interest costs exceed dividend payments 
B)  tax shield benefit exceeds distress costs 
C)  raw material costs exceed dividend payments 
D)  employee costs exceed interest expense

Question 13

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

Accepted Answer

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

Question 14

Equity in a firm with debt is called ________.

Accepted Answer

A)  levered equity 
B)  risk-free equity 
C)  unlevered equity 
D)  preferred equity 
A)  levered equity 
B)  risk-free equity 
C)  unlevered equity 
D)  preferred equity

Question 15

Aside from direct costs of bankruptcy, a firm may also incur other indirect costs such as ________.

Accepted Answer

A)  loss of customers and loss of suppliers 
B)  loss of interest receipts 
C)  loss of dividend receipts 
D)  increase in raw material costs 
A)  loss of customers and loss of suppliers 
B)  loss of interest receipts 
C)  loss of dividend receipts 
D)  increase in raw material costs

Question 16

A financial manager makes a choice of the amount and source of capital based on how the choice will impact the ________.

Accepted Answer

A)  revenue 
B)  face value of bonds 
C)  depreciation 
D)  firm value 
A)  revenue 
B)  face value of bonds 
C)  depreciation 
D)  firm value

Question 17

When a firm's investment decisions have different consequences for the value of equity and the value of debt, managers may take actions ________.

Accepted Answer

A)  to increase debt values 
B)  to decrease costs of distress 
C)  that benefit shareholders at the expense of debt holders 
D)  to reduce fixed costs 
A)  to increase debt values 
B)  to decrease costs of distress 
C)  that benefit shareholders at the expense of debt holders 
D)  to reduce fixed costs

Question 18

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%.
-According to MM Proposition I, the stock price for Firm X is closest to ________.

Accepted Answer

A)  $8.00 
B)  $24.00 
C)  $6.00 
D)  $12.00 
A)  $8.00 
B)  $24.00 
C)  $6.00 
D)  $12.00

Question 19

A firm requires an investment of $30,000 and borrows $7500 at 7%. If the return on equity is 18%, what is the firm's pretax WACC?

Accepted Answer

A)  7.6% 
B)  18.3% 
C)  21.4% 
D)  15.3% 
A)  7.6% 
B)  18.3% 
C)  21.4% 
D)  15.3%

Question 20

The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its ________.

Accepted Answer

A)  capital structure 
B)  dividend expense 
C)  retained earnings 
D)  paid out capital 
A)  capital structure 
B)  dividend expense 
C)  retained earnings 
D)  paid out capital

Exam 16: Capital Structure

The direct costs of bankruptcy are estimated to be far greater, as a percent of assets, than the indirect costs of bankruptcy.

Which of the following statements is FALSE assuming a perfect market?

According to researchers Modigliani and Miller, with perfect capital markets, the total value of a firm should not depend on its capital structure.

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. What is the value of the company if the demand is as expected?

Which of the following statements is FALSE?

The E in the equation above represents ________.

A firm has a market value of equity of $40,000. It borrows $8000 at 7%. If the unlevered cost of equity is 16%, what is the firm's cost of equity capital?

Firms in industries such as real estate tend to have ________ distress costs because of a large proportion of tangible assets.

Which of the following statements is FALSE?

One of the factors that determine the present value (PV) of financial distress costs is ________.

A project will give a one-time cash flow of $22,000 after one year. If the project risk requires a return of 11%, what is the levered value of the firm with perfect capital markets?

As the level of debt increases the tax benefits of debt increase until ________.

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

Equity in a firm with debt is called ________.

Aside from direct costs of bankruptcy, a firm may also incur other indirect costs such as ________.

A financial manager makes a choice of the amount and source of capital based on how the choice will impact the ________.

When a firm's investment decisions have different consequences for the value of equity and the value of debt, managers may take actions ________.

A firm requires an investment of $30,000 and borrows $7500 at 7%. If the return on equity is 18%, what is the firm's pretax WACC?

The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its ________.

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

Time Value of Money: an Introduction

Time Value of Money: Valuing Cash Flow Streams

Interest Rates

Bonds

Stock Valuation

Investment Decision Rules

Fundamentals of Capital Budgeting

Stock Valuation: a Second Look

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

The Cost of Capital

Raising Equity Capital

Debt Financing

Payout Policy

Financial Modeling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Option Applications and Corporate Finance

Mergers and Acquisitions

International Corporate Finance

Leasing

Insurance and Risk Management

Corporate Governance

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