Question 1

A bankruptcy process is complex, time-consuming, and costly. The costs of bankruptcy include ________.

Accepted Answer

A)  dividend payments 
B)  raw material costs 
C)  costs of hiring legal experts, appraisers, and auctioneers 
D)  taxes 
A)  dividend payments 
B)  raw material costs 
C)  costs of hiring legal experts, appraisers, and auctioneers 
D)  taxes

Question 2

The Tradeoff Theory suggests that ________.

Accepted Answer

A)  a firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress 
B)  with higher costs of financial distress, it is optimal for a firm to choose higher leverage 
C)  differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries 
D)  there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield 
A)  a firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress 
B)  with higher costs of financial distress, it is optimal for a firm to choose higher leverage 
C)  differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries 
D)  there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield

Question 3

A firm requires an investment of $60,000 and borrows $20,000 at 8%. If the return on equity is 14% and the tax rate is 30%, what is the firm's WACC?

Accepted Answer

A)  11.2% 
B)  9.0% 
C)  13.4% 
D)  22.4% 
A)  11.2% 
B)  9.0% 
C)  13.4% 
D)  22.4%

Question 4

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%.
-Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as Firm X. You have $5,000 of your own money to invest and you plan on buying Firm Y stock. Using homemade leverage you borrow enough in your margin account so that the payoff of your margined purchase of Firm Y stock will be the same as a $5,000 investment in Firm X stock. The number of shares of Firm Y stock you purchased is closest to ________.

Accepted Answer

A)  425 
B)  1,650 
C)  2,000 
D)  825 
A)  425 
B)  1,650 
C)  2,000 
D)  825

Question 5

The U in the equation above represents ________.

Accepted Answer

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

Question 6

Investment cash flows are independent of financing choices in a ________.

Accepted Answer

A)  market with frictions 
B)  perfect capital market 
C)  setting with frictions in investment returns 
D)  firm with leverage 
A)  market with frictions 
B)  perfect capital market 
C)  setting with frictions in investment returns 
D)  firm with leverage

Question 7

The A in the equation above represents ________.

Accepted Answer

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

Question 8

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 neither 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 (PV) 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 neither 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 (PV) of their future cash flows.

Question 9

It is not correct to discount the cash flows of a levered firm with the cost of equity of the unlevered firm because ________.

Accepted Answer

A)  leverage decreases the risk of equity of the firm 
B)  leverage changes the unlevered cost of equity 
C)  leverage increases the risk of the equity of the firm 
D)  cost of debt decreases in this setting 
A)  leverage decreases the risk of equity of the firm 
B)  leverage changes the unlevered cost of equity 
C)  leverage increases the risk of the equity of the firm 
D)  cost of debt decreases in this setting

Question 10

In a setting where there is no risk that a firm will default, leverage ________ the risk of equity.

Accepted Answer

A)  increases 
B)  decreases 
C)  does not change 
D)  cannot say for sure 
A)  increases 
B)  decreases 
C)  does not change 
D)  cannot say for sure

Question 11

Which of the following statements is FALSE?

Accepted Answer

A)  As long as investors can borrow or lend at the same interest rate as a firm, homemade leverage is a perfect substitute for the use of leverage by the firm. 
B)  When investors use leverage in their own portfolios to adjust the leverage choice made by a firm, we say that they are using homemade leverage. 
C)  The value of a firm is determined by the present value (PV) of the cash flows from its current and future investments. 
D)  The investor can re-create the payoffs of unlevered equity by borrowing and using the proceeds to purchase the equity of a firm. 
A)  As long as investors can borrow or lend at the same interest rate as a firm, homemade leverage is a perfect substitute for the use of leverage by the firm. 
B)  When investors use leverage in their own portfolios to adjust the leverage choice made by a firm, we say that they are using homemade leverage. 
C)  The value of a firm is determined by the present value (PV) of the cash flows from its current and future investments. 
D)  The investor can re-create the payoffs of unlevered equity by borrowing and using the proceeds to purchase the equity of a firm.

Question 12

Which of the following statements is FALSE?

Accepted Answer

A)  If we can identify a comparison firm whose assets have the same risk as the project being evaluated, and if the comparison firm is levered, then we can use its cost of debt as the cost of capital for the project. 
B)  We can calculate the cost of capital of a firm's assets by computing the weighted average of the firm's equity and debt cost of capital, which we refer to as the firm's weighted average cost of capital. 
C)  The portfolio of a firm's equity and debt replicates the returns we would earn if the firm were unlevered. 
D)  When evaluating any potential investment project, we must use a discount rate that is appropriate given the risk of the project's free cash flow. 
A)  If we can identify a comparison firm whose assets have the same risk as the project being evaluated, and if the comparison firm is levered, then we can use its cost of debt as the cost of capital for the project. 
B)  We can calculate the cost of capital of a firm's assets by computing the weighted average of the firm's equity and debt cost of capital, which we refer to as the firm's weighted average cost of capital. 
C)  The portfolio of a firm's equity and debt replicates the returns we would earn if the firm were unlevered. 
D)  When evaluating any potential investment project, we must use a discount rate that is appropriate given the risk of the project's free cash flow.

Question 13

The tradeoff theory of optimal capital structure weighs the benefits of debt against the costs of ________.

Accepted Answer

A)  financial distress 
B)  interest payments 
C)  dividend reinvestment 
D)  input factors 
A)  financial distress 
B)  interest payments 
C)  dividend reinvestment 
D)  input factors

Question 14

Managerial entrenchment means that managers ________ and run the firm for their own best interests.

Accepted Answer

A)  may face little threat of being fired 
B)  are overseen by equity holders 
C)  are overseen by debt holders 
D)  are well compensated 
A)  may face little threat of being fired 
B)  are overseen by equity holders 
C)  are overseen by debt holders 
D)  are well compensated

Question 15

Leverage can ________ a firm's expected earnings per share, but does not necessarily increase the share price.

Accepted Answer

A)  decrease 
B)  dilute 
C)  increase 
D)  never change 
A)  decrease 
B)  dilute 
C)  increase 
D)  never change

Question 16

A firm requires an investment of $36,000 and borrows $12,000 at 9%. If the return on equity is 20%, what is the firm's pretax WACC?

Accepted Answer

A)  8.2% 
B)  19.6% 
C)  16.3% 
D)  22.9% 
A)  8.2% 
B)  19.6% 
C)  16.3% 
D)  22.9%

Question 17

The following equation:
X =  
RE +  
RD
Can be used to calculate all of the following EXCEPT ________.

Accepted Answer

A)  the cost of capital for a firm's assets 
B)  the levered cost of preferred equity 
C)  the unlevered cost of equity 
D)  the weighted average cost of capital 
A)  the cost of capital for a firm's assets 
B)  the levered cost of preferred equity 
C)  the unlevered cost of equity 
D)  the weighted average cost of capital

Question 18

After the repurchase, how many shares will Luther have outstanding?

Accepted Answer

A)  0.75 billion 
B)  1.0 billion 
C)  1.1 billion 
D)  1.2 billion 
A)  0.75 billion 
B)  1.0 billion 
C)  1.1 billion 
D)  1.2 billion

Question 19

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%.
-Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as Firm X. You have $5,000 of your own money to invest and you plan on buying Firm X 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 Firm Y stock. The number of shares of Firm X stock you purchased is closest to ________.

Accepted Answer

A)  100 
B)  417 
C)  1,650 
D)  825 
A)  100 
B)  417 
C)  1,650 
D)  825

Question 20

A firm will give a one-time cash flow of $24,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?

Accepted Answer

A)  $17,454.55 
B)  $26,181.82 
C)  $21,818.18 
D)  more information needed 
A)  $17,454.55 
B)  $26,181.82 
C)  $21,818.18 
D)  more information needed

Exam 16: Capital Structure

A bankruptcy process is complex, time-consuming, and costly. The costs of bankruptcy include ________.

The Tradeoff Theory suggests that ________.

A firm requires an investment of $60,000 and borrows $20,000 at 8%. If the return on equity is 14% and the tax rate is 30%, what is the firm's WACC?

The U in the equation above represents ________.

Investment cash flows are independent of financing choices in a ________.

The A in the equation above represents ________.

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

It is not correct to discount the cash flows of a levered firm with the cost of equity of the unlevered firm because ________.

In a setting where there is no risk that a firm will default, leverage ________ the risk of equity.

Which of the following statements is FALSE?

Which of the following statements is FALSE?

The tradeoff theory of optimal capital structure weighs the benefits of debt against the costs of ________.

Managerial entrenchment means that managers ________ and run the firm for their own best interests.

Leverage can ________ a firm's expected earnings per share, but does not necessarily increase the share price.

A firm requires an investment of $36,000 and borrows $12,000 at 9%. If the return on equity is 20%, what is the firm's pretax WACC?

The following equation: X = RE + RD Can be used to calculate all of the following EXCEPT ________.

After the repurchase, how many shares will Luther have outstanding?

A firm will give a one-time cash flow of $24,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?

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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