[財管] HW6 Capital structure

1. The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because: (A) debt is more risky than equity. (B)bankruptcy and its attendant costs is a disadvantage to debt. (C) debt is more expensive than equity (D) you can always borrow money form banks

2. Conflicts of interest between stockholders and bondholders are known as: (A)trustee costs. (B)financial distress costs. (C)dealer costs. (D)agency costs.

3. One of the agency cost is the incentive for managers to take large risks. When following this strategy, the firm will: (A)rank all projects and take the project which results in the highest expected value of the firm. (B)rank all projects and take the project which results in the highest expected value of the firm's bonds. (C)rank all projects and take the project which results in the highest expected value of the firm's stock. (D)always take the low risk project.

4. When graphing firm value against debt levels, the debt level that maximizes the value of the firm is the level where: (A) the increase in the present value of distress costs from an additional dollar of debt is greater than the increase in the present value of the debt tax shield.(B)the increase in the present value of distress costs from an additional dollar of debt is equal to the increase in the present value of the debt tax shield. (C)the increase in the present value of distress costs from an additional dollar of debt is less than the increase of the present value of the debt tax shield. (D) distress costs as well as debt tax shields are zero

5. When firms issue more debt, the tax shield on debt _____, the agency costs on debt (i.e., costs of financial distress) _____, and the agency costs on equity _____. (A) increases; increases; increases. (B) decreases; decreases; decreases. (C) increases; increases; decreases.(D)decreases; decreases; increases.

6. Which of the following predicts that capital structure has no impact on firm value? (A)Modigliani-Miller Proposition I (no taxes). (B)Modigliani-Miller Proposition I (with corporate taxes). (C)Miller's model (with corporate and personal taxes). (D)None of the above.

7. The Zercon Company has EBIT of $50,000 and market value debt of $100,000 outstanding with a 9% coupon rate. The cost of equity for an all equity firm would be 14%. Zercon has a 35% corporate tax rate. Determine the value of Zercon. (A) $267,142.9 (B) $35,000. (C) $232,142.9. (D) $332,142.9

8. The firm's capital structure refers to: (A)the way a firm invests its assets. (B)the amount of equity or capital in the firm. (C)the amount of dividends a firm pays. (D) the way in which a firm's assets are financed.

9. A general rule for managers to follow is to set the firms capital structure such that: (A)the firm's value is minimized. (B)the firm's value is maximized. (C)the firm's bondholders are made well off. (D)the firms suppliers of raw materials are satisfied.

10. An EBIT-Debt chart shows the trade-off between financing plans and: (A)risk associated with debt financing(B) the breakeven point . (C)the minimum EBIT to pay the debt financing. (D) the optimal debt level

11. Homemade leverage is a term used to describe: (A)a firm borrowing at the risk-free rate. (B)a firm skipping a dividend payment. (C)individuals borrowing on their own account to buy shares in an unlevered firm. (D)individuals lending on their own account to sell shares in a levered firm.

12. An EBIT-Debt chart shows the effect of financial leverage on the performance of the firm depends on: (A)the firm’s level of EBIT. (B)the rate of return on equity. (C)the current market value of the debt.(D)the rate of dividend growth.

13. MM Proposition II states that: (A)the expected return on equity is positively related to leverage. (B)the required return on equity is a linear function of the firm's debt to equity ratio. (C)the risk to equity increases with leverage. (D)all of the above.

14. A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes or other imperfections, its cost of equity capital with the new capital structure would be: (A) 9%. (B) 14%. (C)13%. (D) 10%.

15. In a world of no corporate taxes if the use of leverage does not change the value of the levered firm relative to the unlevered firm this is known as: (A)the conservation of energy principle. (B)MM Proposition I that leverage is invariant to market value. (C)MM Proposition II that the cost of equity is always constant. (D)MM Proposition I that the market value of the firm is invariant to the capital structure.

16. The reason that MM Proposition I does not hold in the presence of corporate taxation is because: (A)levered firms pay less taxes compared with identical unlevered firms. (B)bondholders require higher rates of return compared with stockholders. (C)earnings per share are no longer relevant with taxes. (D)dividends are no longer relevant with taxes.

17. If a firm is unlevered and has a cost of equity capital 9%, what would the cost of equity be if the firms became levered at 1.75. The expected cost of debt would be 7%.(A) 14.5%. (B)15.75 (C)16.0%. (D)12.5%.

18. MM Proposition I with corporate taxes states that: (A)capital structure can affect firm value. (B)by raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value. (C) firm value is maximized at an all debt capital structure. (D)all of the above.

19. A firm has zero debt in its capital structure. Its overall cost of capital is 8%. The firm is considering a new capital structure with 50% debt. The interest rate on the debt would be 5%. Assuming that the corporate tax rate is 40%, its cost of equity capital with the new capital structure would be? (A) 9.2%. (B) 9.8%. (C) 11%. (D) 8.9%.

20. A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If the corporate tax rate is .25, what would its cost of equity be if the debt-to-equity ratio were 0? (A)11.11%. (B) 12.57%. (C)13.33%. (D)16.00%.

Sol:

1. B

2. D

3. C

4. B

5. C

6. A

7. A V_U=50,000*(1-0.35)/0.14=232,142.9 V_L=V_U+100,000*0.35=267,142.9

8. D

9. B

10. D

11. C or D

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12. A

13. D

14. C 10+(10-8)*60/40=13

15. B

16. A

17. X 9+(9-7)*1.75=12.5

18. D

19. C ? 8+0.6*(3)=9.8

20. B 16=x+(x-8)*0.75 x=12.57