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In a perfect world of no taxes,which statement regarding MM propositions is true?


A) According to proposition I, a firm is able to find its optimal capital structure.
B) Proposition II implies that an increase in leverage raises the risk of equity and thereby the required return on equity.
C) According to proposition II, changes in the capital mix of a firm will not affect the debt and equity values of the firm.
D) Proposition I states that the total firm value critically depends on capital structure.

E) None of the above
F) A) and B)

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Which of the following statements is correct?


A) If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted trade-off theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.
B) A change in the personal tax rate should not affect firms' capital structure decisions.
C) "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and factors such as sales variability, cost variability, and operating leverage.
D) The optimal capital structure is the one that simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS.

E) B) and C)
F) B) and D)

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Suppose a firm has a debt-to-equity ratio (D/E) of 0.5,return on assets of 22%,and return on debt of 15%.What will be its return on equity?


A) 24.33%
B) 15.00%
C) 20.00%
D) 21.17%

E) C) and D)
F) B) and C)

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Given that its debt is $500,000,its leverage value is $587,500.a tax rate of 30%,a cost of debt (unleveraged) of 16%,and a cost of debt of 12%,what is this firm's cost of equity?


A) 23.3%
B) 25.9%
C) 28.8%
D) 32.0%

E) C) and D)
F) All of the above

Correct Answer

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The presence of personal taxes completely eliminates the benefits of debt financing.

A) True
B) False

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Which of the following statements is correct regarding interest tax shields?


A) The benefits of interest tax shields are captured only by debtholders.
B) The benefits of interest tax shields are captured only by equity investors.
C) The benefits of interest tax shields are captured only by CRA.
D) The benefits of interest tax shields are captured by both debt and equity investors.

E) None of the above
F) A) and B)

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If debt financing is used,which of the following is correct?


A) The percentage change in sales will be greater than the percentage change in EBIT, which in turn will be greater than the percentage change in net income.
B) The percentage change in net operating income will be equal to a given percentage change in net income.
C) The percentage change in net income relative to the percentage change in net operating income will depend on the interest rate charged on debt.
D) The percentage change in net income will be greater than the percentage change in net operating income.

E) None of the above
F) C) and D)

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When a firm borrows money,which types of leverage is it using?


A) financial leverage
B) operating leverage
C) shareholder leverage
D) combined operating leverage

E) None of the above
F) C) and D)

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What is the major contribution of the Miller model?


A) It demonstrates that personal taxes decrease the value of using corporate debt.
B) It demonstrates that financial distress and agency costs reduce the value of using corporate debt.
C) It demonstrates that equity costs increase with financial leverage.
D) It demonstrates that debt costs increase with financial leverage.

E) All of the above
F) C) and D)

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In a perfect world of no taxes,what happens if the weighted average cost of capital (WACC) is unaffected by the capital structure?


A) MM proposition I holds.
B) MM proposition II holds.
C) SML is positively sloped.
D) SML is negatively sloped.

E) B) and D)
F) B) and C)

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A group of venture investors is considering putting money into Lemma Books,which wants to produce a new reader for electronic books.The variable cost per unit is estimated at $250,the sales price would be set at twice the VC/unit,fixed costs are estimated at $750,000,and the investors will put up the funds if the project is likely to have an operating income of $500,000 or more.What sales volume would be required in order to meet this profit goal?


A) 4,513
B) 4,750
C) 5,000
D) 5,250

E) A) and B)
F) C) and D)

Correct Answer

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It is possible that two firms could have identical financial and operating leverage yet have different degrees of risk as measured by the variability of EPS.

A) True
B) False

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Suppose a firm increases the operating leverage used to produce a given quantity of output.What will this normally lead to?


A) a decrease in the standard deviation of its expected EBIT
B) a decrease in its business risk
C) a decrease in the variability of its expected EPS
D) a reduction in its fixed assets turnover ratio

E) A) and C)
F) A) and B)

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The bankruptcy risk produces an ambiguous effect on agency costs.

A) True
B) False

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Ang Enterprises has a levered beta of 1.10,its capital structure consists of 40% debt and 60% equity,and its tax rate is 40%.What would Ang's beta be if it used no debt,i.e.,what is its unlevered beta?


A) 0.67
B) 0.71
C) 0.75
D) 0.79

E) C) and D)
F) A) and B)

Correct Answer

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Senbet Ventures is considering starting a new company to produce stereos.The sales price would be set at 1.5 times the variable cost per unit; the VC/unit is estimated to be $2.50; and fixed costs are estimated at $120,000.What sales volume would be required in order to break even,i.e.,to have an EBIT of zero for the stereo business?


A) 86,640
B) 91,200
C) 96,000
D) 100,800

E) A) and B)
F) B) and C)

Correct Answer

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Which of the following statements is correct regarding financial risk?


A) Financial risk refers to the extra risk shareholders bear as a result of using preferred shares as compared with the risk they would bear if new debt were used.
B) Financial risk refers to the reduced risk shareholders bear as a result of using debt as compared with the risk they would bear if no debt were used.
C) Financial risk refers to the extra risk shareholders bear as a result of using accounts payable as compared with the risk they would bear if new long-term debt were issued.
D) Financial risk refers to the extra risk shareholders bear as a result of using debt as compared with the risk they would bear if no debt were used.

E) None of the above
F) A) and B)

Correct Answer

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Based on the information below,what is Ezzel Enterprises' optimal capital structure?


A) Debt = 40%; Equity = 60%; EPS = $2.95; Common share price = $26.50
B) Debt = 50%; Equity = 50%; EPS = $3.05; Common share price = $28.90
C) Debt = 60%; Equity = 40%; EPS = $3.18; Common share price = $31.20
D) Debt = 80%; Equity = 20%; EPS = $3.42; Common share price = $30.40

E) A) and B)
F) All of the above

Correct Answer

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Which statement best describes optimal capital structure?


A) As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.
B) The optimal capital structure simultaneously maximizes EPS and minimizes the WACC.
C) The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC.
D) The optimal capital structure simultaneously maximizes common share price and minimizes the WACC.

E) All of the above
F) C) and D)

Correct Answer

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According to MM,in a world without taxes,the optimal capital structure for a firm is approximately 100% debt financing.

A) True
B) False

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