Question 1

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

Accepted Answer

A)   The tax shields should be discounted at the cost of debt.
B)   The value of a growing tax shield is greater than the value of a constant tax shield.
C)   For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax)  assumptions.
D)   For a given D/S, the WACC is greater than the WACC under MM's original (with tax)  assumptions.
E)   The total value of the firm increases with the amount of debt.F) B) and D)
G) B) and E)

Question 2

In the MM extension with growth, the appropriate discount rate for the tax shield is the WACC.

Accepted Answer

A) True 
 B)False

Question 3

Trumbull, Inc., has total value (debt plus equity)  of $500 million and $200 million face value of 1-year zero coupon debt. The volatility ( σ\sigmaσ )  of Trumbull's total value is 0.60, and the risk-free rate is 5%. Assume that N(d1)  = 0.9720 and N(d2)  = 0.9050.
-What is the value (in millions)  of Trumbull's equity if it is viewed as an option?

Accepted Answer

A)   $228.77
B)   $254.19
C)   $282.43
D)   $313.81
E)   $345.19 F) A) and B)
G) A) and E)

Question 4

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Accepted Answer

A) True 
 B)False

Question 5

Gomez computer systems has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Gomez must reinvest 20% of its EBIT in net operating assets. Gomez has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%.
-According to the MM extension with growth, what is Gomez's unlevered value?

Accepted Answer

A)   $1,296,000
B)   $1,440,000
C)   $1,600,000
D)   $1,760,000
E)   $1,936,000F) A) and E)
G) B) and D)

Question 6

In the MM extension with growth, the appropriate discount rate for the tax shield is the unlevered cost of equity.

Accepted Answer

A) True 
 B)False

Question 7

When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.

Accepted Answer

A) True 
 B)False

Exam 26: Analysis of Capital Structure Theory

Correct Answer
verified

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Correct Answer
verified

In the MM extension with growth, the appropriate discount rate for the tax shield is the WACC.

Correct Answer
verified

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

Correct Answer
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In the MM extension with growth, the appropriate discount rate for the tax shield is the unlevered cost of equity.

Correct Answer
verified

When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.

Correct Answer
verified

Correct Answer
verified

Exam 26: Analysis of Capital Structure Theory

Correct AnswerverifiedShow Answer

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Correct AnswerverifiedShow Answer

In the MM extension with growth, the appropriate discount rate for the tax shield is the WACC.

Correct AnswerverifiedShow Answer

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

Correct AnswerverifiedShow Answer

In the MM extension with growth, the appropriate discount rate for the tax shield is the unlevered cost of equity.

Correct AnswerverifiedShow Answer

When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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