Question 1

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

Accepted Answer

A) True 
 B)False

Question 2

The major contribution of the Miller model is that it demonstrates that

Accepted Answer

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

Question 3

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

Accepted Answer

A) True 
 B)False

Question 4

(The following data apply to Problems 29 through 31. The problems MUST be kept together.) 
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 debt if its equity is viewed as an option?

Accepted Answer

A)   $167.57
B)   $186.19
C)   $204.81
D)   $225.29
E)   $247.82 F) B) and C)
G) A) and E)

Question 5

(The following data apply to Problems 26 through 28. The problems MUST be kept together.) 
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 the value of Gomez's tax shield?

Accepted Answer

A)   $156,385
B)   $164,616
C)   $173,280
D)   $182,400
E)   $192,000F) B) and D)
G) None of the above

Question 6

(The following data apply to Problems 29 through 31. The problems MUST be kept together.) 
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 yield on Trumbull's debt?

Accepted Answer

A)   6.04%
B)   6.36%
C)   6.70%
D)   7.05%
E)   7.42% F) A) and C)
G) B) and D)

Question 7

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) D) and E)
G) B) and D) A

Question 8

(The following data apply to Problems 26 through 28. The problems MUST be kept together.) 
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 B)
G) A) and C)

Question 9

The Miller model begins with the MM model with taxes and then adds personal taxes.

Accepted Answer

A) True 
 B)False

Question 10

The MM model is the same as the Miller model, but with zero corporate taxes.

Accepted Answer

A) True 
 B)False

Question 11

(The following data apply to Problems 23 through 25. The problems MUST be kept together.) 
The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%. Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.
-What is the firm's cost of equity?
Answer: e
EASY

Accepted Answer

A)   21.0%
B)   23.3%
C)   25.9%
D)   28.8%
E)   32.0%F) B) and C)
G) A) and B)

Question 12

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 unlevered cost of equity.
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 is independent of the amount of debt it uses.F) D) and E)
G) All of the above

Question 13

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

Question 14

The MM model with corporate taxes is the same as the Miller model, but with zero personal taxes.

Accepted Answer

A) True 
 B)False

Question 15

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 16

Firm L has debt with a market value of $200,000 and a yield of 9%. The firm's equity has a market value of $300,000, its earnings are growing at a rate of 5%, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is Firm L's cost of equity?

Accepted Answer

A)   11.4%
B)   12.0%
C)   12.6%
D)   13.3%
E)   14.0%F) B) and E)
G) A) and C) E

Question 17

(The following data apply to Problems 29 through 31. The problems MUST be kept together.) 
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) All of the above
G) C) and D)

Question 18

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

Accepted Answer

A) True 
 B)False

Question 19

In the MM extension with growth, the appropriate discount rate for the tax shield is the after-tax cost of debt.

Accepted Answer

A) True 
 B)False

Question 20

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

Exam 26: Analysis of Capital Structure Theory

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

Correct Answer
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The major contribution of the Miller model is that it demonstrates that

Correct Answer
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B

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

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

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A

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The Miller model begins with the MM model with taxes and then adds personal taxes.

Correct Answer
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The MM model is the same as the Miller model, but with zero corporate taxes.

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

Correct Answer
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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
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The MM model with corporate taxes is the same as the Miller model, but with zero personal taxes.

Correct Answer
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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
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E

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

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In the MM extension with growth, the appropriate discount rate for the tax shield is the after-tax cost of debt.

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
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Exam 26: Analysis of Capital Structure Theory

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

Correct AnswerverifiedShow Answer

The major contribution of the Miller model is that it demonstrates that

Correct AnswerverifiedB

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedA

Correct AnswerverifiedShow Answer

The Miller model begins with the MM model with taxes and then adds personal taxes.

Correct AnswerverifiedShow Answer

The MM model is the same as the Miller model, but with zero corporate taxes.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

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

The MM model with corporate taxes is the same as the Miller model, but with zero personal taxes.

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

Correct AnswerverifiedE

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

In the MM extension with growth, the appropriate discount rate for the tax shield is the after-tax cost of debt.

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

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B

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A

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E

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