Sample Exam 2 Answers - Sample Exam 2 Answers Business...

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Business Finance (2007) After graduating from the McCombs School of Business, you are hired by Tri-Star Electronics Inc. as its CFO. You are given with the following tasks: 1. ( True or False ) Your colleague, the Chief Marketing Officer (CMO), is confused with many of the financial concepts, and sometimes makes false statements. For each of the following statements, evaluate whether it is true or false. If false, explain why. a) (1 point) According to the Modigliani-Miller model, cost of equity rises with leverage. True. Otherwise, WACC will drop with leverage and increase firm value, which is not consistent with Proposition I. b) (1 point). Under the Modigliani-Miller model with corporate income tax, un- levered firm value is greater than the levered firm value. False. Levered firm has a greater firm value than the un-levered since it will be paying less tax to the government. c) (1 point). Financial distress risk reduces the firm value. False. Financial distress “cost” reduces the firm value, not the risk itself. d) (1 point). Under financial distress, equity holders have incentive to take low risk projects. False. Equity holders will have incentive to take high risk projects, since they can share a larger upside gain, while not sharing any downside loss. e) (1 point). According to the trade-off model, firms with tangible assets tend be more levered. True. Tangible assets can be sold to service the firm’s debt or be used as collateral, which reduces the firm’s present value of financial distress costs. f) (1 point). Since a subscription price is typically lower than the market price under rights offering, existing shareholders become better off by participating in the offering. False.
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Sample Exam 2 Answers - Sample Exam 2 Answers Business...

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