6340practicequestionsmf - 1 Which of the following...

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1. 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 tradeoff 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 such factors 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. If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation. Answer: a 2. Which of the following statements is CORRECT? a. When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase. b. The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share. c. All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio. d. Since debt financing raises the firm’s financial risk, increasing a company’s debt ratio will always increase its WACC. e. Since debt is cheaper than equity, increasing a company’s debt ratio will always reduce its WACC. Answer: c Rollins Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find r s . The firm's marginal tax rate is 40 percent.
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3.) What is Rollins' cost of common stock (r s ) using the CAPM approach? a. 13.6%
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This note was uploaded on 01/15/2010 for the course PUBLIC Public rel taught by Professor Za during the Spring '09 term at Temasek Polytechnic.

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6340practicequestionsmf - 1 Which of the following...

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