HW6 - Problem Set 6 FINA 4200 Spring 2010 Due Tuesday April...

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Problem Set 6 - FINA 4200 Spring 2010 Due Tuesday April 20 before class I. Multiple Choices Chapter 15 1. The firm's business risk is largely determined by the financial characteristics of its industry. a. True b. False 2. Financial risk refers to the extra risk stockholders bear as a result of the use of debt as compared with the risk they would bear if no debt were used. a. True b. False 3. Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical. a. True b. False 4. Financial leverage affects both EPS and EBIT, while operating leverage only affects EBIT. a. True b. False 5. If Miller and Modigliani had considered the cost of bankruptcy, it is unlikely that they would have concluded that 100 percent debt financing is optimal for the firm. a. True b. False 6. Which of the following events is likely to encourage a company to raise its target debt ratio? a. An increase in the corporate tax rate. 1
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b. An increase in the personal tax rate. c. An increase in the company’s operating leverage. d. Statements a and c are correct. e. All of the statements above are correct. 7. Which of the following statements is most correct? a. Since debt financing raises the firm's financial risk, raising a company’s debt ratio will always increase the company’s WACC. b. Since debt financing is cheaper than equity financing, raising a company’s debt ratio will always reduce the company’s WACC. c. Increasing a company’s debt ratio will typically reduce the marginal cost of both debt and equity financing; however, it still may raise the company’s WACC. d. Statements a and c are correct. e. None of the statements above is correct. 8. A consultant has collected the following information regarding Young Publishing: Total assets $3,000 million Tax rate 40% Operating income (EBIT) $800 million Debt ratio 0% Interest expense $0 million WACC 10% Net income $480 million M/B ratio 1.00× Share price $32.00 EPS = DPS $3.20 The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). The consultant believes that if the company moves to a capital structure financed with 20 percent debt and 80 percent equity (based on market values) that the cost of equity will increase to 11 percent and that the pre-tax cost of debt will be 10 percent. If the company makes this change, what would be the total market value of the firm? (The answers are in millions.) a. $3,200 b. $3,600 c. $4,000 d. $4,200 e. $4,800 2
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9. Dabney Electronics currently has no debt.
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HW6 - Problem Set 6 FINA 4200 Spring 2010 Due Tuesday April...

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