Chapter 14 - Capital Structure and Leverage - Questions

Chapter 14 - Capital Structure and Leverage - Questions -...

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Unformatted text preview: Old Exam Questions - Capital Structure and Leverage Page 1 of 36 Pages Capital Structure and Leverage - Questions 1. The optimal capital structure for a firm simultaneously maximizes EPS and minimizes the weighted average cost of capital (WACC). A. True B. False 2. When a company increases its debt ratio, the costs of equity and debt capital both increase. Therefore, the weighted average cost of capital (WACC) must also increase. A. True B. False 3. Because of leverage effects and tax shelter effects, a firm’s use of additional debt financing will increase the firm’s return on equity, but may also increase the stockholders’ required rate of return. A. True B. False 4. A change in a firm’s capital structure (debt versus equity) can have an immediate impact on the levered or equity beta of the firm’s stock, but should have no impact on the firm’s asset or unlevered beta unless the firm also changes the composition (i.e., risk) of its assets. A. True B. False 5. In a world with no taxes, MM show that the capital structure of a firm does not affect the value of the firm. However, when taxes are considered, MM show a positive relationship between debt and value. A. True B. False 6. In a world with no taxes, MM (Modigliani and Miller) show that the capital structure of a firm does not affect the value of the firm (i.e., capital structure is irrelevant). However, when taxes are considered, MM show a positive relationship between debt and value (i.e., firm’s should go towards 100 percent debt financing). A. True B. False Old Exam Questions - Capital Structure and Leverage Page 2 of 36 Pages 7. The optimal capital structure for a firm will maximize the firm’s weighted average cost of capital and minimize the firm’s net income (i.e., the free cash flow that goes to the equity shareholders). A. True B. False 8. The optimal capital structure for a firm will minimize the firm’s weighted average cost of capital and maximize the firm’s net income (i.e., the free cash flow that goes to the equity shareholders). A. True B. False 9. Modigliani and Miller showed that in a world without taxes, a firm’s optimal capital structure would be to go towards 100 percent debt financing. A. True B. False 10. The graphical probability distribution for return on equity (ROE) when financial leverage is used, would tend to be more peaked and have less dispersion than a distribution where no leverage is present, other things held constant. A. True B. False 11. Financial leverage affects both EPS and EBIT, while operating leverage only affects EBIT. A. True B. False 1. Assume that the equity beta for an all equity (unlevered) firm is 1.0. Assume now that the firm changes its capital structure to 50% debt and 50% equity, using 8% debt financing, and a tax rate of 40%. You may also assume that the beta for debt is zero....
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Chapter 14 - Capital Structure and Leverage - Questions -...

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