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

Old Exam Questions - Capital Structure and Leverage - Solutions Page 1 of 69 Pages
Capital Structure and Leverage - Solutions
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 - Solutions Page 2 of 69 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).
*
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).
*
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.
*
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