ch14 - Chapter 14 Capital Structure in a Perfect Market...

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Unformatted text preview: Chapter 14 Capital Structure in a Perfect Market 14.1 Equity Versus Debt Financing 1) Which of the following statements is false? A) The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its capital structure. B) The most common choices are financing through equity alone and financing through a combination of debt and equity. C) The project s NPV represents the value to the new investors of the firm created by the project. D) When corporations raise funds from outside investors, they must choose which type of security to issue. Answer: C Explanation: C) The project s NPV represents the value to the existing shareholders of the firm created by the project. Diff: 1 Skill: Conceptual 2) Equity in a firm with debt is called A) levered equity. B) riskless equity. C) unlevered equity. D) risky equity. Answer: A Diff: 1 Skill: Definition 3) Equity in a firm with no debt is called A) levered equity. B) unlevered equity. C) riskless equity. D) risky equity. Answer: B Diff: 1 Skill: Definition 364 Berk/DeMarzo Corporate Finance 4) Which of the following statements is false? A) Modigliani and Miller s conclusion verified the common view, which stated that even with perfect capital markets, leverage would affect a firm s value. B) We can evaluate the relationship between risk and return more formally by computing the sensitivity of each security s return to the systematic risk of the economy. C) Investors in levered equity require a higher expected return to compensate for its increased risk. D) Leverage increases the risk of equity even when there is no risk that the firm will default. Answer: A Explanation: A) Modigliani and Miller s conclusion went against the common view that even with perfect capital markets, leverage would affect a firms value. Diff: 2 Skill: Conceptual 5) Which of the following statements is false? A) Leverage decreases the risk of the equity of a firm. B) Because the cash flows of the debt and equity sum to the cash flows of the project, by the Law of One Price the combined values of debt and equity must be equal to the cash flows of the project. C) Franco Modigliani and Merton Miller argued that with perfect capital markets, the total value of a firm should not depend on its capital structure. D) It is inappropriate to discount the cash flows of levered equity at the same discount rate that we use for unlevered equity. Answer: A Explanation: A) Leverage increases the risk of the equity of a firm. Diff: 2 Skill: Conceptual Use the information for the question(s) below. Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project s cost of capital is 15%. The risk- free interest rate is 5%....
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This note was uploaded on 02/02/2012 for the course BUS 438 taught by Professor Dutt during the Winter '12 term at Cal Poly.

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ch14 - Chapter 14 Capital Structure in a Perfect Market...

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