19/09/2015 Corporate Finance | Multiple Choice Quiz

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Corporate Finance, 3/eStephen A. Ross, Massachusetts Institute of TechnologyRandolph W. Westerfield, University of Southern CaliforniaJeffrey Jaffe, University of PennsylvaniaGordon Roberts, York University

Capital Structure: Basic Concepts

Multiple Choice Quiz

1 An unlevered firm is a company that has:

A) an equal amount of debt and equity in the capital structure.

B) more debt than equity in the capital structure.

C) all debt in the capital structure.

D) all equity in the capital structure.

E) none of the above.

2 An EPS EBI chart shows the tradeoff between financing plans and:

A) greater risk associated with debt financing which isevidenced by the greater slope.

B) their breakeven point .

C) the minimum earnings need to pay the debt financing.

D) all of the above.

E) none of the above.

3 "A firm cannot change the total value of its outstanding securities bychanging its capital structure proportions." This is a statement:

A) of ModiglianiMiller Proposition I.

B) of the Value Additivity Principle (VAP).

C) of the Separation Theorem.

D) of the First Principle of Valuation.

E) none of the above.

4 Homemade leverage is a term used to describe:

A) a firm borrowing at the riskfree rate.

B) a firm skipping a dividend payment.

C) individuals borrowing on their own account to buy shares inan unlevered firm.

D) individuals lending on their own account to sell shares in alevered firm.

E) both a and b.

5 The effect of financial leverage on the performance of the firm dependson:

A) the firm's level of EBIT.

B) the rate of return on equity.

C) the current market value of the debt.

D) the rate of dividend growth.

19/09/2015 Corporate Finance | Multiple Choice Quiz

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E) none of the above.

6 MM Proposition II states that:

A) the expected return on equity is positively related toleverage.

B) the required return on equity is a linear function of thefirm's debt to equity ratio.

C) the risk to equity increases with leverage.

D) all of the above.

E) only two of the above.

7 A firm has a debttoequity ratio of .50. Its cost of debt is 12%. Its overallcost of capital is 14%. What is its cost of equity if there are no taxes orother imperfections?

A) 13%.

B) 16%.

C) 15%.

D) 18%.

E) None of the above.

8 If a firm is unlevered and has a cost of equity capital 9% what would thecost of equity be if the firms became levered at 1.75? The expected cost ofdebt would be 7%.

A) 15.75

B) 16.0%.

C) 12.5%.

D) 14.5%.

E) None of the above.

9 The positive value to the firm of adding debt to the capital structure in thepresence of corporate taxes is:

A) due to the extra cashflow going to the investors of the firminstead of the tax authorities.

B) due to the earnings before interest and taxes being fullytaxed at the corporate rate.

C) due to the generosity of the shareholders to protect theinterests of the debtholders.

D) because personal tax rates are the same as corporate taxrates.

E) because shareholders prefer to let financial managerschoose the capital structure thus making their valueindependent of it.

10 A firm has zero debt in its capital structure. Its overall cost of capital is8%. The firm is considering a new capital structure with 50% debt. Theinterest rate on the debt would be 5%. Assuming that the corporate taxrate is 40%, its cost of equity capital with the new capital structure wouldbe?

A) 9.2%.

B) 9.8%.

C) 11%.

D) 8.9%.

E) None of the above.

11 A firm has a debttoequity ratio of 1.0. If it had no debt, its cost of equitywould be 14%. Its cost of debt is 10%. What is its cost of equity if thecorporate tax rate is 50%?

A) 18.0%.

B) 16.0%.

19/09/2015 Corporate Finance | Multiple Choice Quiz

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C) 14.0%.

D) 12.0%.

E) None of the above.

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