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    Practice MC Questions CH 16

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    This document contains 9 multiple choice practice questions about capital structure and weighted average cost of capital (WACC). The questions cover topics like the Modigliani-Miller propositions, optimal capital structure, components of WACC, and how individual investors can alter their exposure to financial leverage. The key provided gives the answer for each question.

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    Practice MC Questions CH 16

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    business doc
    92 views3 pages
    This document contains 9 multiple choice practice questions about capital structure and weighted average cost of capital (WACC). The questions cover topics like the Modigliani-Miller propositions, optimal capital structure, components of WACC, and how individual investors can alter their exposure to financial leverage. The key provided gives the answer for each question.

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    Practice MC Questions Ch 16

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    This document contains 9 multiple choice practice questions about capital structure and weighted average cost of capital (WACC). The questions cover topics like the Modigliani-Miller propositions, optimal capital structure, components of WACC, and how individual investors can alter their exposure to financial leverage. The key provided gives the answer for each question.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    92 views3 pages

    Practice MC Questions CH 16

    Uploaded by

    business doc
    This document contains 9 multiple choice practice questions about capital structure and weighted average cost of capital (WACC). The questions cover topics like the Modigliani-Miller propositions, optimal capital structure, components of WACC, and how individual investors can alter their exposure to financial leverage. The key provided gives the answer for each question.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 3

    Practice MC Questions Ch 16

    1. The proposition that the value of the firm is independent of its capital structure is called:
    A. The Capital Asset Pricing Model.
    B. M&M Proposition I (without taxes).
    C. M&M Proposition II.
    D. The Law of One Price.
    E. The Efficient Markets Hypothesis.

    2. The proposition that a firm borrows up to the point where the marginal benefit of the interest
    tax shield derived from increased debt is just equal to the marginal expense of the resulting
    increase in financial distress costs is called the:
    A. Static Theory of Capital Structure.
    B. M&M Proposition I.
    C. M&M Proposition II.
    D. Capital Asset Pricing Model.
    E. Open Markets Theorem.

    3. The explicit costs associated with corporate default, such as legal expenses, are the ________
    of the firm.
    A. flotation costs
    B. default beta coefficients
    C. direct bankruptcy costs
    D. indirect bankruptcy costs
    E. default risk premium

    4. The fact that individual investors can alter the amount of financial leverage to which they are
    exposed is referred to as:
    A. Capital structure targeting.
    B. Adjusting the business risk.
    C. The static theory of capital structure.
    D. Homemade leverage.
    E. M&M Proposition II.

    5. Which of the following is true about the WACC?


    A. The WACC is the appropriate discount rate for all new projects of the firm.
    B. The optimal capital structure is the one that maximizes the WACC.
    C. The value of the firm will be maximized when the WACC is minimized.
    D. The WACC is virtually impossible to calculate for a firm with multiple divisions.
    E. Since discount rates and firm value move in the same direction, minimizing the WACC will
    minimize the value of the firm.
    6. The Brassy Co. has expected EBIT = $910, an unlevered cost of capital of 12%, and debt with
    a face and market value of $2,000 paying an 8.5% annual coupon. If the tax rate is 34%, what is
    the WACC of Brassy Co.?
    A. 10.56%
    B. 11.12%
    C. 13.25%
    D. 13.64%
    E. 14.45%

    7. An unlevered firm with a market value of $1 million has 50,000 shares outstanding. The firm
    restructures itself by issuing 200 new bonds with face value $1,000 and an 8% coupon. The firm
    uses the proceeds to repurchase outstanding stock. In considering the newly levered versus
    formerly unlevered firm, what is the break-even EBIT? Ignore taxes.
    A. $25,000
    B. $50,000
    C. $75,000
    D. $80,000
    E. $95,000

    8. The optimal capital structure is the mixture of debt and equity which:

    I. Maximizes the value of the firm.


    II. Minimizes the firm's weighted average cost of capital.
    III. Maximizes the market price of the firm's bonds.
    A. I only
    B. III only
    C. I and II only
    D. I and III only
    E. I, II, and III

    9. An investor owns 500 shares of stock in a Montreal firm with a debt/equity ratio = 1.0. The
    investor prefers a debt/equity ratio = 1.5. If the stock price is $2 per share, what should the
    investor do?
    A. Borrow $500 and buy 250 new shares.
    B. Borrow $1,500 and buy 750 new shares.
    C. Borrow $2,500 and buy 1,250 new shares.
    D. Sell 250 shares and lend $500.
    E. Sell 25 shares and lend $50.
    Key
    1. B
    2. A
    3. C
    4. D
    5. C
    6. A
    7. D
    8. C
    9. B

    6. The Brassy Co. has expected EBIT = $910, an unlevered cost of capital of 12%, and debt with
    a face and market value of $2,000 paying an 8.5% annual coupon. If the tax rate is 34%, what is
    the WACC of Brassy Co.?
    A. 10.56%
    B. 11.12%
    C. 13.25%
    D. 13.64%
    E. 14.45%

    VU = EBIT(1-T) / RU (910*(1-0.34))/ 5,005.00


    VL = VU + DTC 5005+(2000*0.34) 5,685.00
    E=V-D 5685 - 2000 3,685.00
    RE = RU + (RU – RD)(D/E)(1-T C) 0.12 + ((0.12 - 0.085) * (2000 / 3685) * (1 - 0.34)) 13.25%

    WACC = (E/V)RE + (D/V)(RD)(1-T C) ((3685 / 5685) * 0.132537313432836) + ((2000 / 5685) * (0.085) * (110.56%
    - 0.34))

    7. An unlevered firm with a market value of $1 million has 50,000 shares outstanding. The firm
    restructures itself by issuing 200 new bonds with face value $1,000 and an 8% coupon. The firm
    uses the proceeds to repurchase outstanding stock. In considering the newly levered versus
    formerly unlevered firm, what is the break-even EBIT? Ignore taxes.
    A. $25,000
    B. $50,000
    C. $75,000
    D. $80,000
    E. $95,000

    EBIT/50000=(EBIT-
    BE EBIT (0.08*200000))/40000
    EBIT/50000=(EBIT-
    16000)/40000
    EBIT=(EBIT-
    16000)*50000/40000
    EBIT=(EBIT-16000)*1.25
    1.25EBIT-EBIT=20000
    EBIT=20000/.25 80,000.00

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