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Practice MC Questions CH 16

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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267 views3 pages

Practice MC Questions CH 16

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.

Uploaded by

business doc
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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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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