02 Jan The MM theory with taxes

IncorrectQuestion 1

0 / 2 pts

A key assumption of MM’s Proposition I without taxes is:

that individuals can borrow on their own account at rates less than the firm.

All of these.

that financial leverage increases risk.

managers are acting to maximize the value of the firm.

that individuals must be able to borrow on their own account at rates equal to the firm.

Question 2

2 / 2 pts

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

personal offset.

dividend recapture.

private debt placement.

the weighted average cost of capital.

homemade leverage.

Question 3

2 / 2 pts

A manager should attempt to maximize the value of the firm by:

changing the capital structure if and only if the value of the firm increases to the benefit of inside management.

changing the capital structure if and only if the value of the firm increases.

changing the capital structure if and only if the value of the firm increases although it decreases the stockholders’ value.

changing the capital structure if and only if the value of the firm increases only to the benefits of the debtholders.

changing the capital structure if and only if the value of the firm increases and stockholder wealth is constant.

Question 4

2 / 2 pts

In an EPS-EBI graphical relationship, the slope of the debt ray is steeper than the equity ray. The debt ray has a lower intercept because:

the break-even point is higher with debt.

a fixed interest charge must be paid even at low earnings.

the amount of interest per share has only a positive effect on the intercept.

the higher the interest rate the greater the slope.

more shares are outstanding for the same level of EBI.

Question 5

2 / 2 pts

MM Proposition I with taxes supports the theory that:

the value of a firm is inversely related to the amount of leverage used by the firm.

a firm’s cost of capital is the same regardless of the mix of debt and equity used by the firm.

the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield.

a firm’s weighted average cost of capital increases as the debt-equity ratio of the firm rises.

there is a positive linear relationship between the amount of debt in a levered firm and its value.

Question 6

2 / 2 pts

MM Proposition II is the proposition that:

supports the argument that the capital structure of a firm is irrelevant to the value of the firm.

supports the argument that the size of the pie does not depend on how the pie is sliced.

the cost of equity is equivalent to the required return on the total assets of a firm.

a firm’s cost of equity capital is a positive linear function of the firm’s capital structure.

the cost of equity depends on the return on debt, the debt-equity ratio and the tax rate.

Question 7

2 / 2 pts

MM Proposition I without taxes is used to illustrate:

capital structure changes have no effect on stockholders’ welfare.

that one capital structure is as good as another.

leverage does not affect the value of the firm.

All of these.

the value of an unlevered firm equals that of a levered firm.

Question 8

2 / 2 pts

When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of EBIT because:

interest payments on the debt stay fixed, leaving more income to be distributed over more shares.

interest payments on the debt stay fixed, leaving less income to be distributed over less shares.

interest payments on the debt vary with EBIT levels.

interest payments on the debt stay fixed, leaving less income to be distributed over more shares.

interest payments on the debt stay fixed, leaving more income to be distributed over less shares.

Question 9

2 / 2 pts

Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure?

I. A reduction in tax rates

II. A large tax loss carryforward

III. A large depreciation tax deduction

IV. A sizeable increase in taxable income

I, II, and III only

I, II, III, and IV

I and II only

II and III only

I and III only

IncorrectQuestion 10

0 / 2 pts

A levered firm is a company that has:

some debt in the capital structure.

all equity in the capital structure.

All of these.

None of these.

Accounts Payable as the only liability on the balance sheet.

Question 11

2 / 2 pts

The change in firm value in the presence of corporate taxes only is:

positive as equity holders gain the tax shield on the debt interest.

negative because of the increased risk of default and fewer shares outstanding.

negative because of a reduction of equity outstanding.

None of these.

positive as equity holders face a lower effective tax rate.

Question 12

2 / 2 pts

The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

All of these.

earnings per share are no longer relevant with taxes.

levered firms pay less taxes compared with identical unlevered firms.

dividends are no longer relevant with taxes.

bondholders require higher rates of return compared with stockholders.

Question 13

2 / 2 pts

A general rule for managers to follow is to set the firm’s capital structure such that:

the firm’s value is minimized.

the firms dividend payout is maximized.

the firm’s bondholders are made well off.

the firm’s value is maximized.

the firms suppliers of raw materials are satisfied.

IncorrectQuestion 14

0 / 2 pts

Which of the following is true?

A firm with low anticipated profit will likely take on a high level of debt.

Rational investors are likely to infer a higher firm value from a zero debt level.

A successful firm will probably take on zero debt.

Rational firms raise debt levels when profits are expected to decline.

Investors will generally view an increase in debt as a positive sign for the firm’s value.

Question 15

2 / 2 pts

The explicit costs, such as the legal expenses, associated with corporate default are classified as _____ costs.

flotation

beta conversion

indirect bankruptcy

direct bankruptcy

unlevered

Question 16

2 / 2 pts

The value of a firm in financial distress is diminished if the firm:

Both is declared bankrupt and proceeds to be liquidated; and is declared insolvent and undergoes financial reorganization.

is a partnership.

is declared insolvent and undergoes financial reorganization.

is declared bankrupt and proceeds to be liquidated.

Both is declared bankrupt and proceeds to be liquidated; and is a partnership.

Question 17

2 / 2 pts

The optimal capital structure has been achieved when the:

debt-equity ratio is such that the cost of debt exceeds the cost of equity.

cost of equity is maximized given a pre-tax cost of debt.

weight of equity is equal to the weight of debt.

debt-equity ratio selected results in the lowest possible weighed average cost of capital.

debt-equity ratio is equal to 1.

Question 18

2 / 2 pts

The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

personal tax rate on the distribution of income to stockholders is greater than the personal tax rate on interest income.

personal tax rate on the distribution of income to stockholders is less than the personal tax rate on interest income.

personal tax rate on the distribution of income to stockholders is equal to the personal tax rate on interest income.

personal tax rate on interest income is zero.

None of these.

Question 19

2 / 2 pts

If a firm issues debt but writes protective and restrictive covenants into the loan contract, then the firm’s debt may be issued at a _____ interest rate compared with otherwise similar debt.

equal

slightly higher

lower

Either significantly higher or slightly higher

significantly higher

Question 20

2 / 2 pts

The costs of avoiding a bankruptcy filing by a financially distressed firm are classified as _____ costs.

financial solvency

capital structure

direct bankruptcy

flotation

indirect bankruptcy

Question 21

2 / 2 pts

One of the indirect costs to bankruptcy is the incentive toward underinvestment. Following this strategy may result in:

the firm always choosing projects with the positive NPVs.

the firm turning down positive NPV projects that it would clearly accept in an all equity firm.

Both the firm always choosing projects with the positive NPVs; and stockholders contributing the full amount of the investment, but both stockholders and bondholders sharing in the benefits of the project.

Both the firm turning down positive NPV projects that it would clearly accept in an all equity firm; and stockholders contributing the full amount of the investment, but both stockholders and bondholders sharing in the benefits of the project.

stockholders contributing the full amount of the investment, but both stockholders and bondholders sharing in the benefits of the project.

IncorrectQuestion 22

0 / 2 pts

The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because:

bankruptcy is a disadvantage to debt.

Both debt is more risky than equity; and bankruptcy is a disadvantage to debt.

firms will incur large agency costs of short term debt by issuing long term debt.

debt is more risky than equity.

Both bankruptcy is a d