Capital Structure Exercises | Assignment

Capital structure exercises
1) 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.
2) 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.
3) Which of the following is NOT one of Modigliani and Miller's set of conditions
referred to as perfect capital markets?
A) All investors hold the efficient portfolio of assets.
B) There are no taxes, transaction costs, or issuance costs associated with security trading.
C) A firm's financing decisions do not change the cash flows generated by its investments,
nor do they reveal new information about them.
D) Investors and firms can trade the same set of securities at competitive market prices equal
to the present value of their future cash flows.
4) Which of the following statements is FALSE?
A) With no debt, the WACC is equal to the unlevered equity cost of capital.
B) With perfect capital markets, a firm's WACC is dependent of its capital structure and is
equal to its equity cost of capital only the firm it is unlevered.
C) As the firm borrows at the low cost of capital for debt, its equity cost of capital rises, but
the net effect is that the firm's WACC is unchanged.
D) Although debt has a lower cost of capital than equity, leverage does not lower a firm's
WACC.
5) Suppose that Rearden Metal currently has no debt and has an equity cost of capital of 12%.
Rearden is considering borrowing funds at a cost of 6% and using these funds to repurchase
existing shares of stock. Assume perfect capital markets. If Taggart borrows until they
achieved a debt -to-equity ratio of 50%, then Rearden's levered cost of equity would be
closest to:
A) 10.0%
B) 12.0%
C) 15.0%
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