Chapter 13

Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases? M&M Proposition I without taxes M&M Proposition II without taxes M&M Proposition I with taxes Static theory of capital structure No theory suggests this.

M&M Proposition I with taxes

Which one of the following states that a firm's cost of equity capital is a positive linear function of the firm's capital structure? Static theory of capital structure M&M Proposition I without taxes M&M Proposition II without taxes Homemade leverage theory M&M Proposition I with taxes

M&M Proposition II without taxes

Which one of the following represents the present value of the interest tax shield? D ×(1 -Tc) D/(1 -Tc) D/Tc D-D(Tc) Tc ×D

Tc ×D

Which one of the following statements is the core principle of M&M Proposition I, without taxes? A firm's cost of equity is directly related to the firm's debt-equity ratio. A firm's WACC is directly related to the firm's debt-equity ratio. The interest tax shield increases the value of a firm. The capital structure of a firm is totally irrelevant. Levered firms have greater value than unlevered firms.

The capital structure of a firm is totally irrelevant.

Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered. Which one of the following statements is correct regarding these two firms? The levered firm has higher EPS (earnings per share) than the unlevered firm at the break-even point. The levered firm will have higher EPS than the unlevered firm at all levels of EBIT. The unlevered firm will have higher EPS than the levered firm at relatively high levels of EBIT. The EPS for the unlevered firm will always exceed those of the levered firm. The unlevered firm will have higher EPS at relatively low levels of EBIT.

The unlevered firm will have higher EPS at relatively low levels of EBIT.

Which one of the following conditions exists at the point where a firm maximizes its value? The tax benefit from an additional dollar of debt is zero. Financial distress costs are equal to zero. The debt-equity ratio is 1.0. WACC is minimized. The cost of equity is minimized.

WACC is minimized

M&M Proposition II, without taxes, states that the: capital structure of a firm is highly relevant. weighted average cost of capital decreases as the debt-equity ratio decreases. cost of equity increases as a firm increases its debt-equity ratio. return on equity is equal to the return on assets multiplied by the debt-equity ratio. return on equity remains constant as the debt-equity ratio increases.

cost of equity increases as a firm increases its debt-equity ratio.

The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as: M&M Proposition I. capital restructuring. homemade leverage. M&M Proposition II. financial risk management.

homemade leverage.

Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship? Static theory of interest rates M&M Proposition I Financial risk Interest tax shield Homemade leverage

interest tax shield

T.L.C. Enterprises just revised its capital structure from a debt-equity ratio of .37 to a debt-equity ratio of .48. The firm's shareholders who prefer the old capital structure should: sell some shares and hold the sale proceeds in cash. sell all of their shares and loan out the entire sale proceeds. do nothing. sell some shares and loan out the sale proceeds. borrow funds and purchase more shares.

sell some shares and loan out the sale proceeds.

M&M Proposition I with taxes states that: the optimal capital structure is the all-equity option. the levered value of a firm exceeds the firm's unlevered value. a firm's capital structure is irrelevant. the value of a firm is independent of taxes. WACC remains constant given any debt-equity ratio.

the levered value of a firm exceeds the firm's unlevered value.

According to M&M Proposition I with taxes, the value of a levered firm will increase when the: value of the unlevered firm increases. tax rate is decreased. debt-equity ratio is lowered. interest rate on the debt is lowered. interest rate on the debt is increased.

value of the unlevered firm increases.

You are comparing two possible capital structures for a firm. The first option is an all-equity firm. The second option involves the use of $3.8 million of debt. The break-even point between these two financing options occurs when the earnings before interest and taxes (EBIT) are $428,000. Given this, you know that leverage is beneficial to the firm: whenever EBIT is less than $428,000. only when EBIT is $428,000. whenever EBIT exceeds $428,000. only if the debt is decreased by $428,000. only if the debt is increased by $428,000.

whenever EBIT exceeds $428,000.

Which one of the following statements concerning financial leverage is correct? The benefits of leverage are unaffected by the amount of a firm's earnings. The use of leverage will always increase a firm's earnings per share. The shareholders of a firm are exposed to less risk anytime a firm uses financial leverage. Changes in the capital structure of a firm will generally change the firm's earnings per share. Financial leverage is beneficial to a firm only when the firm has negative earnings.

Changes in the capital structure of a firm will generally change the firm's earnings per share.