Corporate Finance practice (16-22)

In the following example, the proposed debt issue would raise $4,000,000; the interest rate would be 10%. In addition, the EBIT would be $2,000,000. What would be the increase in the Return on Equity (ROE) from to current to the proposed structure? (#1 on print)

6.67%

Free cash flow (FCF) and net income (NI) differ in the following ways: I) Net income accrues to shareholders, calculated after interest expense; free cash flow is calculated assuming all flows go to equity holders. II) Net income is calculated after various noncash expenses, including depreciation; FCF adds back depreciation. III) Capital expenditures and investments in working capital do not appear in net income calculations; they do reduce free cash flows. IV) Net income is never negative; free cash flows can be negative for rapidly growing firms, even if the firm is profitable, because investments can exceed cash flows from operations. Multiple Choice a. I only b. I and II only c. I, II, and III only d. I, II, III, and IV

c

Lollipop Corp. provides the following information: EBIT = $286.50 Tax (TC )= 35% Debt= $810 Cost of debt capital = 10% RU = 15% What is the value of the firm? Multiple Choice a. $1,050.72 b. $1,241.53 c. $1,525.03 d. $1,654.91 e. $1,784.03

c

Mirion Tech, Inc., has rE of 12%, an rD of 6%, at a debt-equity ratio of 0.50. Mirion plans to raise enough preferred stock to retire half of their outstanding common stock, which currently has a market value of $7 million. If the preferred stock has an expected rate of return of 10%, what is the new WACC? (Assume a 21% marginal corporate tax rate and that rD remains at 6%.) Multiple Choice a. 14.23% b. 11.02% c. 9.58% d. 6.60%

c

Suppose an investor sells (writes) a put option. What will happen if the stock price on the exercise date exceeds the exercise price? Multiple Choice a. The seller will need to deliver stock to the owner of the option. b. The seller will be obliged to buy stock from the owner of the option. c. The owner will not exercise the option. d. The option will extend for nine more months.

c

The delta of a put option always equals Multiple Choice a. the delta of an equivalent call option. b the delta of an equivalent call option with a negative sign. c. the delta of an equivalent call option minus one. d. the delta of an equivalent call option plus one.

c

The equation for M & M Proposition I, without taxes, is best shown as: Multiple Choice a. VL = VU + Tc × D b. VL = VU × Tc × D c. VL = VU d. VL = VU/TD e. VL + TD = VU

c

The pecking order theory of capital structure implies that: I) high-risk firms will end up borrowing more; II) firms prefer internal finance; III) firms prefer debt to equity when external financing is required Multiple Choice a. I only b. II only c. II and III only d. III only

c

What does an equity option's delta reflect? Multiple Choice a. The volatility of the underlying stock price b. The dividends paid to the underlying stockholders c. The number of shares needed to replicate one call option d. The time to expiration

c

When financial distress is a possibility, the value of a levered firm is a function of: I) value of the firm if all-equity-financed; II) present value of tax shield; III) present value of costs of financial distress; IV) present value of omitted dividend payments Multiple Choice a. I only b. I + II c. I + II − III d. I + II - III − IV

c

When one uses the after-tax weighted average cost of capital (WACC) to value a levered firm, the interest tax shield is Multiple Choice a. not accounted for by the use of the WACC. b. considered by deducting the interest payment from the cash flows. c. automatically considered because the after-tax cost of debt is included within the WACC formula. d. capitalized by the levered cost of equity.

c

Why does a discounted cash-flow approach to options valuation not work? Multiple Choice a. It is impossible to estimate expected cash flows. b. One cannot find the appropriate interest rate for an infinitely small interval. c. Finding the opportunity cost of capital is impossible as the risk of options changes every time the stock price moves. d. The strike price of options changes.

c

_________ tax rate is the amount of tax payable on the next dollar earned. Multiple Choice a. Average b. Extra c. Marginal d. Weighted e. Planned

c

he effect of financial leverage depends on the company's _____________. Multiple Choice a. Net Income. b. Free Cash Flow. c. Earnings before interest and taxes. d. Earnings Per Share. e. Return on Equity

c

Assume the following data for Project X: NPV of the project without abandonment: −$2 million; abandonment option value: $4 million. Calculate the adjusted present value (APV) of the project. Multiple Choice a. −$2 million b. −$4 million c. +$2 million d. +$4 million

c (APV = −2 + 4 = +2.)

Project M requires an initial investment of $25 million. The project is expected to generate $2.25 million in after-tax cash flow each year forever. If the weighted average cost of capital (WACC) is 9 percent, calculate the NPV of the project. Multiple Choice a. −2.5 million b. +2.5 million c. Zero d. +2.1 million

c (NPV = −25 + 2.25/0.09 = 0.)

Suppose Ralph's stock price is currently $50. In the next six months it will either fall to $30 or rise to $80. What is the option delta of a call option with an exercise price of $50? Multiple Choice a. 0.375 b. 0.500 c. 0.600 d. 0.750

c (Option delta = (30 − 0)/(80 − 30) = 30/50 = 0.6.)

If a firm permanently borrows $50 million at an interest rate of 10 percent, what is the present value of the interest tax shield? Assume a 21 percent marginal corporate tax rate. Multiple Choice a. $50.0 million b. $25.0 million c. $10.5 million d. $1.5 million

c (PV of interest tax shield = (0.21)(50) = $10.5 million.)

Consider the following data for Kriya Company: Year 1: FCF= 4 million Year 2: 5 m Year 3: 6 m Year 4: 6.24 m A constant growth rate of 4 percent is sustained forever after year 3. The weighted average cost of capital is 10 percent.Calculate the present value of the horizon value. (Assume that the horizon value includes the 6.24M FCF in year 4.) a. 90.4 million b. 104 million c. 78.1 million d. 75.1 million

c (PV(horizon value) = [6.24/(0.10 − 0.04)]/(1.1)^3 = 7)

A rational manager may be reluctant to commit to a positive net present value project when Multiple Choice a. the value of the option to abandon is high. b. the exercise price is high. c. the opportunity cost of capital is high. d. the value of the option to wait is high.

d

A stock split is characterized by all of the following, except: a. An increase in a firm's shares outstanding. b. Same as a stock dividend. c. Each share is split to create additional shares. d. Paid in cash to outstanding shareholders. e. Expressed as a ratio.

d

An example of a real option is Multiple Choice a. the option to make follow-on investments. b. the option to abandon a project. c. the option to wait before investing. d. all of the options are correct.

d

Benson Company has 150,000 outstanding shares @ $20/share. The company has declared a two-for-one stock split. How many shares will be outstanding and at what value after the split? a. 75,000 shares @ $20/share b. 75,000 shares @ $40/share c. 150,000 shares @ $40 share d. 300,000 shares @ $10/share e. 300,000 shares @ $20/share

d

Capital structure is irrelevant if I) capital markets are efficient; II) each investor can borrow/lend on the same terms as the firm; III) there are no tax benefits to debt Multiple Choice a. I only b. II only c. III only d. I, II, and III

d

Figure 2 depicts the Multiple Choice a. position diagram for the buyer of a call option. b. profit diagram for the buyer of a call option. c. position diagram for the buyer of a put option. d. profit diagram for the buyer of a put option.

d

Firms can repurchase shares in the following ways: I) open market repurchase; II) tender offer; III) Dutch auction; IV) direct negotiation with a major shareholder Multiple Choice a. I only b. II only c. III only d. I, II, III, and IV

d

Lowering the debt-equity ratio of the firm can change the firm's I) financial leverage; II) cost of equity; III) cost of debt; IV) effective tax rate Multiple Choice a. II and III only b. I only c. I, II, and III only d. I, II, III, and IV

d

Suppose ABCD's stock price is currently $50. In the next six months it will either fall to $40 or rise to $80. What is the current value of a six-month call option with an exercise price of $50? The six-month risk-free interest rate is 2 percent (periodic rate). Multiple Choice a. $2.40 b. $15.00 c. $8.25 d. $8.09

d

Suppose that there are no taxes, transactions costs, or other market imperfections. Which of the following actions is most likely to make shareholders better off? a. Increase dividends. b. Reduce share repurchases. c. Announce that dividends will not change for at least three years. d. Eliminate negative-NPV projects.

d

The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because: I) debt is more risky than equity; II) bankruptcy and its attendant costs are a disadvantage to debt; III) the payment of personal taxes may offset the tax benefit of debt Multiple Choice a. I only b. II only c. III only d. II and III only

d

The following are indicators that the firm has a cash surplus:. I) Free cash flow is reliably positive. II) The firm has a low debt ratio compared to similar firms. III) The firm has sufficient debt capacity to cover unexpected opportunities or setbacks. Multiple Choice a. I only b. II only c. III only d. I, II, and III

d

The opportunity to defer investing to a later date may have value because I) the cost of capital may increase in the near future; II) uncertainty may be increased in the future; III) the project has positive, short-term cash flows; IV) market conditions may change and increase the NPV of the project Multiple Choice a. I only b. I and II only c. III only d. IV only

d

The writer (seller) of a regular exchange-listed call-option on a stock Multiple Choice a. has the right to buy 100 shares of the underlying stock at the exercise price. b. has the right to sell 100 shares of the underlying stock at the exercise price. c. has the obligation to buy 100 shares of the underlying stock at the exercise price. d. has the obligation to sell 100 shares of the underlying stock at the exercise price.

d

What signal is sent to the market when a firm decides to issue new stock to raise capital? Multiple Choice a. Bond markets are overpriced. b. Bond markets are underpriced. c. Stock price is too low. d. stock price is too high

d

Which of the following are examples of applications of real options analysis? I) a strategic investment in the computer business; II) the valuation of an aircraft purchase option; III) the option to develop commercial real estate; IV) the decision to mothball an oil tanker Multiple Choice a. I only b. I and II only c. I, II, and III only d. I, II, III, and IV

d

Which of the following are examples of real options? I) the option to expand if an investment project succeeds; II) the option to wait (and learn) before investing; III) the option to shrink or abandon a project; IV) the option to vary the mix of output or the firm's production methods Multiple Choice a. I only b. I and II only c. I, II, and III only d. I, II, III, and IV

d

The RTP Corporation has the following call option information. You are interested in purchasing four contracts for the July Call. How much will be the cost of the transaction? a. $1,000 b. $1,250 c. $1,500 d. $1,800 e. $2,000

d (4 contracts × 100/shares per contract × 4.5/share = $1,800)

Given are the following data for year 1:Profits after taxes = $20 million; Depreciation = $6 million; Interest expense = $4 million; Investment in fixed assets = $12 million; Investment in working capital = $4 million. The corporate tax rate is 25 percent. Calculate the free cash flow (FCF) for year 1. Multiple Choice a. $4 million b. $6 million c. $8 million d. $13 million

d (FCF = 20 + 6 + (1 − 0.25) x 4 − 12 − 4 = $13 million)

The following are examples of expansion options: I) A mining company acquires mineral rights to land that is not worth developing today but could be profitable if ore prices increase. II) A film studio acquires the rights to produce a film based on the novel. III) A real estate developer acquires a parcel of land that could be turned into a shopping mall. IV) A pharmaceutical company purchases a patent to market a new drug. Multiple Choice a. I only b. I and II only c. I, II, and III only d. I, II, III, and IV

d.

Samuel Corp. provides the following information: EBIT = $386.50 Tax (TC ) = 35% Debt = $810 RU = 15% What is the value of Samuel's equity? (#3) Multiple Choice a. $1,674.83 b. $1584.83 c. $1,274.83 d. $948.83 e. $864.83

e

A call option has an exercise price of $100. At the exercise date, the stock price could be either $50 or $150. Which investment strategy provides the same payoff as the stock? Multiple Choice a. Lend PV of $50 and buy two calls. b. Lend PV of $50 and sell two calls. c. Borrow $50 and buy two calls. d. Borrow $50 and sell two calls.

a

Dividend Reinvestment Plans have the option of: a. Automatically reinvesting some or all of their cash dividends in shares of stock. Investing with other investors on an exchange. b. Creating homemade dividends by selling back shares. c. Choosing companies that will pay dividends in the future. d. Ensuring a time pattern of dividend payouts in the future.

a

Generally, investors interpret the announcement of a decrease in dividends as Multiple Choice a. bad news, and the stock price drops. b. good news, and the stock price increases. c. a nonevent that does not affect the stock prices. d. very good news, and the stock price jumps up.

a

Given are the following data for Golf Corporation:Market price/share = $12; Book value/share = $10; Number of shares outstanding = 100 million; Market price/bond = $800; Face value/bond = $1,000; Number of bonds outstanding = 1 million. Calculate the proportions of debt (D/V) and equity (E/V) for Golf Corporation that you should use for estimating its weighted average cost of capital (WACC). a. 40 percent debt and 60 percent equity b. 50 percent debt and 50 percent equity c. 45.5 percent debt and 54.5 percent equity d. 66.7 percent debt and 33.3 percent equity

a

If dividends are taxed more heavily than capital gains, then investors Multiple Choice a. should be willing to pay more for stocks with low dividend yields. b. should be willing to pay more for stocks with high dividend yields. c. should be willing to pay the same for stocks regardless of their dividend yields. d. should be willing to pay more for stocks having infrequent share repurchases.

a

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20 percent expected return. If the company repurchases 50 percent of the stock and substitutes an equal value of debt yielding 8 percent, what is the expected return on its common stock after refinancing? Multiple Choice a. 32 percent b. 28 percent c. 20 percent d. 14 percent

a

Modigliani and Miller's Proposition I states that Multiple Choice a. the market value of any firm is independent of its capital structure. b. the market value of a firm's debt is independent of its capital structure. c. the market value of a firm's common stock is independent of its capital structure. d. None of these options.

a

Suppose ABCD's stock price is currently $50. In the next six months it will either fall to $40 or rise to $60. What is the current value of a six-month call option with an exercise price of $50? The six-month risk-free interest rate is 2 percent (periodic rate). Multiple Choice a. $5.39 b. $15.00 c. $8.25 d. $8.09

a

The equation for M & M Proposition I, with taxes, is best shown as: Multiple Choice a VL = VU + Tc × D b. VL = VU × Tc × D c. VL = VU d. VL = VU / TD e. VL + TD = VU

a

The value of a call option is negatively related to the: I) exercise price; II) risk-free rate; III) time to expiration Multiple Choice a. I only b. II only c. III only d. II and III only

a

The value of a put option is negatively related to the: I) stock price; II) volatility of the underlying stock price; III) exercise price Multiple Choice a. I only b. II only c. I and II only d. III only

a

The value of a put option is positively related to the: I) exercise price; II) time to expiration; III) volatility of the underlying stock price; IV) risk-free rate Multiple Choice a. I, II, and III only b. II, III, and IV only c. I, II, and IV only d. IV only

a

To calculate the total value of the firm (V), one should rely on the Multiple Choice a. market values of debt and equity. b. market value of debt and the book value of equity. c. book values of debt and the market value of equity. d. book values of debt and equity.

a

Which of the following entities likely has the highest cost of financial distress? Multiple Choice a. A pharmaceuticals development company b. A downtown bayfront hotel c. A yacht leasing company d. A real estate investment trust

a

Johnston Company has a 7 percent cost of debt, a 50 percent debt ratio, and a 15 percent cost of equity. The marginal tax rate is 25 percent. What is Johnston's WACC if it were 100 percent equity financed? Multiple Choice a. 11 percent b. 10.13 percent c. 7.50 percent d. 15 percent

a (MM proposition I allows: (0.5 × 7) + (0.5 × 15) = 11% = rA)

Consider the following data for Kriya Company: Year 1: FCF= 4 million Year 2: 5 m Year 3: 6 m Year 4: 6.24 m A constant growth rate of 4 percent is sustained forever after year 3. The weighted average cost of capital is 10 percent.Calculate the value of the firm. a. $90.4 million b. $104 million c. $82.6 million d. $83.3 million

a (PV(firm) = 4/(1.10) + 5/(1.10)^2 + [ 6 + 6.24/(0.10 − 0.04)]/(1.10)^3 = 90.4)

Given are the following data for Outsource Company: PV (of FCFs for years 1-3) = $35 million; PV (horizon value) = $65 million. Calculate the value of the firm. Multiple Choice a. $100 million b. $65 million c. $30 million d. $170 million

a (PV(firm) = PV (of FCFs for years 1−3) + PV (horizon value) = 35 + 65 = 100.)

Given are the following data: Cost of debt = rD = 6.0%; Cost of equity = rE = 12.1%; Marginal tax rate = 21%; and the firm has 50 percent debt and 50 percent equity. Calculate the after-tax weighted average cost of capital (WACC). Multiple Choice a. 8.42 percent b. 7.1 percent c. 9.0 percent d. 5.9 percent

a (WACC = (0.5)(1 − 0.21) (6.0) + (0.5)(12.1) = 8.42%.)

The asset beta of a levered firm is 1.1. The beta of debt is 0.3. If the debt equity ratio is 0.5, what is the equity beta? (Assume no taxes.) Multiple Choice a. 1.50 b. 1.10 c. 0.30 d. 0.15

a (bE = 1.1 + 0.5(1.1 − 0.3) = 1.5.)

Health and Wealth Company is financed entirely by common stock that is priced to offer a 15 percent expected return. If the company repurchases 25 percent of the common stock and substitutes an equal value of debt yielding 6 percent, what is the expected return on the common stock after refinancing? (Ignore taxes.) Multiple Choice a. 18.0 percent b. 21.0 percent c. 15.0 percent d. 10.5 percent

a (rE = rA + (D/E)(rA − rD) = 15 + (0.25/0.75)(15 − 6) = 18%.)

Suppose Carol's stock price is currently $20. In the next six months it will either fall to $10 or rise to $40. What is the current value of a six-month call option with an exercise price of $15? The six-month risk-free interest rate is 5 percent per six-month period. (Use the replicating portfolio method.) Multiple Choice a. $8.73 b. $10.28 c. $16.88 d. $13.33

a.

All else equal, as the underlying stock price increases: Multiple Choice a. the call price decreases. b. the call price increases. c. there is no effect on call price. d. the call price can either increase, decrease, or remain the same.

b

All else equal, as the underlying stock price increases: Multiple Choice a. the put price increases. b. the put price decreases. c. there is no effect on put price. d. the put price can either increase, decrease, or remain the same.

b

An abandonment option, in effect, Multiple Choice a. limits the flexibility of management's decision-making. b. limits the downside risk of an investment project. c. limits the profit potential of a proposed project. d. applies only to new projects.

b

An option that can be exercised any time before its expiration date is called: Multiple Choice a. a European option. b.. an American option. c. a call option. d. a put option.

b

Consider the procedure whereby the firm states a series of prices at which it is prepared to repurchase stock. Shareholders then submit offers indicating how many shares they wish to sell and at which price. The firm then calculates the lowest price at which it is able to buy the desired number of shares. This procedure is known as a(n) Multiple Choice a. open market repurchase. b. Dutch auction. c. green mail. d. tender offer.

b

For a levered firm where bA = beta of assets and bD = beta of debt, the equity beta (bE) equals Multiple Choice a. bE = bA b. bE = bA + (D/E) × [bA - bD] c. bE = bA + (D/(D + E)) × [bA − bD] d. None of these options.

b

Generally, investors view the announcement of an open-market repurchase program as Multiple Choice a. bad news, and the stock price drops. b. good news, and the stock price increases. c. a nonevent that does not affect the stock price. d. very bad news, and the stock price plunges.

b

If a firm has preferred stock, the after-tax weighted average cost of capital (WACC) equals Multiple Choice a. rD (D/V) + rP (P/V) + rE (E/V); (where V = D + P + E). b. rD (1 − TC)(D/V) + rP (P/V) + rE (E/V); (where V = D + P + E). c. rD (D/V) + (1 − TC)[rP (P/V) + rE (E/V)]; (where V = D + P + E). d. (1 − TC)[rD (D/V) + rP (P/V) + rE (E/V)]; (where V = D + P + E).

b

In order to calculate the tax shields provided by debt, the tax rate used is the Multiple Choice a. average corporate tax rate. b. marginal corporate tax rate c. average of shareholders' equity tax rates. d. average of bondholders' personal tax rates.

b

One calculates the after-tax weighted average cost of capital (WACC) as Multiple Choice a.WACC = rD (D/V) + rE (E/V); (where V = D + E). b. WACC = rD (1 − TC)(D/V) + rE (E/V); (where V = D + E) c. WACC = rD (D/V) + rE (1 − TC)(E/V); (where V = D + E). d. WACC = (1 − TC) × ( rD (D/V) + rE (E/V)); (where V = D + E).

b

Samuel Corp. provides the following information: EBIT = $286.50 Tax (TC ) = 35% Debt = $810 RU = 15% What is the value of the firm? (#2) Multiple Choice a. $1,050.72 b. $1,241.53 c. $1,427.76 d. $1,654.91 e. $1,784.32

b

Suppose VS's stock price is currently $20. In the next six months it will either fall to $10 or rise to $30. What is the current value of a put option with an exercise price of $15? The six-month risk-free interest rate is 5 percent per six-month period. Multiple Choice a. $5.00 b. $2.14 c. $0.86 d. $7.86

b

The act of buying or selling the underlying asset via the option contract is called _______________ the option. Multiple Choice a. Exposing b. Exercising c. Striking d. Selling e.. Contracting

b

The capital structure of the firm can be defined as I) the firm's mix of different debt securities; II) the firm's mix of different securities used to finance assets; III) the market imperfection that the firm's managers can exploit Multiple Choice a. I only b. II only c. III only d. I, II, and III

b

The discounted cash-flow (DCF) approach should be a. augmented by real options analysis even if there are no imbedded options. b. augmented by added analysis if a decision has significant imbedded options. c. jettisoned if there are any embedded options. d. computed carefully to identify the options.

b

Which of the following conditions might lead a financial manager to delay a positive-NPV project? (Assume that project NPV—if undertaken immediately—is held constant.) Multiple Choice a. The risk-free interest rate falls. b. Uncertainty about future project value increases. c. The first cash inflow generated by the project is higher than previously thought. d. Investment required for the project increases.

b

Suppose ACC's stock price is currently $25. In the next six months it will either fall to $15 or rise to $40. What is the current value of a six-month call option with an exercise price of $20? The six-month risk-free interest rate is 5 percent per six-month period. (Use the replicating portfolio method.) Multiple Choice a. $20.00 b. $8.57 c. $9.52 d. $13.10

b (Delta = (20 − 0)/(40 − 15) = 20/25 = 0.8. Value of call = (delta) × (share price) − PV(0.8 × 15 − 0) = 0.8 × 25 − 12/1.05 = $8.57.)

Given are the following data for year 1:Profits after taxes = $14 million; Depreciation = $6 million; Interest expense = $6 million; Investment in fixed assets = $12 million; Investment in working capital = $3 million. The corporate tax rate is 25 percent. Calculate the free cash flow (FCF) for year 1. a. $4 million b. $9.5 million c. $6 million d. $7 million

b (FCF = 14 + 6 + (1 − 0.25) x 6 − 12 − 3 = $9.5 m)

Consider the following data:FCF1 = $20 million; FCF2 = $20 million; FCF3 = $20 million. Assume that free cash flow grows at a rate of 5 percent for year 4 and beyond. If the weighted average cost of capital is 12 percent, calculate the value of the firm. Multiple Choice a. $300 million b. $261.57 million c. $213.53 million d. $238.69 million

b (Horizon value in year 3 = (20)(1.05)/(0.12 − 0.05) = $300 m; PV = (20/1.12) + (20/1.12^2) + [(20 + 300)/(1.12^3)] = $261.57 m)

Consider the following data:FCF1 = $7 million; FCF2 = $45 million; FCF3 = $55 million. Assume that free cash flow grows at a rate of 4 percent for year 4 and beyond. If the weighted average cost of capital is 10 percent, calculate the value of the firm. Multiple Choice a. $953.33 million b. $801.12 million c. $716.25 million d. $736.02 million

b (Horizon value in year 3 = (55)(1.04)/(0.10 − 0.04) = $953.33 m; PV = (7/1.10) + (45/1.10^2) + [(55 + 953.33)/(1.10^3)] = $801.12 m)

Given are the following data for Outsource Company: PV (of FCFs for years 1-3) = $35 million; PV (horizon value) = $65 million. Suppose that the market value of the debt = $30 million and the number of shares outstanding = 5 million. Calculate the share price. Multiple Choice a. $20 b. $14 c. $13 d. $6

b (PV(firm) = PV (of FCFs for years 1−3) + PV (horizon value) = 35 + 65 = 100. Total value of equity = 100 − 30 = 70; Value per share = 70/5 = $14)

The beta of an all-equity firm is 1.2. Suppose the firm changes its capital structure to 50 percent debt and 50 percent equity using 8 percent debt financing. What is the equity beta of the levered firm? The beta of debt is 0.2. (Assume no taxes.) Multiple Choice a. 1.2 b. 2.2 c. 2.4 d. 1.7

b (βE = 1.2 + (0.5/0.5)(1.2 − 0.2) = 2.2.)

A firm has debt beta of 0.2 and an asset beta of 1.9. If the debt-equity ratio is 75 percent, what is the levered equity beta? Multiple Choice a. 1.90 b. 3.18 c. 2.42 d. 2.63

b (βE = βA + (D/E) × (βA − βD). 1.9 + (0.75) × (1.9 − 0.2); βA = 3.175)

Assuming that bonds are sold at a fair price, the benefits from the interest tax shield go to the Multiple Choice a. managers of the firm. b. bondholders of the firm. c. stockholders of the firm. d. lawyers of the firm.

c

Dividend policy changes are decided and announced by I) the managers of a firm; II) the government; III) the board of directors Multiple Choice a. I only b. II only c. III only d. I and II only

c

Dividend policy may affect firm value because I) there is an unsatisfied clientele that prefer dividends to capital gains; II) there are sufficient loopholes in the tax system that wealthy shareholders can avoid taxes on dividends; III) well-managed companies prefer to signal their worth by paying high dividends Multiple Choice a. I only b. I and II only c. I and III only d. II and III only

c