Finance 4010 Exam 3

5 Which of the following statements are correct in relation to M&M Proposition II with no taxes? I. The required return on assets is equal to the weighted average cost of capital. II. Financial risk is determined by the debt-equity ratio. III. Financial risk determines the return on assets. IV. The cost of equity declines when the amount of leverage used by a firm rises. I and III only II and IV only I and II only III and IV only I and IV only

I and II only

The concept of homemade leverage is most associated with: M&M Proposition I with no tax. M&M Proposition II with no tax. M&M Proposition I with tax. M&M Proposition II with tax. static theory proposition.

M&M Proposition I with no tax.

When choosing a capital structure, when will the firm's value be maximized? WACC is minimized WACC is maximized WACC has no effect on the firm's value WACC is equal to the value The firm's value can never be maximized

WACC is minimized

M&M Proposition I with tax supports the theory that: a firm's weighted average cost of capital decreases as the firm's debt-equity ratio increases. the value of a firm is inversely related to the amount of leverage 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 cost of capital is the same regardless of the mix of debt and equity used by the firm. a firm's cost of equity increases as the debt-equity ratio of the firm decreases.

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

A firm's cost of capital: depends upon how the funds raised are going to be spent. will decrease as the risk level of the firm increases. for a specific project is primarily dependent upon the source of the funds used for the project. is independent of the firm's capital structure. should be applied as the discount rate for any project considered by the firm.

depends upon how the funds raised are going to be spent.

The static theory of capital structure advocates that the optimal capital structure for a firm: is dependent on a constant debt-equity ratio over time. remains fixed over time. is independent of the firm's tax rate. is independent of the firm's weighted average cost of capital. equates the tax savings from an additional dollar of debt to the increased bankruptcy costs related to that additional dollar of debt.

equates the tax savings from an additional dollar of debt to the increased bankruptcy costs related to that additional dollar of debt.

D.L. Jones & Co. recently went public. The firm received $20.80 a share on the entire offer of 25,000 shares. Keeser & Co. served as the underwriter and sold 23,700 shares to the public at an offer price of $22 a share. What type of underwriting was this? best efforts shelf over subscribed private placement firm commitment

firm commitment

A firm is technically insolvent when: it has a negative book value. total debt exceeds total equity. it is unable to meet its financial obligations. it files for bankruptcy protection. the market value of its stock is less than its book value.

it is unable to meet its financial obligations.

Which one of the following has the greatest tendency to increase the percentage of debt included in the optimal capital structure of a firm? exceptionally high depreciation expenses very low marginal tax rate substantial tax shields from other sources low probabilities of financial distress minimal taxable income

low probabilities of financial distress

Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding? consumer claim dividend payment to preferred shareholder company contribution to the employees' retirement account payment to an unsecured creditor payment of employee wages

payment of employee wages

Distressed Automotive Corp (DAC) has incurred large losses over the last few years and has $2 B in existing tax-loss carry forwards. Securities analysts estimate it will take several years to generate $2 B in earnings (i.e. no taxes will be paid on earnings in the immediate future). DAC already has a moderate amount of debt in the capital structure, leading debt investors to question their ability to repay their obligations. The firm needs to issue securities for an upcoming positive NPV project. Assuming taxes are 40%, what type of security should they issue? A. If there are no information asymmetries, DAC should issue equity to fund their investment. B. If there are no information asymmetries, DAC should issue debt to fund their investment. C. If information asymmetries are very high and they exceed the costs of financial distress, DAC should issue debt to fund their investment. D. Both A and C are correct. E. Both B and C are correct

D. Both A and C are correct.

The beta of a firm is more likely to be high under what two conditions? High cyclical business activity and low operating leverage High cyclical business activity and high operating leverage Low cyclical business activity and low financial leverage Low cyclical business activity and low operating leverage None of the above.

High cyclical business activity and high operating leverage

If a firm uses the same company cost of capital for evaluating all projects, which of the following is likely? I) Rejecting good low risk projects II) Accepting poor high risk projects III) Correctly accept projects with average risk I only I and II only I, II, and III II only None of the above are correct.

I, II, and III

Arrange the following in the chronological order for a startup firm: I) VC financing; II) Mezzanine financing; III) Stage 1, 2, 3, 4 etc. financing; and IV) IPO I, II, III, and IV I, III, II, and IV IV, I, II, and III III, I, II, and IV

I, III, II, and IV

Which one of the following statements related to Chapter 7 bankruptcy is correct? A firm in Chapter 7 bankruptcy is reorganizing its operations such that it can return to being a viable concern. Under a Chapter 7 bankruptcy, a trustee will assume control of the firm's assets until those assets can be liquidated. Chapter 7 bankruptcies are always involuntary on the part of the firm. Under a Chapter 7 bankruptcy, the claims of creditors are paid prior to the administrative costs of the bankruptcy. Chapter 7 bankruptcy allows a firm to restructure its equity such that new shares of stock are generally issued prior to the firm coming out of bankruptcy.

Under a Chapter 7 bankruptcy, a trustee will assume control of the firm's assets until those assets can be liquidated.

The pecking order states how financing should be raised. In order to avoid asymmetric information problems and misinterpretation of whether management is sending a signal on security overvaluation, the firm's first rule is to: finance with internally generated funds. always issue debt then the market won't know when management thinks the security is overvalued. issue new equity first. issue debt first. Never issue outside capital, whatever the cost.

finance with internally generated funds.

M&M Proposition I with no tax supports the argument that: business risk determines the return on assets. the cost of equity rises as leverage rises. the debt-equity ratio of a firm is completely irrelevant. a firm should borrow money to the point where the tax benefit from debt is equal to the cost of the increased probability of financial distress. homemade leverage is irrelevant.

the debt-equity ratio of a firm is completely irrelevant.