Finance 410

most common choices with financing involved w equity and debt

The most common choices are financing *through equity alone and financing through a combination* of debt and equity.

equity in a firm with no debt is called

unlevered equity

Modigliani and Miller's set of conditions referred to as perfect capital markets? dealing w cash flows

A firm's financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them.

12) 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.

A) All investors hold the efficient portfolio of assets.

5) 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.

A) Leverage decreases the risk of the equity of a firm.

Which of the following statements is FALSE? A) The Law of One Price implies that leverage will affect the total value of the firm under perfect capital market conditions. B) In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the firm's assets. C) With perfect capital markets, leverage merely changes the allocation of cash flows between debt and equity, without altering the total cash flows of the firm. D) In a perfect capital market, the total value of a firm is equal to the market value of the total cash flows generated by its assets and is not affected by its choice of capital structure.

A) The Law of One Price implies that leverage will affect the total value of the firm under perfect capital market conditions.

39) Which of the following statements is FALSE? A) If firms smooth dividends, the firm's dividend choice will contain information regarding management's expectations of future earnings. B) Because of the increasing popularity of repurchases, firms cut dividends much more frequently than they increase them. C) Announcing a share repurchase today does not necessarily represent a long-term commitment to repurchase shares. D) While cutting the dividend is costly for managers in terms of their reputation and the reaction of investors, it is by no means as costly as failing to make debt payments.

B) Because of the increasing popularity of repurchases, firms cut dividends much more frequently than they increase them.

22) 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.

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.

Because the cash flows of the debt and equity sum to the ____ ____ of the project, by the ____ ____ ___ _____ the combined values of debt and equity must be equal to the cash flows of the project.

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.

38) Which of the following statements is FALSE? A) Firms adjust dividends relatively infrequently, and dividends are much less volatile than earnings. This practice of maintaining relatively constant dividends is called dividend signaling. B) When a firm increases its dividend, it sends a positive signal to investors that management expects to be able to afford the higher dividend for the foreseeable future. C) The average size of the stock price reaction increases with the magnitude of the dividend change, and is larger for dividend cuts. D) When managers cut the dividend, it may signal that they have given up hope that earnings will rebound in the near term and need to reduce the dividend to save cash.

C) The average size of the stock price reaction increases with the magnitude of the dividend change, and is larger for dividend cuts.

Which of the statements is FALSE: A) The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its capital structure. B) The most common choices are financing through equity alone and financing through a combination of debt and equity. C) The project's NPV represents the value to the new investors of the firm created by the project. D) When corporations raise funds from outside investors, they must choose which type of security to issue.

C: The project's NPV represents the value to the new investors of the firm created by the project.

Which of the following statements is FALSE? A) As long as the firm's choice of securities does not change the cash flows generated by its assets, the capital structure decision will not change the total value of the firm or the amount of capital it can raise. B) If securities are fairly priced, then buying or selling securities has an NPV of zero and, therefore, should not change the value of a firm. C) The future repayments that the firm must make on its debt are equal in value to the amount of the loan it receives up front. D) An investor who would like more leverage than the firm has chosen can lend and add leverage to his or her own portfolio.

D) An investor who would like more leverage than the firm has chosen can lend and add leverage to his or her own portfolio.

Which of the following statements is FALSE? A) As long as investors can borrow or lend at the same interest rate as the firm, homemade leverage is a perfect substitute for the use of leverage by the firm. B) When investors use leverage in their own portfolios to adjust the leverage choice made by the firm, we say that they are using homemade leverage. C) The value of the firm is determined by the present value of the cash flows from its current and future investments. D) The investor can re-create the payoffs of unlevered equity by borrowing and using the proceeds to purchase the equity of the firm.

D) The investor can re-create the payoffs of unlevered equity by borrowing and using the proceeds to purchase the equity of the firm.

23) Which of the following statements is FALSE? A) The unlevered beta measures the market risk of the firm's business activities, ignoring any additional risk due to leverage. B) If a firm holds $1 in cash and has $1 of risk-free debt, then the interest earned on the cash will equal the interest paid on the debt. The cash flows from each source cancel each other, just as if the firm held no cash and no debt. C) The unlevered beta measures the market risk of the firm without leverage, which is equivalent to the beta of the firm's assets. D) When a firm changes its capital structure without changing its investments, its levered beta will remain unaltered, however, its asset beta will change to reflect the effect of the capital structure change on its risk.

D) When a firm changes its capital structure without changing its investments, its levered beta will remain unaltered, however, its asset beta will change to reflect the effect of the capital structure change on its risk.

Franco Modigliani and Merton Miller argued that with ___ ___ ____, the total value of a firm should not depend on its ______ ______.

Franco Modigliani and Merton Miller argued that with *perfect capital markets*, the total value of a firm should not depend on its *capital structure.*

In a perfect capital market, the total value of a firm is equal to the ____ ____ __ ______ _____ _____ generated by its assets and is not affected by its choice of ____ ______

In a perfect capital market, the total value of a firm is equal to the *market value of the total cash flows* generated by its assets and is not affected by its choice of *capital structure.*

In the absence of _____ ___ _____ _______ ____, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the _____ _____>

In the absence of *taxes or other transaction costs*, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the *firm's assets.*

Modigliani and Miller's set of conditions referred to as perfect capital markets? dealing w trading securities

Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows.

investors in levered equity require a ___ expected return to compensate for its ____ risk

Investors in levered equity require a *higher* expected return to compensate for its *increased* risk.

it is inappropriate to discount the cash flows of ___ ____ at the same discount that we use for _____ ______

It is inappropriate to discount the cash flows of *levered equity* at the same discount rate that we use for *unlevered equity.*

leverage ___ the risk of equity even when there is ____ _____ that firm will default

Leverage *increases* the risk of equity even when there is *no risk* that the firm will default.

what relative portions constitute a firms capital structure

The relative proportions of *debt, equity, and other securities that a firm has outstanding* constitute its capital structure.

Modigliani and Miller's set of conditions referred to as perfect capital markets? dealing w security trading

There are no taxes, transaction costs, or issuance costs associated with security trading.

we can evaluate the relationship between ___ and ___ more formally by computing the ____ of each security's return to the systematic risk of the economy

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.

When corporations raise funds from outside investors they must...

When corporations raise funds from outside investors, they must *choose which type of security to issue.*

With perfect capital markets, leverage merely changes the _____ __ _____ _____ between debt and equity, ____ _____ the total cash flows of the firm.

With perfect capital markets, leverage merely changes the *allocation of cash flows* between debt and equity, *without altering* the total cash flows of the firm.

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.

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.

equity in a firm with debt is called

levered equity