chp 16
holding the stock as collateral requiring additional cash contributions from the investor selling the stock to satisfy the loan
Brokers who sell stock on margin will protect themselves by ___.
15.6%
Calculate the cost of capital for an all-equity firm with equity of $225,000 and expected earnings of $35,000.
9000
If an investor buys $20,000 worth of stock by investing $11,000 of their own money, how much was borrowed?
50 mill
Solid Rock is an unlevered firm with an EBIT of $10 million and an unlevered cost of capital of 12 percent. If the tax rate is 40 percent, what is the value of the firm?
is variable
The effect of financial leverage ______ for all earning levels.
positively related
The expected return on equity is _____ to leverage.
the return on assets (RO) is unchanged
Under MM Proposition II with no taxes, the WACC is invariant to the debt-equity ratio because ___.
is unchanged
Under MM Proposition II with no taxes, the return on assets ______ as debt increases.
positively
Under MM Proposition II, a firm's cost of equity capital is ______ related to the firm's debt-equity ratio provided the cost of capital for an all-equity firm exceeds the cost of debt.
as debt is added, the equity becomes more risky the overall cost of capital cannot be reduced
Under the MM propositions with no taxes, managers cannot change the value of the firm by repackaging its securities because __.
risk
Volatility or ______ increases for equity holders when leverage increases.
low
When buying on margin, brokers typically charge ______ interest.
cash flows to both bondholders and stockholders
When calculating the cash flow for a levered firm, you must consider
Financial leverage increases the slope of the EPS line. The rate of return on assets is unaffected by leverage. Below the indifference or break-even point in EBIT, an unlevered capital structure is best.
Which of the following statements are true regarding the effect of financial leverage and the firm's operating earnings (EBI)?
homemade leverag
With ____, an investor is able to replicate a corporation's capital structure by borrowing funds and using those funds along with her own money to buy the company's stock.
capital structure does not matter
With no taxes, MM showed:
the value of the unlevered firm.
With taxes, MM Proposition I says the value of the levered firm will be _____
decreases
With taxes, the weighted average cost of capital ______ as debt is added to the capital structure.
debt; equity
the WACC is the weighted average cost of ______ plus the weighted average cost of ______.
the firms value is maximized
A beneficial rule to follow is to set the firm's capital structure so that ___.
unlevered
A firm with no debt in its capital structure is:
it does not use historical values
A market value balance sheet differs from an accounting balance sheet because ___.
new info
According to efficient capital markets theory, stock prices will only react to ___.
increase immediately
According to the efficient markets theory, the announcement of a future plant expansion (with a positive NPV) should cause the stock price and therefore the value of the firm to ___.
levered
After the issuance of debt, an unlevered firm becomes ___.
historical; current
An accounting balance sheet uses ______ values and a market balance sheet uses ______ values.
shareholders capture the interest tax shield
An increase in the value of a previously all-equity firm occurs when debt is borrowed to repurchase stock because:
has an all-equity capital structure
An unlevered firm ____.
increases with leverage
Whenever the cost of capital for an all-equity firm is greater than the cost of debt, the cost of equity ___.
homemade leverage
An individual can duplicate a levered firm through a strategy called ____ where the investor uses his own funds plus borrowed funds to buy stocks.
$30.8 million
An unlevered firm has a value of $30 million. An identical firm has debt of $2 million with a 7 percent annual coupon. The tax rate is 40 percent. What is the value of the levered firm?
