Corporate Finance Final Uiowa - Conceptual

If an investor buys a portion (X) of an unlevered firm's equity, then his/her payoff is

(X) x (profits)

The beta of the market portfolio is

+1.0

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.)

18 percent

Which of the following entities likely has the highest cost of financial distress?

A pharmaceuticals development company

According to Modigliani and Miller Proposition II, the rate of return required by debtholders linearly increases as the firm's debt-equity ratio increases.

False

Firms with cyclical revenues tend to have lower asset betas.

False

According to survey data, which is the least-often cited dividend policy consideration?

Firms would prefer to raise new funds rather than reduce dividends

The merger of two similar pharmaceutical firms is an example of a

Horizontal Merger

Capital budgeting projects that incorporate both investment and financing decision side effects can be properly analyzed by: I) adjusting the project's present value (APV); II) adjusting the project's discount rate (WACC); III) relying only on MM Propositions I and II

I and II only

If firm U is unlevered and firm L is levered, then which of the following is true? I) VU = EU. II) VL = EL + DL. III) VL = EU + DL.

I and II only

The flow-to-equity method uses: I) cash flows to equity, after interest and after taxes; II) the cost of equity capital as the discount rate; III) the weighted average cost of capital for discount rate; IV) after-tax cash flows without considering interest and dividend payments

I and II only

When using the weighted average cost of capital (WACC) to discount cash flows from a project, we assume the following: I) The project's risks are the same as those of the firm's other assets and remain so for the life of the project. II) The project supports the same fraction of debt to value as the firm's overall capital structure, and that fraction remains constant for the life of the project. III) The cash flows from the project occur in perpetuity.

I and II only

An investor can undo the effect of leverage on his/her own account by I) investing in the equity of an unlevered firm; II) borrowing on his/her own account; III) investing in risk-free debt like T-bills

I and III above

An investor can create the effect of leverage on his/her account by I) buying equity of a levered firm; II) investing in risk-free debt like T-bills; III) borrowing on his/her own account

I and III only

The costs of financial distress depend on the: I) probability of financial distress; II) corporate and personal tax rates; III) magnitude of costs encountered if financial distress occurs

I and III only

In the case of Facebook, which has issued Class A and Class B shares, I) both classes of shares have the same cash-flow rights; II) both classes of shares have the same control rights; III) both classes of shares have different cash-flow rights; IV) both classes of shares have different control rights

I and IV only

Given corporate taxes, why does adding debt to the capital structure increase firm value? I) Extra cash flow goes to the firm's investors rather than the tax authorities. II) Earnings before interest and taxes are fully taxed at the corporate rate. III) Personal tax rates are the same as marginal corporate tax rates.

I only

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.

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.

Arrange the following in chronological order for a typical start-up firm: I) VC financing; II) mezzanine financing; III) stage 1, 2, 3, 4, etc.,financing; IV) IPO

I) VC financing; III) stage 1, 2, 3, 4, etc.,financing; II) mezzanine financing; IV) IPO

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

I) open market repurchase; II) tender offer; III) Dutch auction; IV) direct negotiation with a major shareholder

A general cash offer involves the following processes: I) register the issue with the SEC; II) sell the securities through an underwriter or a syndicate of underwriters; III) have underwriter build up a book of likely demand for the securities IV) price of the issue is fixed; V) sell the securities to the public

I) register the issue with the SEC; II) sell the securities through an underwriter or a syndicate of underwriters; III) have underwriter build up a book of likely demand for the securities IV) price of the issue is fixed; V) sell the securities to the public

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

I, II, III, and IV

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

I, II, and III

Generally, managers of corporations prefer internally generated cash to finance their capital expenditures because I) they can avoid the discipline of financial markets; II) the costs of issuing new securities are high; III) the announcement of a new equity issue is usually bad news for investors

I, II, and III

If a firm uses the same company cost of capital for evaluating all projects, which situation(s) will likely occur? I) The firm will reject good low-risk projects; II) The firm will accept poor high-risk projects; III) The firm will correctly accept projects with average risk

I, II, and III

The following are debts in disguise: I) accounts payable II) leases III) underfunded pensions

I, II, and III

The following functions, provided by financial intermediaries, enable the smooth functioning of the economy: I) processing of payments; II) borrowing and lending; III) pooling risks

I, II, and III

The following situations typically require that the financial manager value an entire business: I) If firm A is about make a takeover offer for firm B, then A's financial managers have to decide how much the combined business A + B is worth under A's management. II) If firm C is considering the sale of one of its divisions or a business line, it has to decide what the division or the business line is worth in order to negotiate with potential buyers. III) When a firm goes public, the investment bank must evaluate how much the firm is worth in order to set the price.

I, II, and III

The law of conservation of value implies that I) the mix of common stock and preferred stock does not affect the value of the firm; II) the mix of long-term and short-term debt does not affect the value of the firm; III) the mix of secured and unsecured debt does not affect the value of the firm

I, II, and III

When faced with financial distress, managers of firms acting on behalf of their shareholders' interests will tend to: I) favor high-risk, high-return projects even if they have negative NPV; II) refuse to invest in low-risk, low-return projects with positive NPVs; III) delay the onset of bankruptcy as long as they can

I, II, and III

One of the indirect costs to bankruptcy is the incentive toward underinvestment. Following this strategy may result in: I) the firm always choosing projects with positive NPVs; II) stockholders turning down low-risk, low-return but positive NPV projects; III) the firm declaring and paying high cash dividends

II and III only

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

II and III only

The main advantage of debt financing for a firm is: I) no SEC registration is required for bond issues; II) interest expenses are tax deductible; III) unlevered firms have higher value than levered firms

II only

What are some of the possible consequences of financial distress? I) Bondholders, who face the prospect of getting only part of their money back, will likely want the company to take additional risks. II) Equity investors would like the company to cut its dividend payments to conserve cash. III) Equity investors would like the firm to shift toward riskier lines of business.

III only

Most financial economists attribute the drop in the price of equity subsequent to the announcement of a new issue to

Information effect

Suppose that a company can direct $1 to either debt interest or capital gains for equity investors. If there were no personal taxes on capital gains, which of the following investors would not care how the money was channeled? (The marginal corporate tax rate is 21 percent.)

Investors paying personal tax of 21 percent

Shelf registration is more often used for the

Issue of corporate bonds

A poison pill defense may be implemented by

Issuing rights that allow existing shareholders to buy stock at a bargain price

What is the likely impact on a typical individual investor if a firm undertakes a stock repurchase in lieu of a cash dividend?

Lower income taxes, if capital gains tax rates are less than dividend tax rates

Different classes of stocks are usually issued in order to

Maintain ownership control, by holding the class of stock with greater voting rights

Beta is a measure of

Market Risk

To calculate the total value of the firm (V), one should rely on the

Market values of debt and equity

If a bond is junior or subordinated, it

Must give preference to senior creditors in the event of default

The rare event in which a firm's existing directors and management compete with outsiders for the effective control of the corporation is called a

Proxy contest

Project X has the following cash flows: C0 = +2,000, C1 = -1,300, and C2 = -1,500. If the IRR of the project is 25 percent and if the cost of capital is 18 percent, you would

Reject the project This is a loan project (i.e., borrowing) with IRR greater than the cost of capital. Therefore, reject it.

The trade-off theory of capital structure predicts that

Safe firms should borrow more than risky ones

The main reason for the recent migration of a large number of firms from public-to-private ownership is

Sarbanes-Oxley Act

Firms looking to raise funds will file registration statements with the

Securities and Exchange commission (SEC)

Preference in position among creditors when it comes to repayment is called

Seniority

As a provider of funds to a corporation, owning which of the following corporate securities will give you the strongest rights to cash flow?

Short-term bank loan

Who usually gains the most in a merger?

Target firm's shareholders

Which of the following investment rules has the value additivity property?

The NPV Method

Generally, initial public offerings (IPOs) are

Underpriced

The type of the risk that can be eliminated by diversification is called

Unique risk

The possibility that the winner (highest bidder) in an auction process may have bid a price that is very high (far above the value) is called

Winner's curse

Generally, which of the following is true? (b = beta)

bD < bA < bE

According to the trade-off theory of capital structure,

optimal capital structure occurs when the present value of tax savings on account of additional borrowing just offsets the increase in the present value of costs of distress.

Generally, which of the following is true?

rE > rA > rD

The IRR is defined as

the discount rate that makes a project's NPV equal to zero.

The WACC formula calculates the cost of capital for the "average risk" project.

True

The pecking order theory implies that firms prefer internal to external financing.

True

True or False: The gain from a merger is computed as Gain = PVAB − (PVA + PVB).

True

U.S. firms, in general, have been repurchasing shares and thus net equity issues have been negative.

True

If investors do not like dividends because of the additional taxes that they have to pay, how would you expect stock prices to behave on the ex-dividend date?

Fall by less than the amount of the dividend

If a stock were underpriced, it would plot

Above the security market line.

Which of the following is NOT a sensible reason for a firm to rely on internal funds? - Equity issues are generally expensive - A new bond issue may drive the firm's debt ratio too high - Financial markets interpret the issuance of equity unfavorably

All of these are sensible reasons to rely on internal funds

For a levered firm,

As EBIT increases, EPS increases by a larger percentage

For an all-equity firm,

As EBIT increases, the EPS increases by the same percentage

Generally investors interpret the announcement of a decrease in dividends as:

Bad news, and stock price drops

On a graph with common stock returns on the y-axis and market returns on the x-axis, the slope of the regression line represents

Beta

Suppose a firm sets aside assets to protect particular investors. These assets are called

Collateral

As a provider of funds to a corporation, owning which of the following corporate securities will give you the most control rights?

Common stock

The APV method includes the NPV of a project assuming all-equity financing and then adds in the NPV of financing effects. The financing effects are

Cost of issuing new securities, cost of financial distress, tax subsidy of debt, and other subsidies.

The following are sensible motives for mergers EXCEPT - Economies of scale - Complementary resources - Diversification - Eliminating inefficiencies

Diversification

Which of these dates, when arranged in chronological order, occurs last?

Dividend Payment Date

Modigliani and Miller's Proposition I states that

The market value of any firm is independent of its capital structure

In Miller's model, when the quantity (1 − TC)(1 − TpE) = (1 − Tp), then

The tax shield on debt is exactly offset by higher personal taxes paid on interest income

A project will have only one internal rate of return if

There is a one-sign change in the cash flows.

"Accept investments that have positive net present values" is called the net present value rule.

True

According to Modigliani and Miller Proposition II, the cost of equity increases as more debt is issued, but the weighted average cost of capital remains unchanged.

True

Compared to normal bondholders, convertible bondholders have a greater interest in seeing the firm's stock price increase.

True

Consider the impact of inflation risk on the term structure of interest rates. If investors become more wary of inflation, one would expect to observe a steeper, more upwards sloping, term structure of interest rates.

True

Financial intermediaries provide the following important functions for the economy: the payment mechanism, borrowing and lending, and pooling of risks.

True

Financial leverage increases the expected return and risk of the shareholder.

True

Investors require higher returns on levered equity than on equivalent unlevered equity.

True

Risk shifting, refusing to contribute equity, and playing for time are some of the consequences of firms facing bankruptcy.

True