FINA Chp 17

Which of the following entities likely has the highest cost of financial distress? A pharmaceuticals development company A yacht leasing company A downtown bayfront hotel A real estate investment trust

A pharmaceuticals development company The more tangible the assets available to liquidate, the lower the cost to exercise bankruptcy.

MM Proposition II states that: I) the expected return on equity is positively related to leverage; II) the required return on equity is a linear function of the firm's debt to equity ratio; III) the risk to equity increases with leverage I, II, and III I only II only III only

I, II, and III

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

Stock price is too high.

If an individual wants to borrow with limited liability, he/she should: invest in a risk-free asset like T-bills. borrow on his/her own account. invest in the equity of a levered firm. invest in the equity of an unlevered firm.

invest in the equity of a levered firm.

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

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

Generally, which of the following is true? rD > rA > rE rA > rE > rD rE > rD > rA rE > rA > rD

rE > rA > rD

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

βE = 1.2 + (0.5/0.5)(1.2 - 0.2) = 2.2.

Assume the marginal corporate tax rate is 30%. The firm has no debt in its capital structure. It is valued at $100 million. What would be the value of the firm if it issued $50 million in perpetual debt and repurchased the same amount of equity? $115 million $100 million $150 million $65 million

VU = 100; (TC)(B) = 0.3(50) = 15; VL = VU + TCB = 100 + 15 = $115.

The M&M Company is financed by $4 million (market value) in debt and $6 million (market value) in equity. The cost of debt is 5% and the cost of equity is 10%. Calculate the weighted average cost of capital. (Assume no taxes.) 10% 7% 8% 15%

Weighted average cost of capital (WACC) = (4/10)(5) + (6/10)(10) = 2 + 6 = 8%.

For a levered firm: as EBIT increases, EPS decreases by a larger percentage. as EBIT increases, EPS decreases by the same percentage. as earnings before interest and taxes (EBIT) increases, earnings per share (EPS) increases by the same percentage. as EBIT increases, EPS increases by a larger percentage.

as EBIT increases, EPS increases by a larger percentage.

Which of the following is true? bA > bE > bD bD > bA > bE bE > bA > bD bA > bD > bE

bE > bA > bD