1 An unlevered firm is a company that has:

an equal amount of debt and equity in the capital structure.

A)
more debt than equity in the capital structure.
B)
all debt in the capital structure.
C)
all equity in the capital structure.
D)
none of the above.
E)

2 An EPS - EBI chart shows the trade-off between financing plans and:
greater risk associated with debt financing which is evidenced by the greater
A) slope.
their breakeven point .
B)
the minimum earnings need to pay the debt financing.
C)
all of the above.
D)
none of the above.
E)

3 "A firm cannot change the total value of its outstanding securities by changing its
capital structure proportions." This is a statement:
of Modigliani-Miller Proposition I.
A)
of the Value Additivity Principle (VAP).
B)
of the Separation Theorem.
C)
of the First Principle of Valuation.
D)
none of the above.
E)

4 Homemade leverage is a term used to describe:

a firm borrowing at the risk-free rate.
A)
a firm skipping a dividend payment.
B)
individuals borrowing on their own account to buy shares in an unlevered
 C) firm.
individuals lending on their own account to sell shares in a levered firm.
D)
both a and b.
E)

5 The effect of financial leverage on the performance of the firm depends on:
the firm's level of EBIT.
A)
the rate of return on equity.
B)
the current market value of the debt.
C)
the rate of dividend growth.
D)
none of the above.
E)

6 MM Proposition II states that:

the expected return on equity is positively related to leverage.
A)
the required return on equity is a linear function of the firm's debt to equity
B) ratio.
the risk to equity increases with leverage.
C)
all of the above.
D)
only two of the above.
E)

7 A firm has a debt-to-equity ratio of .50. Its cost of debt is 12%. Its overall cost of
capital is 14%. What is its cost of equity if there are no taxes or other imperfections?
13%.
A)
16%.
B)
15%.
C)
18%.
D)
None of the above.
E)

8 If a firm is unlevered and has a cost of equity capital 9% what would the cost of equity
be if the firms became levered at 1.75? The expected cost of debt would be 7%.
15.75
A)
 16.0%.
B)
12.5%.
C)
14.5%.
D)
None of the above.
E)

9 The positive value to the firm of adding debt to the capital structure in the presence of
corporate taxes is:
due to the extra cashflow going to the investors of the firm instead of the
A) tax authorities.
due to the earnings before interest and taxes being fully taxed at the
B) corporate rate.
due to the generosity of the shareholders to protect the interests of the
C) debtholders.
because personal tax rates are the same as corporate tax rates.
D)
because shareholders prefer to let financial managers choose the capital
E) structure thus making their value independent of it.

10 A firm has zero debt in its capital structure. Its overall cost of capital is 8%. The firm is
considering a new capital structure with 50% debt. The interest rate on the debt would
be 5%. Assuming that the corporate tax rate is 40%, its cost of equity capital with the
new capital structure would be?
9.2%.
A)
9.8%.
B)
11%.
C)
8.9%.
D)
None of the above.
E)

11 A firm has a debt-to-equity ratio of 1.0. If it had no debt, its cost of equity would be
14%. Its cost of debt is 10%. What is its cost of equity if the corporate tax rate is
50%?
18.0%.
A)
16.0%.
B)
14.0%.
C)
12.0%.
 D)
None of the above.
E)
Your Results:
The correct answer for each question is indicated by a .

1 INCORRECT An unlevered firm is a company that has:

A)an equal amount of debt and equity in the capital structure.
B)more debt than equity in the capital structure.
C)all debt in the capital structure.
D)all equity in the capital structure.
E)none of the above.
Feedback: See p. 408

2 INCORRECT An EPS - EBI chart shows the trade-off between financing plans and:
A)greater risk associated with debt financing which is
evidenced by the greater slope.
B)their breakeven point .
C)the minimum earnings need to pay the debt financing.
D)all of the above.
E)none of the above.
Feedback: See p. 411-412
"A firm cannot change the total value of its outstanding securities by
3 CORRECT
changing its capital structure proportions." This is a statement:
A)of Modigliani-Miller Proposition I.
B)of the Value Additivity Principle (VAP).
C)of the Separation Theorem.
D)of the First Principle of Valuation.
E)none of the above.
Feedback: See p. 412

4 INCORRECT Homemade leverage is a term used to describe:

A)a firm borrowing at the risk-free rate.
B)a firm skipping a dividend payment.
C)individuals borrowing on their own account to buy shares in
an unlevered firm.
D)individuals lending on their own account to sell shares in a
levered firm.
E)both a and b.
Feedback: See p. 413-414
The effect of financial leverage on the performance of the firm
5 CORRECT
depends on:
A)the firm's level of EBIT.
B)the rate of return on equity.
 C)the current market value of the debt.
D)the rate of dividend growth.
E)none of the above.
Feedback: See p. 410-411

6 INCORRECT MM Proposition II states that:

A)the expected return on equity is positively related to
leverage.
B)the required return on equity is a linear function of the
firm's debt to equity ratio.
C)the risk to equity increases with leverage.
D)all of the above.
E)only two of the above.
Feedback: See p. 415-416
A firm has a debt-to-equity ratio of .50. Its cost of debt is 12%. Its
7 INCORRECT overall cost of capital is 14%. What is its cost of equity if there are no
taxes or other imperfections?
A)13%.
B)16%.
C)15%.
D)18%.
E)None of the above.
Feedback: Rationale: 14 = 1/3(4) + 2/3(X) 14 = 4 + 2/3X 10 -
2/3*X X = 15
If a firm is unlevered and has a cost of equity capital 9% what would
8 INCORRECT the cost of equity be if the firms became levered at 1.75? The
expected cost of debt would be 7%.
A)15.75
B)16.0%.
C)12.5%.
D)14.5%.
E)None of the above.
Feedback: Rationale: rs = 9 + 1.75(9 - 7) = 12.5
The positive value to the firm of adding debt to the capital structure in
9 CORRECT
the presence of corporate taxes is:
A)due to the extra cashflow going to the investors of the firm
instead of the tax authorities.
B)due to the earnings before interest and taxes being fully
taxed at the corporate rate.
C)due to the generosity of the shareholders to protect the
interests of the debtholders.
D)because personal tax rates are the same as corporate tax
rates.
E)because shareholders prefer to let financial managers
choose the capital structure thus making their value
 independent of it.
Feedback: See p. 423-424
A firm has zero debt in its capital structure. Its overall cost of capital
is 8%. The firm is considering a new capital structure with 50% debt.
10 INCORRECT The interest rate on the debt would be 5%. Assuming that
thecorporate tax rate is 40%, its cost of equity capital with the new
capital structure would be?
A)9.2%.
B)9.8%.
C)11%.
D)8.9%.
E)None of the above.
Feedback: Rationale: rs = 8 + (1 - .4)(1)(8-5) = 8 + 1.8 =
9.8%
A firm has a debt-to-equity ratio of 1.0. If it had no debt, its cost of
11 INCORRECT equity would be 14%. Its cost of debt is 10%. What is its cost of
equity if the corporate tax rate is 50%?
A)18.0%.
B)16.0%.
C)14.0%.
D)12.0%.
E)None of the above.
Feedback: Rationale: rs = 14 + 1.0(1 - .5)(14 - 10) = 14 + 2.0
= 16.0