Cf2.C2.sum

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

• personal offset

• homemade leverage.

• the weighted average cost of capital.

The proposition that the value of the firm is independent of its capital structure is called:

A. the capital asset pricing model.

B. MM Proposition I (no taxes).

C. MM Proposition II (no taxes).

D. the law of one price.

• A

• B

• C

• D

The proposition that the cost of equity is a positive linear function of capital structure is called:

A. the capital asset pricing model.

B. MM Proposition I (no taxes).

C. MM Proposition II (no taxes).

D. the law of one price.

• A

• B

• C

• D

The unlevered cost of capital is:

A. the cost of capital for a firm with no equity in its capital structure.

B. the cost of capital for a firm with no debt in its capital structure.

C. the interest tax shield times pretax net income.

D. equal to the profit margin for a firm with some debt in its capital structure.

• A

• B

• C

• D

The effects of financial leverage depend on the operating earnings of the company. Based on this relationship, assume you graph the EPS and EBI for a firm, while ignoring taxes. Which one of these statements correctly states a relationship illustrated by the graph?

A. Financial leverage decreases the slope of the EPS line.

B. Below the break-even point unlevered structures have a lower EPS for every dollar of EBI than levered structures do.

C. Above the break-even point the increase in EPS for unlevered structures is greater than that of levered structures for every dollar increase in EBI.

D. Leverage only provides value above the break-even point.

• A

• B

• C

• D

A key underlying assumption of MM Proposition I without taxes is that:

A. financial leverage increases risk.

B. individuals can borrow at lower rates than corporations.

C. individuals and corporations borrow at the same rate.

D. managers always act to maximize the value of the firm.

• A

• B

• C

• D

In an EPS-EBI graphical relationship, the slope of the debt ray is steeper than the equity ray. The debt ray has a lower intercept because:

A. more shares are outstanding for the same level of EBI.

B. the break-even point is higher with debt.

C. a fixed interest charge must be paid even at low earnings.

D. the break-even point is lower with debt.

• A

• B

• C

• D

The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

A. levered firms pay less taxes compared with identical unlevered firms.

B. bondholders require higher rates of return than stockholders do.

C. dividends become a tax shield.

D. debt is more expensive than equity.

• A

• B

• C

• D

Bryan invested in Bryco stock when the firm was financed solely with equity. The firm now has a debt-equity ratio of .3. To maintain the same level of leverage he originally had, Bryan needs to:

A. borrow some money and purchase additional shares of Bryco stock.

B. maintain his current position in Bryco stock.

C. sell some shares of Bryco stock and hold the proceeds in cash.

D. sell some shares of Bryco stock and loan out the proceeds.

• A

• B

• C

• D

MM Proposition I with no tax supports the argument that:

A. business risk determines the return on assets.

B. the cost of equity rises as leverage rises.

C. it is completely irrelevant how a firm arranges its finances.

D. a firm should borrow money to the point where the tax benefit from debt is equal to the cost of the increased probability of financial distress.

• A

• B

• C

• D