Chapter 4 Capital Structure

M&M Proposition I with no tax supports the argument that:

• business risk determines the return on assets.

• the cost of equity rises as leverage rises.

• the debt-equity ratio of a firm is completely irrelevant.

• 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.

Which one of the following does not affect the total equity of a firm but does increase the number of shares outstanding?

• special dividend

• stock split

• share repurchase

• rights offer

Which one of these statements is correct?

• Capital structure has no effect on shareholder value.

• The optimal capital structure occurs when the cost of equity is minimized.

• The optimal capital structure maximizes shareholder value.

• shareholder value is maximized when WACC is also maximized.

Which one of the following makes the capital structure of a company irrelevant?

• taxes

• Interest tax shield

• Debt-equity ratio that is greater than 0 but less than 1

• Homemade leverage

The business risk of a company:

• depends on the company's level of unsystematic risk.

• is inversely related to the required return on the company's assets.

• has a positive relationship with the company's cost of equity.

• has no relationship with the required return on a company's assets according to M&M theory.