Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 16 Capital Structure
16.1 Capital Structure Choices
1) Financial managers prefer to choose the same debt level no matter which industry they
operate in.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
2) Even if two irms operate in the same industry, they may prefer diferent choices of debt-
equity ratios.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
3) Equity in a irm with no debt is called unlevered equity.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
4) The relative proportions of debt, equity, and other securities that a irm has outstanding
constitute its ________.
A) capital structure
B) dividend expense
C) retained earnings
D) paid out capital
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
1
5) A irm’s ________ ratio is the fraction of the irm’s total value that corresponds to debt.
A) debt-to-equity
B) equity-to-debt
C) debt-to-value
D) liability
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
6) Which of the following statements is FALSE?
A) The relative proportions of debt, equity, and other securities that a irm has outstanding
constitute its capital structure.
B) The most common choices are inancing through equity alone and inancing through a
combination of debt and equity.
C) A project’s net present value (NPV) represents the value to the new investors of a irm
created by the project.
D) When corporations raise funds from outside investors, they must choose which type of
security to issue.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
7) Equity in a irm with debt is called ________.
A) levered equity
B) risk-free equity
C) unlevered equity
D) preferred equity
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
2
8) Equity in a irm with no debt is called ________.
A) levered equity
B) unlevered equity
C) risk-free equity
D) preferred equity
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
9) Which of the following does a irm consider in the choice of securities issued?
A) the tax consequences of the chosen security
B) the transactions costs of the chosen security
C) whether the chosen security will have a fair price in the market
D) All of the above are considered.
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
10) What role do industries play in the capital structure choice for a irm?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
11) What is the capital structure of a irm?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
3
12) What considerations should managers have while deciding on irms’ capital structure?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
16.2 Capital Structure in Perfect Capital Markets
1) According to researchers Modigliani and Miller, with perfect capital markets, the total
value of a irm should not depend on its capital structure.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
2) With perfect capital markets, because diferent choices of capital structure ofer a
beneit to investors, the capital structure afects the value of a irm.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
3) A inancial manager makes a choice of the amount and source of capital based on how
the choice will impact the ________.
A) revenue
B) face value of bonds
C) depreciation
D) irm value
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
4
4) Investment cash lows are independent of inancing choices in a ________.
A) market with frictions
B) perfect capital market
C) setting with frictions in investment returns
D) irm with leverage
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
5) A project will give a one-time cash low of $22,000 after one year. If the project risk
requires a return of 10%, what is the levered value of the irm with perfect capital
markets?
A) $20,000
B) $16,000
C) $24,000
D) more information needed
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
6) A project will give a one-time cash low of $22,000 after one year. If the project risk
requires a return of 11%, what is the levered value of the irm with perfect capital
markets?
A) $15,855.86
B) $19,819.82
C) $23,783.78
D) more information needed
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
5
7) A irm will give a one-time cash low of $24,000 after one year. If the project risk
requires a return of 10%, what is the levered value of the irm with perfect capital
markets?
A) $17,454.55
B) $26,181.82
C) $21,818.18
D) more information needed
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
8) MM Proposition I states that in a perfect capital market the total value of a irm is equal
to the market value of the ________ generated by its assets.
A) earnings after taxes
B) earnings after interest
C) cash lows after taxes
D) free cash lows
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
9) It is not correct to discount the cash lows of a levered irm with the cost of equity of the
unlevered irm because ________.
A) leverage decreases the risk of equity of the irm
B) leverage changes the unlevered cost of equity
C) leverage increases the risk of the equity of the irm
D) cost of debt decreases in this setting
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
6
10) By adding leverage, the returns on a irm are split between debt holders and equity
holders, but equity holder risk increases because ________.
A) interest payments can be rolled over
B) dividends are paid irst
C) debt and equity have equal priority
D) interest payments have irst priority
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
11) In a setting where there is no risk that a irm will default, leverage ________ the risk of
equity.
A) increases
B) decreases
C) does not change
D) cannot say for sure
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
12) A irm requires an investment of $18,000 and will return $25,000 after one year. If the
irm borrows $10,000 at 6%, what is the return on levered equity?
A) 80%
B) 64%
C) 96%
D) 112%
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
7
13) A irm requires an investment of $20,000 and will return $26,500 after one year. If the
irm borrows $6000 at 7%, what is the return on levered equity?
A) 35%
B) 52%
C) 43%
D) 61%
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
14) A irm requires an investment of $25,000 and will return $36,500 after 1 year. If the
irm borrows $20,000 at 7%, what is the return on levered equity?
A) 162%
B) 202%
C) 242%
D) 283%
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
15) When investors use leverage in their own portfolios to adjust the leverage choice made
by the irm, it is referred to as ________.
A) outside debt
B) retained earnings
C) homemade leverage
D) payout ratio
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
16) A irm requires an investment of $30,000 and borrows $15,000 at 7%. If the return on
equity is 19%, what is the irm’s pretax WACC?
A) 13%
B) 6.5%
C) 15.6%
8
D) 18.2%
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
17) A irm requires an investment of $36,000 and borrows $12,000 at 9%. If the return on
equity is 20%, what is the irm’s pretax WACC?
A) 8.2%
B) 19.6%
C) 16.3%
D) 22.9%
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
18) A irm requires an investment of $30,000 and borrows $7500 at 7%. If the return on
equity is 18%, what is the irm’s pretax WACC?
A) 7.6%
B) 18.3%
C) 21.4%
D) 15.3%
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
19) A irm has a market value of equity of $30,000. It borrows $7500 at 8%. If the
unlevered cost of equity is 15%, what is the irm’s cost of equity capital?
A) 16.75%
B) 6.70%
C) 20.10%
D) 23.45%
The irm’s cost of equity capital = 15% + ($7500 / $30,000)(15% – 8%) = 16.75%
Dif: 2 Var: 48
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
20) A irm has a market value of equity of $30,000. It borrows $7500 at 8%. If the
unlevered cost of equity is 16%, what is the irm’s cost of equity capital?
A) 9.0%
B) 18.0%
C) 21.6%
D) 25.2%
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
21) A irm has a market value of equity of $40,000. It borrows $8000 at 7%. If the
unlevered cost of equity is 16%, what is the irm’s cost of equity capital?
A) 8.9%
B) 21.4%
C) 17.8%
D) 24.9%
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
22) Leverage can ________ a irm’s expected earnings per share, but does not necessarily
increase the share price.
A) decrease
B) dilute
C) increase
D) never change
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
23) In general, issuing equity may not dilute the ownership of existing shareholders if
________.