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B) the new shares are sold at a fair price
C) the irm has no debt inancing
D) the irm uses debt conservatively
Answer: B
Dif: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
24) Which of the following is NOT one of Modigliani and Miller's set of conditions referred
to as perfect capital markets?
A) All investors hold the eicient portfolio of assets.
B) There are no taxes, transaction costs, or issuance costs associated with security trading.
C) A irm's inancing decisions neither change the cash lows generated by its investments,
nor do they reveal new information about them.
D) Investors and irms can trade the same set of securities at competitive market prices
equal to the present value (PV) of their future cash lows.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
11
25) Which of the following statements is FALSE?
A) The Law of One Price implies that leverage will afect the total value of a irm under
perfect capital market conditions.
B) In the absence of taxes or other transaction costs, the total cash low paid out to all of a
irm's security holders is equal to the total cash low generated by the irm's assets.
C) With perfect capital markets, leverage merely changes the allocation of cash lows
between debt and equity, without altering the total cash lows of a irm.
D) In a perfect capital market, the total value of a irm is equal to the market value of the
total cash lows generated by its assets and is not afected by its choice of capital structure.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
26) Which of the following statements is FALSE?
A) As long as a irm's choice of securities does not change the cash lows generated by its
assets, the capital structure decision will not change the total value of the irm or the
amount of capital it can raise.
B) If securities are fairly priced, then buying or selling securities has a net present value
(NPV) of zero and, therefore, should not change the value of a irm.
C) The future repayments that the irm must make on its debt are equal in value to the
amount of the loan it receives up front.
D) An investor who would like more leverage than the irm has chosen can lend and add
leverage to his or her own portfolio.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
12
27) Which of the following statements is FALSE?
A) As long as investors can borrow or lend at the same interest rate as a irm, homemade
leverage is a perfect substitute for the use of leverage by the irm.
B) When investors use leverage in their own portfolios to adjust the leverage choice made
by a irm, we say that they are using homemade leverage.
C) The value of a irm is determined by the present value (PV) of the cash lows from its
current and future investments.
D) The investor can re-create the payofs of unlevered equity by borrowing and using the
proceeds to purchase the equity of a irm.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
28) Which of the following statements is FALSE?
A) When a irm borrows money to repurchase shares that account for a signiicant
percentage of its outstanding shares, the transaction is called a leveraged recapitalization.
B) MM Proposition I applies to capital structure decisions made at any time during the life
of a irm.
C) By choosing positive-NPV projects that are worth more than their initial investment, a
irm can enhance its value.
D) The choice of capital structure does not change the value of a irm if the cost of equity is
higher than the cost of debt.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
13
29) Which of the following statements is FALSE?
A) Investors can alter the leverage choice of a irm to suit their personal tastes either by
borrowing and reducing leverage or by holding bonds and adding more leverage.
B) As per MM proposition II, the cost of capital of levered equity is equal to the cost of
capital of unlevered equity plus a premium that is proportional to the debt-equity ratio.
C) The MM propositions imply that the true role of a irm’s inancial policy is to deal with
inancial market imperfections such as taxes and transaction costs.
D) In practice, we will ind that capital structure can have an efect on a irm’s value.
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Previous Edition
Use the information for the question(s) below.
Consider two irms, Firm X and Firm Y, that have identical assets that generate identical
cash lows. Firm Y is an all-equity irm, with 1 million shares outstanding that trade for a
price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at
an interest rate of 5%.
30) According to MM Proposition I, the stock price for Firm X is closest to ________.
A) $8.00
B) $24.00
C) $6.00
D) $12.00
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Previous Edition
14
31) Assume that MM's perfect capital markets conditions are met and that you can borrow
and lend at the same 5% rate as Firm X. You have $5000 of your own money to invest and
you plan on buying Firm Y stock. Using homemade leverage, how much do you need to
borrow in your margin account so that the payof of your margined purchase of Firm Y
stock will be the same as a $5,000 investment in Firm X stock?
A) $10,000
B) $5,000
C) $2,500
D) $0
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Previous Edition
15
32) Assume that MM's perfect capital markets conditions are met and that you can borrow
and lend at the same 5% rate as Firm X. You have $5,000 of your own money to invest and
you plan on buying Firm Y stock. Using homemade leverage you borrow enough in your
margin account so that the payof of your margined purchase of Firm Y stock will be the
same as a $5,000 investment in Firm X stock. The number of shares of Firm Y stock you
purchased is closest to ________.
A) 425
B) 1,650
C) 2,000
D) 825
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Previous Edition
33) Assume that MM's perfect capital markets conditions are met and that you can borrow
and lend at the same 5% rate as Firm X. You have $5,000 of your own money to invest and
you plan on buying Firm X stock. Using homemade (un)leverage, how much do you need to
invest at the risk-free rate so that the payof of your account will be the same as a $5,000
investment in Firm Y stock?
A) $5,000
B) $0
C) $2,500
D) $4,000
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Previous Edition
16
34) Assume that MM's perfect capital markets conditions are met and that you can borrow
and lend at the same 5% rate as Firm X. You have $5,000 of your own money to invest and
you plan on buying Firm X stock. Using homemade (un)leverage you invest enough at the
risk-free rate so that the payof of your account will be the same as a $5,000 investment in
Firm Y stock. The number of shares of Firm X stock you purchased is closest to ________.
A) 100
B) 417
C) 1,650
D) 825
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Revised
Use the information for the question(s) below.
Luther is a successful logistical services irm that currently has $5 billion in cash. Luther
has decided to use this cash to repurchase shares from its investors and has already
announced the stock repurchase plan. Currently Luther is an all-equity irm with 1.25
billion shares outstanding. Luther's shares are currently trading at $20 per share.
35) The market value of Luther's non-cash assets is closest to ________.
A) $20 billion
B) $19 billion
C) $25 billion
D) $24 billion
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
36) After the repurchase, how many shares will Luther have outstanding?
A) 0.75 billion
B) 1.0 billion
C) 1.1 billion
D) 1.2 billion
Explanation: B) Shares repurchased = $5 billion / $20 Share = 0.250 billion
Shares outstanding = 1.25 billion - 0.25 billion = 1.0 billion
Dif: 2 Var: 1
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
37) With perfect capital markets, what is the market value of Luther's equity after the
share repurchase?
A) $15 billion
B) $10 billion
C) $25 billion
D) $20 billion
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Revised
38) With perfect capital markets, what is the market price per share of Luther's stock after
the share repurchase?
A) $20
B) $24
C) $15
D) $25
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Revised
18
39) Assume that in addition to 1.25 billion common shares outstanding, Luther has stock
options given to employees valued at $2 billion. The market value of Luther's non-cash
assets is closest to ________.
A) $22 billion
B) $20 billion
C) $25 billion
D) $18 billion
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Revised
40) Assume that in addition to 1.25 billion common shares outstanding, Luther has stock
options given to employees valued at $2 billion. After the repurchase how many shares will
Luther have outstanding?
A) 1.15 billion
B) 1.2 billion
C) 0.75 billion
D) 1.1 billion
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
Consider the following equation for the question(s) below.
E + D = U = A
41) The E in the equation above represents ________.
A) the value of the irm's equity
B) the value of the irm's debt
C) the value of the irm's unlevered equity
D) the market value of the irm's assets
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
19
42) The U in the equation above represents ________.
A) the value of the irm's equity
B) the market value of the irm's assets
C) the value of the irm's unlevered equity
D) the value of the irm's debt
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
43) The A in the equation above represents ________.
A) the value of the irm's debt
B) the market value of the irm's assets
C) the value of the irm's equity
D) the value of the irm's unlevered equity
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
44) Which of the following statements is FALSE?
A) While debt itself may be cheap, it increases the risk and therefore the cost of capital of
the irm's equity.
B) Although debt does not have a lower cost of capital than equity, we can consider this
cost in isolation.
C) We can use MM Proposition I to derive an explicit relationship between leverage and the
equity cost of capital.
D) The total market value of the irm's securities is equal to the market value of its assets,
whether the irm is unlevered or levered.
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Previous Edition
20
