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Question
Modigliani and Miller's first article led to the conclusion that capital structure is "irrelevant" because it has no effect on a firm's value. However, that article was criticized because it assumed that no taxes existed. MM then revised their original article to include corporate taxes, and this model led to the conclusion that a firm's value would be maximized if it used (almost) 100% debt.
a. True
b. False
Answer
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Related questions
Q:
Master Card and other credit card issuers must by law print the Annual Percentage Rate (APR) on their monthly statements. If the APR is stated to be 19.25%, with interest paid monthly, what is the card's EFF%?
a. 21.04%
b. 19.57%
c. 20.20%
d. 17.68%
e. 23.15%
Q:
What's the future value of $4,500 after 5 years if the appropriate interest rate is 6%, compounded semiannually?
a. $5,321.91
b. $6,047.62
c. $4,777.62
d. $4,959.05
e. $4,656.67
Q:
Your father paid $10,000 (CF at t = 0) for an investment that promises to pay $750 at the end of each of the next 5 years, then an additional lump sum payment of $11,500 at the end of the 5th year. What is the expected rate of return on this investment?
a. 9.96%
b. 5.19%
c. 12.11%
d. 10.42%
e. 10.86%
Q:
You sold a car and accepted a note with the following cash flow stream as your payment. What was the effective price you received for the car assuming an interest rate of 13.0%?
0 1 2 3 4
CFs: $0 $1,000 $2,000 $2,000 $2,000
a. $5,267
b. $5,064
c. $5,672
d. $6,330
e. $4,304
Q:
Some of these questions are just definitions, but others require real thought about the make-up of the ratios and relationships among the ratios. We tell our students that to answer some of these questions it is useful (1) to write out the relevant ratio or ratios, (2) then to think about how the ratios would change if the accounting data changed, and (3) occasionally to make up illustrative data to test their conclusions.
Q:
Refer to Exhibit 4.1. What is the firm's market-to-book ratio? Do not round your intermediate calculations.
a. 1.82
b. 1.55
c. 1.72
d. 1.42
e. 1.89
Q:
Refer to Exhibit 4.1. What is the firm's total debt to total capital ratio? Do not round your intermediate calculations.
a. 43.14%
b. 47.76%
c. 58.04%
d. 53.93%
e. 51.36%
Q:
Some people--including the former chairman of the Federal Reserve Board of Governors (Ben Bernanke) --have argued that one advantage of corporate debt from the stockholders' standpoint is that the existence of debt forces managers to focus on cash flow and to refrain from spending too much of the firm's money on private plane and other "perks." This is one of the factors that led to the rise of LBOs and private equity firms.
a. True
b. False
Q:
Modigliani and Miller (MM), in their second article, took account of taxes, bankruptcy, and other factors that were assumed away in their original article. Once they took account of all these assumptions, they concluded that every firm has a unique optimal capital structure. Moreover, a manager can use the second MM model to determine his or her firm's optimal debt ratio.
a. True
b. False
Q:
The Miller model begins with the Modigliani and Miller (MM) model without corporate taxes and then adds personal taxes.
a. True
b. False
Q:
As the text indicates, a firm's financial risk can and should be divided into separate market and diversifiable risk components.
a. True
b. False
Q:
It is possible for Firms A and B to have identical financial and operating leverage, yet for Firm A to have more risk as measured by the variability of EPS. This would occur if Firm A has more business risk than Firm B.
a. True
b. False
Q:
Thomson Media is considering some new equipment whose data are shown below. The equipment has a 3-year tax life. Under the new tax law, the equipment is eligible for 100% bonus depreciation, so it will be fully depreciated at t = 0. The equipment would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, additional net operating working capital (NOWC) would be required, but it would be recovered at the end of the project's life. Revenues and operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? Do not round the intermediate calculations and round the final answer to the nearest whole number.
WACC 10.0%
Equipment cost $70,000
Required net operating working capital (NOWC) $10,000
u200b u200b
Annual sales revenues $61,000
Annual operating costs $30,000
Expected pre-tax salvage value $5,000
Tax rate 25.0%
a. $5,650
b. $378
c. $344
d. $8,521
e. $2,543
Q:
Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT?
a. The yield curve should be downward sloping, with the rate on a 1-year bond at 6%.
b. The interest rate today on a 2-year bond should be approximately 6%.
c. The interest rate today on a 2-year bond should be approximately 7%.
d. The interest rate today on a 3-year bond should be approximately 7%.
e. The interest rate today on a 3-year bond should be approximately 8%.
Q:
Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?
a. In equilibrium, long-term rates must be equal to short-term rates.
b. An upward-sloping yield curve implies that future short-term rates are expected to decline.
c. The maturity risk premium is assumed to be zero.
d. Inflation is expected to be zero.
e. Consumer prices as measured by an index of inflation are expected to rise at a constant rate.
Q:
In the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.1(t 1)%, where t is the number of years until the bond matures. Given this information, which of the following statements is CORRECT?
a. The yield on 2-year Treasury securities must exceed the yield on 5-year Treasury securities.
b. The yield on 5-year Treasury securities must exceed the yield on 10-year corporate bonds.
c. The yield on 5-year corporate bonds must exceed the yield on 8-year Treasury bonds.
d. The yield curve must be "humped."
e. The yield curve must be upward sloping.
Q:
A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells for $825. If the yield to maturity remains at its current rate, what will the price be 5 years from now?
a. $801.76
b. $626.38
c. $843.52
d. $835.17
e. $726.60
Q:
Adams Enterprises noncallable bonds currently sell for $1,480. They have a 15-year maturity, an annual coupon of $85, and a par value of $1,000. What is their yield to maturity?
a. 3.31%
b. 4.14%
c. 3.52%
d. 4.55%
e. 4.64%
Q:
The indenture contains covenants that restrict the use of additional debt.
a. 1, 3, 4, 6
b. 1, 4, 6
c. 1, 2, 3, 4, 6
d. 1, 2, 3, 4, 5, 6
e. 1, 3, 4, 5, 6
Q:
Which of the following statements is CORRECT?
a. A zero coupon bond of any maturity will have more price risk than any coupon bond, even a perpetuity.
b. If their maturities and other characteristics were the same, a 5% coupon bond would have more price risk than a 10% coupon bond.
c. A 10-year coupon bond would have more reinvestment risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of reinvestment risk.
d. A 10-year coupon bond would have more price risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of price risk.
e. If their maturities and other characteristics were the same, a 5% coupon bond would have less price risk than a 10% coupon bond.
Q:
Last year Jandik Corp. had $270,000 of assets (which is equal to its total invested capital), $18,750 of net income, and a debt-to-total-capital ratio of 37%. Now suppose the new CFO convinces the president to increase the debt-to-total-capital ratio to 48%. Sales, total assets and total invested capital will not be affected, but interest expenses would increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged. By how much would the change in the capital structure improve the ROE? Do not round your intermediate calculations.
a. 2.77%
b. 2.15%
c. 1.87%
d. 2.33%
e. 2.75%
Q:
Wie Corp's sales last year were $250,000, and its year-end total assets were $355,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.4. The firm's new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average, holding sales constant? Do not round your intermediate calculations.
a. $250,833
b. $263,375
c. $268,392
d. $208,192
e. $228,258
Q:
Song Corp's stock price at the end of last year was $28.50 and its earnings per share for the year were $1.30. What was its P/E ratio?
a. 22.58
b. 18.85
c. 21.48
d. 21.92
e. 20.39
Q:
Herring Corporation has operating income of $275,000 and a 25% tax rate. The firm has short-term debt of $143,000, long-term debt of $323,000, and common equity of $466,000. What is its return on invested capital?
a. 20.88%
b. 21.46%
c. 22.13%
d. 23.38%
e. 24.23%
Q:
X-1 Corp's total assets at the end of last year were $365,000 and its EBIT was $52,500. What was its basic earning power (BEP) ratio?
a. 14.10%
b. 14.67%
c. 17.40%
d. 13.23%
e. 14.38%
Q:
Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are not useful for visualizing complex problems prior to doing actual calculations.
c. Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.
e. Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.
Q:
Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are not useful for visualizing complex problems prior to doing actual calculations.
c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.
e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.
Q:
Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are useful for visualizing complex problems prior to doing actual calculations.
c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods.
e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.
Q:
When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage declines in the loan's later years.
a. True
b. False
Q:
As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).
a. True
b. False