Corporate Finance EXIT EXAM ACCURATE TESTED VERSIONS OF THE EXAM FROM 2024, Exams of Finance

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Corporate Finance EXIT EXAM ACCURATE

TESTED VERSIONS OF THE EXAM FROM

2023TO 2024 | ACCURATE AND VERIFIED

ANSWERS | NEXT GEN FORMAT |

GUARANTEED PASS WITH 150 QUESTIONS

Modigliani and Miller's Proposition I states that: A. the market value of any firm is independent of its capital structure B. the market value of a firm's debt is independent of its capital structure C. the market value of a firm's common stock is independent of its capital structure D. none of the options

• CORRECT ANS-A. the market value of any firm is independent of its capital structure An investor can create the effect of leverage on his/her account by: I) buying equity of an unlevered firm; II) investing in risk-free debt like T-bills; III) borrowing on his/her own account A. I only

B. II only C. III only D. I and III only

• CORRECT ANS-D. I and III only If firm U is unlevered and firm L is levered, then which of the following is true: I) VU = EU. II) VL = EL + DL. III) VL = EU + DL. A. I only B. I and II only C. I, II, and III D. III only
• CORRECT ANS-B. I and II If an investor buys a portion (X) of an unlevered firm's equity, then his/her payoff is: A. (X) × (profits)

B. (X) × (interest) C. (X) × (profits - interest) D. (1/X) × (profits)

• CORRECT ANS-A. (X) × (profits) If an investor buys a portion (X) of both the debt and equity of a levered firm, then his/her payoff is: A. (X) × (profits) B. (X) × (interest) C. (X) × (profits - interest)
• CORRECT ANS-A. (X) × (profits) If an investor buys a portion (X) of the equity of a levered firm, then his/her payoff is: A. (X) × (profits) B. (X) × (interest) C. (X) × (profits - interest)

D. (1/X) × (profits - interest)

• CORRECT ANS-C. (X) × (profits - interest) The law of conservation of value implies that: A. the return on a firm's common stock is unchanged when debt is added to its capital structure. B. the value of any asset is preserved regardless of the nature of the claims against it. C. the return on a firm's debt is unchanged when common stock is added to its capital structure. D. the value of an asset increases as debt is reduced.
• CORRECT ANS-B. the value of any asset is preserved regardless of the nature of the claims against it An investor can undo the effect of leverage on his/her own account by: I) investing in the equity of a levered firm; II) borrowing on his/her own account; III) investing in risk-free debt like T-bills A. I only B. II only

C. III only D. I and III above

• CORRECT ANS-D. I and III above If an individual wants to borrow with limited liability, he/she should: A. invest in the equity of an unlevered firm. B. borrow on his/her own account. C. invest in the equity of a levered firm. D. invest in a risk-free asset like T-bills.
• CORRECT ANS-C. invest in the equity of a levered firm Value additivity works for: I) combining assets; II) splitting up of assets; III) the mix of debt securities issued by the firm A. I only B. II only C. I and II only

D. I, II, and III

• CORRECT ANS-D. I, II, and III The law of conservation of value implies that: I) the mix of senior and subordinated debt does not affect the value of the firm; II) the mix of convertible and nonconvertible debt does not affect the value of the firm; III) the mix of common stock and preferred stock does not affect the value of the firm A. I only B. II only C. III only D. I, II, and III
• CORRECT ANS-D. I, II, and III The law of conservation of value implies that: I) the mix of common stock and preferred stock does not affect the value of the firm; II) the mix of long-term and short-term debt does not affect the value of the firm; III) the mix of secured and unsecured debt does not affect the value of the firm A. I only

B. II only C. III only D. I, II, and III

• CORRECT ANS-D. I, II, and III Capital structure is irrelevant if: I) capital markets are efficient; II) each investor can borrow/lend on the same terms as the firm; III) there are no tax benefits to debt A. I only B. II only C. III only D. I, II, and III
• CORRECT ANS-D. I, II, and III For an all-equity firm,

A. as earnings before interest and taxes (EBIT) increases, the earnings per share (EPS) increases by the same percentage B. as EBIT increases, the EPS increases by a larger percentage C. as EBIT increases, the EPS decreases at the same rate D. as EBIT increases, the EPS decreases by a larger percentage

• CORRECT ANS-A. as EBIT increases, the EPS increases by the same percentage For a levered firm, A. as earnings before interest and taxes (EBIT) increases, the earnings per share (EPS) increases by the same percentage B. as EBIT increases, the EPS increases by a larger percentage C. as EBIT increases, the EPS decreases at the same rate D. as EBIT increases, the EPS decreases by a larger percentage
• CORRECT ANS-B. as EBIT increases, the EPS increases by a larger percentage An EPS-operating income graph, for different debt ratios, shows the: I) greater risk associated with debt financing, which is evidenced by a greater slope; II) the break-even point where EPS of two different debt ratios are equal; III) the minimum earnings needed to pay the debt financing for a given level of debt

A. I only B. II only C. III only D. I, II, and III only

• CORRECT ANS-D. I, II, and III only According to an EPS-operating income graph, debt financing is the preferred outcome in the case when expected operating income is: A. less than the break-even income. B. greater than the break-even income. C. equal to the break-even income. D. not able to be determined.
• CORRECT ANS-B. greater than the break-even income When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of operating income because interest payments on the debt:

A. vary with EBIT levels. B. stay fixed, leaving less income to be distributed over fewer shares. C. stay fixed, leaving less income to be distributed over more shares. D. stay fixed, leaving more income to be distributed over fewer shares. - CORRECT ANS-D. stay fixed, leaving more income to be distributed over fewer shares In an EPS-operating income graphical relationship, the slope of the debt line is steeper than the equity line. The debt line has a negative intercept because: A. the break-even point is higher with debt. B. a fixed interest charge must be paid even at low earnings. C. the amount of interest per share has only a positive effect on the intercept. D. the higher the interest rate, the greater the slope. - CORRECT ANS-B. a fixed interest charge must be paid even at low earnings The effect of financial leverage on the performance of the firm depends on the: A. expected rate of return on equity. B. firm's level of operating income.

C. current market value of the debt. D. rate of dividend growth. - CORRECT ANS-B. firm's level of operating income Health and Wealth Company is financed entirely by common stock that is priced to offer a 15% expected return. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected return on the common stock after refinancing? (Ignore taxes.) A. 18.0% B. 21.0% C. 15.0% D. 10.5% - CORRECT ANS-A. 18.0% rE = rA + (D/E)(rA - rD) = 15 + (0.25/0.75)(15 - 6) = 18%. Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected return. If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%, what is the expected return on its common stock after refinancing? A. 32% B. 28%

C. 20%

D. 14% - CORRECT ANS-A. 32%

RE = 0.2 + (0.5/0.5)(0.20 - 0.08) = 0.32 = 32%.

Wealth and Health Company is financed entirely by common stock that is priced to offer a 15% expected return. The common stock price is $40/share. The earnings per share (EPS) is expected to be $6. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected value of earnings per share after refinancing? (Ignore taxes.) A. $6. B. $7. C. $7. D. $6.90 - CORRECT ANS-C. $7. Firm borrows $10 per share. Interest per share = ($10)(0.06) = $0.60. New EPS = (6 - 0.60)/0. = $7.20/share. Note that the new expected return on equity is 18%. Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return. The stock price is $60 and the earnings per share are $12. If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%, what is the expected earnings per share value after refinancing? A. $12.

B. $19.

C. $24.

D. $15.60 - CORRECT ANS-B. $19.

MM Proposition II states that: I) the expected return on equity is positively related to leverage; II) the required return on equity is a linear function of the firm's debt to equity ratio; III) the risk to equity increases with leverage A. I only B. II only C. III only D. I, II, and III - CORRECT ANS-D. I, II, and III Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return. The stock price is $60 and the earnings per share are $12. The company wishes to repurchase 50% of the stock and substitutes an equal value of debt yielding 8%. Suppose that before refinancing, an investor owned 100 shares of Learn and Earn common stock. What should he do if he wishes to ensure that risk and expected return on his investment are unaffected by this refinancing?

A. Borrow $3,000 and buy 50 more shares. B. Continue to hold 100 shares. C. Sell 50 shares and purchase $3,000 of 8% debt (bonds). D. Sell 8% of his stock and invest in bonds. - CORRECT ANS-C. Sell 50 shares and purchase $3,000 of 8% debt (bonds) The refinancing results in a D/E ratio of 1.0. The new expected return on the stock increases from 20% to 32%. With 50 shares (worth $3,000) and $3,000 of 8% debt, the expected return remains at 0.5 × 32% + 0.5 × 8% = 20%. A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes, its cost of equity capital with the new capital structure would be: A. 8% B. 16% C. 13% D. 10% - CORRECT ANS-C. 13% rE = 10 + (60/40)(10 - 8) = 10 + 3 = 13 The cost of capital for a firm, rWACC, in a tax-free environment is: I) equal to the market value weighted average of the return on equity and the return on debt;

II) equal to rA, the rate of return for that business risk class; III) equal to the overall rate of return required on the levered firm A. I only B. II only C. III only D. I, II, and III - CORRECT ANS-D. I, II, and III A firm has a debt-to-equity ratio of 1.0. If it had no debt, its cost of equity would be 12%. Its cost of debt is 9%. What is its cost of equity if there are no taxes? A. 21% B. 18% C. 15% D. 16% - CORRECT ANS-C. 15% rE = 12 + 1.0(12 - 9) = 15%. A firm has a debt-to-equity ratio of 0.50. Its cost of debt is 10%. Its overall cost of capital is 14%. What is its cost of equity if there are no taxes?

A. 13%

B. 16%

C. 15%

D. 18% - CORRECT ANS-B. 16%

14 = 1/3 + (2/3)(X); solve for X; 42 = 10 + 2X; X = 16%. A firm is unlevered and has a cost of equity capital of 9%. What is the cost of equity if the firm becomes levered at a debt-equity ratio of 2? The expected cost of debt is 7%. (Assume no taxes.) A. 15.0% B. 16.0% C. 14.5% D. 13.0% - CORRECT ANS-D. 13.0% rE = 9 + 2(9 - 7) = 13%. A firm has a debt-to-equity ratio of 1. Its levered cost of equity is 16%, and its cost of debt is 8%. If there were no taxes, what would be its cost of equity if the debt-to-equity ratio were zero?

A. 8%

B. 10%

C. 12%

D. 14% - CORRECT ANS-C. 12%

16 = rA + 1(rA - 8); 16 = 2rA - 8; 24 = 2rA; rA = 12%. For a levered firm where bA = beta of assets and bD = beta of debt, the equity beta (bE) equals: A. bE = bA B. bE = bA + (D/E) × [bA - bD] C. bE = bA + (D/(D + E)) × [bA - bD] D. none of the options - CORRECT ANS-B. bE = bA + (D/E) × [bA - bD] The beta of an all-equity firm is 1.2. Suppose the firm changes its capital structure to 50% debt and 50% equity using 8% debt financing. What is the equity beta of the levered firm? The beta of debt is 0.2. (Assume no taxes.) A. 1. B. 2.

C. 2.

D. 1.7 - CORRECT ANS-B. 2.

βE = 1.2 + (0.5/0.5)(1.2 - 0.2) = 2.2. The equity beta of a levered firm is 1.2. The beta of debt is 0.2. The firm's market value debt to equity ratio is 0.5. What is the asset beta if the tax rate is zero? A. 1. B. 0. C. 0. D. 0.87 - CORRECT ANS-D. 0. 1.2 = βA + (0.5)( βA - 0.2); 1.5βA = 1.3; βA = 1.3/1.5 = 0. The asset beta of a levered firm is 1.1. The beta of debt is 0.3. If the debt equity ratio is 0.5, what is the equity beta? (Assume no taxes.) A. 1. B. 1. C. 0.

D. 0.15 - CORRECT ANS-A. 1.

bE = 1.1 + 0.5(1.1 - 0.3) = 1.5. Generally, which of the following is true? A. rD > rA > rE B. rE > rD > rA C. rE > rA > rD D. rA > rE > rD - CORRECT ANS-C. rE > rA > rD Generally, which of the following is true? A. rE < rD < rA B. rD < rA < rE C. rE < rA < rD D. rD < rE < rA - CORRECT ANS-B. rD < rA < rE Which of the following is true?

A. bD > bA > bE B. bE > bA > bD C. bA > bE > bD D. bA > bD > bE - CORRECT ANS-B. bE > bA > bD The M&M Company is financed by $4 million (market value) in debt and $6 million (market value) in equity. The cost of debt is 5% and the cost of equity is 10%. Calculate the weighted average cost of capital. (Assume no taxes.) A. 10% B. 15% C. 8% D. 7% - CORRECT ANS-C. 8% Weighted average cost of capital (WACC) = (4/10)(5) + (6/10)(10) = 2 + 6 = 8%. The M&M Company is financed by $10 million in debt (market value) and $40 million in equity (market value). The cost of debt is 10% and the cost of equity is 20%. Calculate the weighted average cost of capital assuming no taxes.

A. 18%

B. 20%

C. 10%

D. 12% - CORRECT ANS-A. 18%

WACC = (1/5)(10) + (4/5)(20) = 2 + 16 = 18%.

If the debt beta is zero, then the relationship between the equity beta and the asset beta is given by: A. equity beta = 1 + [(beta of assets)/(debt-equity ratio)] B. equity beta = (1 - debt-equity ratio)(beta of assets) C. equity beta = (1 + debt-equity ratio)(beta of assets) D. equity beta = 1 + (debt-equity ratio/ beta of assets) - CORRECT ANS-C. equity beta = (1 + debt-equity ratio)(beta of assets) Minimizing the weighted average cost of capital (WACC) is the same as maximizing the: A. market value of the firm.

B. book value of the firm. C. profits of the firm. D. liquidating value of the firm. - CORRECT ANS-A. market value of the firm The after-tax weighted average cost of capital (WACC) is given by (corporate tax rate = TC): A. WACC = (rD)(D/V) + (rE)(E/V) B. WACC = (rD)(D/V) +[(rE )(E/V)/(1 - TC)] C. WACC = [(rD)(D/V) + (rE)(E/V)]/(1 - TC) D. WACC = (rD)(1 - TC)(D/V) + (rE)(E/V) - CORRECT ANS-D. WACC = (rD)(1 - TC)(D/V) + (rE)(E/V) Assume the following data for U&P Company: Debt (D) = $100 million; Equity (E) = $300 million; rD = 6%; rE = 12%; and TC = 30%. Calculate the after-tax weighted average cost of capital (WACC): A. 10.50% B. 15.00% C. 10.05%

D. 9.45% - CORRECT ANS-C. 10.05%

After-tax WACC = (1/4)(1 - 0.3)(6) + (3/4)(12) = 10.05%. According to the graph of WACC for Union Pacific, which of the following is (are) true? I) The cost of equity is an increasing function of the debt-equity ratio. II) The cost of debt is an increasing function of the debt-equity ratio. III) The weighted average cost of capital (WACC) is a decreasing function of the debt-equity ratio. A. I only B. I and II only C. III only D. I, II, and III - CORRECT ANS-D. I, II, and III A firm's return on assets is 12% and the cost of the firm's debt is 7%. Given a 0.7 debt to equity ratio, what is the levered cost of equity? A. 7.0% B. 12.0% C. 13.6%

D. 15.5% - CORRECT ANS-D. 15.5%

Re = 0.12 + (.12 - .07) × 0.7 = .155 A firm's equity beta is 1.2 and its debt is risk free. Given a 0.7 debt to equity ratio, what is the firm's asset beta? (Assume no taxes.) A. 0.7 B. 1.0 C. 1.2 D. 0.0 - CORRECT ANS-A. 0.7 1.2 = BA + 0.7 × (BA - 0); 1.2 = 1.7BA; BA = (1.2/1.7) = 0.706. The main advantage of debt financing for a firm is: I) no SEC registration is required for bond issues; II) interest expenses are tax deductible; III) unlevered firms have higher value than levered firms A. I only B. II only

C. III only D. I and III only - CORRECT ANS-B. II only If a firm permanently borrows $100 million at an interest rate of 8%, what is the present value of the interest tax shield? (Assume that the marginal corporate tax rate is 30%.) A. $8.00 million B. $5.60 million C. $30.00 million D. $26.67 million - CORRECT ANS-C. $30.00 million PV of interest tax shield = (0.3)(100) = $30 million If a firm borrows $50 million for one year at an interest rate of 10%, what is the present value of the interest tax shield? Assume a 30% marginal corporate tax rate. A. $1.36 million B. $1.50 million C. $1.00 million