The cost of debt is generally lower than the cost of equity.

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True

False

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M&M’s Proposition I states that a company’s value is independent of its capital structure.

Top of Form

True

False

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A higher level of leverage generally reduces managerial discretion.

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True

False

Bottom of Form

The Pecking Order Theory of capital structure implies a unique optimum capital structure.

Top of Form

True

False

Bottom of Form

As EBIT drops, the return on equity (ROE) of a levered firm drops ______ the ROE of an otherwise identical unlevered firm.

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the same as

relatively more than

relatively less than

more or less than (it cannot be determined)

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Shareholders prefer high risk projects when facing a high probability of bankruptcy because

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High risk projects usually bring high rewards.

Shareholders have the residual claim on a company.

Creditors have the residual claim on a company, and therefore bear the risk.

There is a good chance the government will rescue them in bankruptcy.

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The _________ states that the value of the firm is determined solely by the value of its assets.

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Static Tradeoff Model

M&M proposition I

The Pecking Order Model

Agency Theory

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Which of the following expresses the value of a levered firm (VL) in the Static Tradeoff model of optimal capital structure? [Note: VU denotes the value of the unlevered firm; CFD denotes expected costs of financial distress; and PV denotes present value.]

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VL = PV(Tax Shield) – PV(CFD)

VL = VU + PV(Tax Shield) / PV(CFD)

VL = VU + PV(Tax Shield) – PV(CFD)

VL = VU + PV(Tax Shield)

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A example of indirect costs of bankruptcy is

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Court costs

Attorney and advisor fees

Lost sales due to costumers and suppliers lost trust

All of the above

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Which of the following are equivalent under M&M proposition I?

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Maximizing firm value and maximizing firm profit

Maximizing firm value and minimizing the cost of capital

Minimizing firm’s cost of capital and minimizing firm’s debt burden

Maximizing profit and minimizing taxes

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