Saint MBA570 module 7 quiz

Question 1. 1. Nielson Motors (NM) has no debt. Its assets will be worth $600 million in one year if the economy is strong, but only $300 million if the economy is weak. Both events are equally likely. The market value today of Nielson's assets is $400 million. Suppose the risk-free interest rate is 4%. If Nielson borrows $150 million today at this rate and uses the proceeds to pay an immediate cash dividend, then according to Modigliani and Miller, the market value of its equity just alter the dividend is paid would be closest to __________. (Points : 10) $0 $150 million $250 million $400 million

Question 2. 2. Which of the following is not one of Modigliani and Miller's sets of conditions referred to as perfect capital markets? (Points : 10) All investors hold the efficient portfolio of assets. There are no taxes, transaction costs, or issuance costs associated with security trading. A firm's financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them. Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows.

Question 3. 3. Galt Industries has no debt, total equity capitalization of $600 million, and an equity beta of 1.2. Included in Galt's assets is $90 million in cash and risk-free securities. Assume the risk-free rate is 4% and the market risk premium is 6%. Galt's enterprise value is closest to __________. (Points : 10) $90 million $510 million $600 million $690 million

Question 4. 4. Which of the following statements is false? (Points : 10) Since the publication of their original paper, Modigliani and Miller’s ideas have greatly influenced finance research and practice. Modigliani and Miller’s Proposition I was one of the first arguments to show that the Law of One Price could have strong implications for security prices and firm values in a competitive market; it marks the beginning of the modern theory of corporate finance. Modigliani and Miller’s Proposition I holds even with taxes and transaction costs. The conservation of value principle for financial markets states that with perfect capital markets, financial transactions neither add nor destroy value, but instead represent a repackaging of risk (and therefore return).

Question 5. 5. Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%. Rosewood's net income is closest to __________. (Points : 10) $450 million $179 million $290 million $95 million

Question 6. 6. Flagstaff Enterprises has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket. If Flagstaff has $5 million in debt and $5 million in equity, then Flagstaff's after-tax WACC is closest to __________. (Points : 10) 10.25% 10.00% 9.63% 8.78%

Question 7. 7. KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt. KD has had consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares. The present value of KD's interest tax shield is closest to __________. (Points : 10) $130 million $200 million $400 million $70 million

Question 8. 8. Which of the following statements regarding recapitalizations is false? (Points : 10) With a recapitalization, even though leverage reduces the total value of equity, shareholders capture the benefits of the interest tax shield up front. Some of the original shareholders, those that sell their shares, do not benefit from the interest tax shield involved in a recapitalization. Leveraged recaps were especially popular in the mid- to late-1980s, when many firms found that these transactions could reduce their tax payments. When a firm makes a significant change to its capital structure, the transaction is called a recapitalization.

Question 9. 9. Which of the following statements is false? (Points : 10) The value of a firm is equal to the amount of money the firm can raise by issuing securities. By reducing a firm's corporate tax liability, debt allows the firm to pay more of its cash flows to investors. Equity investors must pay taxes on dividends but not capital gains. For individuals, interest payments received from debt are taxed as income.

Question 10. 10. Which of the following statements is false? (Points : 10)

If there is uncertainty regarding EBIT, then with a higher interest expense there is a greater risk that interest will exceed EBIT.
Even for a firm with positive earnings, growth will affect the optimal leverage ratio.
From a tax perspective, the firm's optimal level of debt is proportional to its current earnings.
The optimal proportion of debt in the firm's capital structure will be higher, the higher the firm’s growth rate.