Answer Choices:
a. True
b. False
Answer: a. True
Question: A major contribution of the Miller model is that it demonstrates, other things held constant, that
personal taxes increase the value of using corporate debt.
personal taxes lower the value of using corporate debt.
personal taxes have no effect on the value of using corporate debt.
financial distress and agency costs reduce the value of using corporate debt.
debt costs increase with financial leverage.
Answer Choices:
a. personal taxes increase the value of using corporate debt.
b. personal taxes lower the value of using corporate debt.
c. personal taxes have no effect on the value of using corporate debt.
d. financial distress and agency costs reduce the value of using corporate debt.
e. debt costs increase with financial leverage.
Answer: b. personal taxes lower the value of using corporate debt.
Question: Companies HD and LD have identical tax rates, total assets, total investor-supplied capital, and returns on investors’ capital (ROIC), and their ROICs exceed their after-tax costs of debt, r_d(1 − T). However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT?
Company HD has a higher net income than Company LD.
Company HD has a lower ROA than Company LD.
Company HD has a lower ROE than Company LD.
The two companies have the same ROA.
The two companies have the same ROE.
Answer Choices:
a. Company HD has a higher net income than Company LD.
b. Company HD has a lower ROA than Company LD.
c. Company HD has a lower ROE than Company LD.
d. The two companies have the same ROA.
e. The two companies have the same ROE.
Answer: b. Company HD has a lower ROA than Company LD.
Question: The Modigliani and Miller (MM) articles implicitly assumed, among other things, that outside stockholders have the same information about a firm’s future prospects as its managers. That was called “symmetric information,” and it is questionable. The introduction of “asymmetric information” led to the development of the “signaling” theory of capital structure, which postulated that firms are reluctant to issue new stock because investors will interpret such an act as a signal that the firm’s managers are worried about its future. Other actions give off different signals, and the end result is that capital structure is affected by managers’ perceptions about how their financing decisions will affect investors’ views of the firm and thus its value.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT, holding other things constant?
In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.
There is no reason to think that changes in the personal tax rate would affect firms’ capital structure decisions.
A firm with a relatively high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.
If a firm’s after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt.
Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity.
Answer Choices:
a. In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.
b. There is no reason to think that changes in the personal tax rate would affect firms’ capital structure decisions.
c. A firm with a relatively high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.
d. If a firm’s after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt.
e. Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity.
Answer: d. If a firm’s after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt.
Question: Other things held constant, firms with more stable and predictable sales tend to use more debt than firms with less stable sales.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Other things held constant, the lower a firm’s tax rate, the more logical it is for the firm to use debt.
Answer Choices:
a. True
b. False
Answer: b. False
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.
Answer Choices:
a. True
b. False
Answer: a. True
Question: 4: If a firm borrows money, it is using financial leverage.
Answer Choices:
a. True
b. False
Answer: a. True
Question: According to Modigliani and Miller (MM), in a world with corporate income taxes the optimal capital structure calls for approximately 100% debt financing.
Answer Choices:
a. True
b. False
Answer: a. True