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The trade-off theory states that capital structure decisions involve a tradeoff between the costs and benefits of debt financing.

A) True
B) False

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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

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Dyson Inc.currently finances with 20.0% debt (i.e. ,wd = 20%) ,but its new CFO is considering changing the capital structure so wd = 62.5% by issuing additional bonds and using the proceeds to repurchase and retire common shares so the percentage of common equity in the capital structure (wc) = 1 - wd.Given the data shown below,by how much would this recapitalization change the firm's cost of equity? Do not round your intermediate calculations.(Hint: You must unlever the current beta and then use the unlevered beta to solve the problem. ) ​ Dyson Inc.currently finances with 20.0% debt (i.e. ,w<sub>d</sub> = 20%) ,but its new CFO is considering changing the capital structure so w<sub>d</sub> = 62.5% by issuing additional bonds and using the proceeds to repurchase and retire common shares so the percentage of common equity in the capital structure (w<sub>c</sub>) = 1 - w<sub>d</sub>.Given the data shown below,by how much would this recapitalization change the firm's cost of equity? Do not round your intermediate calculations.(Hint: You must unlever the current beta and then use the unlevered beta to solve the problem. ) ​ A) 9.18% B) 10.93% C) 11.39% D) 11.48% E) 9.64%


A) 9.18%
B) 10.93%
C) 11.39%
D) 11.48%
E) 9.64%

F) A) and B)
G) B) and E)

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Your company,which is financed entirely with common equity,plans to manufacture a new product,a cell phone that can be worn like a wristwatch.Two robotic machines are available to make the phone,Machine A and Machine B.The price per phone will be $250.00 regardless of which machine is used to make it.The fixed and variable costs associated with the two machines are shown below,along with the capital (all equity) that must be invested to purchase each machine.The expected sales level is 33,000 units.Your company has tax loss carry-forwards that will cause its tax rate to be zero for the life of the project,so T = 0.How much higher or lower will the project's ROE be if you select the machine that produces the higher ROE,i.e. ,what is ROEB - ROEA? (Hint: Since the firm uses no debt and its tax rate is zero,ROE = EBIT/Required investment. ) ​ Your company,which is financed entirely with common equity,plans to manufacture a new product,a cell phone that can be worn like a wristwatch.Two robotic machines are available to make the phone,Machine A and Machine B.The price per phone will be $250.00 regardless of which machine is used to make it.The fixed and variable costs associated with the two machines are shown below,along with the capital (all equity) that must be invested to purchase each machine.The expected sales level is 33,000 units.Your company has tax loss carry-forwards that will cause its tax rate to be zero for the life of the project,so T = 0.How much higher or lower will the project's ROE be if you select the machine that produces the higher ROE,i.e. ,what is ROE<sub>B</sub> - ROE<sub>A</sub>? (Hint: Since the firm uses no debt and its tax rate is zero,ROE = EBIT/Required investment. ) ​ A) 20.97% B) 15.77% C) 19.76% D) 16.29% E) 17.33%


A) 20.97%
B) 15.77%
C) 19.76%
D) 16.29%
E) 17.33%

F) B) and C)
G) B) and D)

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The Miller model begins with the Modigliani and Miller (MM)model without corporate taxes and then adds personal taxes.

A) True
B) False

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The firm's target capital structure should do which of the following?


A) Maximize the earnings per share (EPS) .
B) Minimize the cost of debt (rd) .
C) Obtain the highest possible bond rating.
D) Minimize the cost of equity (rs) .
E) Minimize the weighted average cost of capital (WACC) .

F) A) and C)
G) A) and E)

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As a consultant to First Responder Inc. ,you have obtained the following data (dollars in millions) .The company plans to pay out all of its earnings as dividends,hence g = 0.Also,no net new investment in operating capital is needed because growth is zero.The CFO believes that a move from zero debt to 20.0% debt would cause the cost of equity to increase from 10.0% to 12.0%,and the interest rate on the new debt would be 8.0%.What would the firm's total market value be if it makes this change? Hints: Find the FCF,which is equal to NOPAT = EBIT(1 - T) because no new operating capital is needed,and then divide by (WACC - g) .Do not round your intermediate calculations. ​ As a consultant to First Responder Inc. ,you have obtained the following data (dollars in millions) .The company plans to pay out all of its earnings as dividends,hence g = 0.Also,no net new investment in operating capital is needed because growth is zero.The CFO believes that a move from zero debt to 20.0% debt would cause the cost of equity to increase from 10.0% to 12.0%,and the interest rate on the new debt would be 8.0%.What would the firm's total market value be if it makes this change? Hints: Find the FCF,which is equal to NOPAT = EBIT(1 - T) because no new operating capital is needed,and then divide by (WACC - g) .Do not round your intermediate calculations. ​ A) $4,444 B) $4,400 C) $5,111 D) $3,733 E) $4,667


A) $4,444
B) $4,400
C) $5,111
D) $3,733
E) $4,667

F) C) and E)
G) B) and D)

Correct Answer

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El Capitan Foods has a capital structure of 45% debt and 55% equity,its tax rate is 25%,and its beta (leveraged) is 1.20.Based on the Hamada equation,what would the firm's beta be if it used no debt,i.e. ,what is its unlevered beta,bU?


A) 0.74
B) 0.58
C) 0.86
D) 0.77
E) 0.95

F) A) and B)
G) B) and C)

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