Question

Which of the following statements is FALSE?

A. Franco Modigliani and Merton Miller argued that with perfect capital markets, the total value of a firm should not depend on its capital structure.

B. Because the cash flows of the debt and equity sum to the cash flows of the project, by the Law of One Price the combined values of debt and equity must be equal to the cash flows of the project.

C. Leverage decreases the risk of the equity of a firm.

D. It is inappropriate to discount the cash flows of levered equity at the same discount rate that we use for unlevered equity.

Answer #1

Statement C is False

Leverage increases the risk of the firm. HIgher the leverage, higher the debt burden and higher is the chance that the firm can default. This reduces its creditworthiness and also its risk to equity shareholders.

A is True. In perfect capital markets the capital structure of a company is not a factor in its value since there are no taxes.

B is true: If the cash flows of debt and equity separately equate to the cash flows of the project, the sum of cash flows of debt and equity will also equate to the cash flows of the project.

D is true: The discount rates for levered and unlevered equity differ due to difference in risk in both cases.

Which of the following statements may NOT be TRUE? Select
one:
a. It is inappropriate to discount the cash flows of levered
equity at the same discount rate that we use for unlevered
equity.
b. Under current market condition, Modigliani and Miller argued
that the total value of a firm should not depend on its capital
structure.
c. Leverage increases the risk of the equity of a firm.
d. Because the cash flows of the debt and equity sum to...

1- Under the theory of Modigliani & Miller without taxes,
which of the following statements is false?
a) The capital structure is irrelevant.
b) The cost of equity is a linear function of the equity-to-debt
ratio.
c) The value of the levered company is equal to the value of the
unlevered company.
d) The cost of equity increases as the debt-to-equity ratio
increases.
2 - Which of the following statements is true regarding the
pecking order theory?
a) The external...

In perfect and complete markets Miller and Modigliani (1958)
show that there is no advantage to debt vs equity in the capital
structure. That is, the value of the firm is determined by its
income from operations, not from its capital structure.
What do Miller and Modigliani mean by perfect and complete
markets?
How did their argument change with the introduction of corporate
taxes into their model?

In perfect and complete markets Miller and Modigliani (1958)
show that there is no advantage to debt vs equity in the capital
structure. That is, the value of the firm is determined
by its income from operations, not from its capital structure.
What do MM mean by perfect and complete markets?
How did their argument change with the introduction of corporate
taxes into their model?

Which of the following statement is true regarding the
Modigliani and Miller (M&M) propositions (1958) in a perfect
financial market?
A) Capital structure is irrelevant because of the assumption
that investors and companies have differing tax rates.
B) It is assumed that the firm’s future cash flows remain fixed
under any circumstances.
C) The basic lesson of M&M propositions is that company’s
capital budgeting decisions are dependent upon the company's
capital structure decision.
D) The debt-to-equity ratio is an important...

The basic point being made by Modigliani and Miller is that in
the absence of taxes and transaction costs
1. the optimal capital structure balances the firm’s tax-shield
and financial distress costs.
2. a firm cannot change the total value of its outstanding
securities by changing its capital structure
3. greater debt leads to a lower weighted-average cost of
capital and greater firm value.
4. we must account for the timing and risk of cash flows in
order to properly...

Using the Modigliani-Miller (MM) theory in a perfect market, you
want to evaluate a project and how to finance it. The project has
free cash flows in one year (year 1) of $90 in a weak economy or
$120 in a strong economy. There is 75% chance that the economy is
strong. The initial investment required for the project is $80, and
the project's cost of capital is 10%. The risk free interest rate
is 5%. Suppose that to raise...

Assume a Modigliani and Miller world. All cash flows are
perpetuities. Parts A, B, and C below are 6, 6, and 8
points respectively.
Rent-a-Raptor is 100% equity financed. The firm is expected to
have perpetual EBIT of $70 million per year. The unlevered equity
or asset Beta is 1.0. The riskless rate is 4%, and the market risk
premium is 6%. There are 10 million shares of common stock
outstanding. The corporate tax rate is 40%.
A. Calculate the...

Which of the following statements is false
if capital markets have both taxes and financial distress as the
market imperfections?
A.
If two firms are identical but differ only in their capital
structure, then the value of the levered firm is higher than the
value of the unlevered firm by the present value of the interest
tax shield
B.
There is an optimal capital structure that can maximize firm
value
C.
The capital structure choice considers a trade-off between the
tax...

According to the Modigliani-Miller theorem, which of the
following would have to be true in order for capital structure to
have no impact upon firm value?
I. Taxes have an impact upon the firm's earnings
II. The risk of defaulting on debt is nonexistent
III. There are no transaction costs of moving from one capital
structure to another
Select one:
A. I only
B. I and II only
C. I and III only
D. II and III only
E. I,...

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