Question

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 value the firm.

5. when new projects are added to the firm, the firm’s value is the sum of its old value plus the value of the new project.

Answer #1

Modigilani and Millar theory states that the value of the firm in absence of taxes and transaction cost reamins the same irrespective of whether the firm is levered (mix of debt and equity) or unlevered(only equity).

That means value of the firm is not depending on the choice of financial decision or capital structure of the firm.

Therfore, Option 2 is the correct answer which states that a firm cannot change the total value of its outstanding securities by changing its capital structure.

According to the Modigliani-Miller theorem, a firm’s value is
independent of its capital structure assuming no taxes or
bankruptcy costs. Describe how changing these assumptions (i.e.,
assume a firm faces taxes with and without bankruptcy costs)
influences its choice of capital structure and provide examples of
bankruptcy costs.

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?

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...

Within the Modigliani Miller framework, under Scenario I (with
no frictional costs, no taxes, and no financial distress), consider
a firm with $40 million in cash flows, initially all equity
financed, and the cost of equity is 13%. If the firm takes on new
debt of $150 million, with a 9% interest rate, what is the new Re
or cost of equity for the firm?
Select one:
a. 13%
b. just over 16%
c. 18.4%
d. 26.5%
e. just under...

Answer the problem based on the framework of Modigliani and
Miller Propositions. Assume that a company has earnings before
interest and taxes (EBIT) of $1,000,000 every year forever. The
firm also has perpetual bonds with the market value of $2,000,000.
The before-tax cost of debt is 8 percent. The firm’s unlevered cost
of capital is 15 percent. The tax rate is 25 percent.
a) Find the value of the firm.
b) Find the value of equity.
c) Find the firm’s...

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?

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,...

Consider a world where the assumptions of the Modigliani Miller
Theorem hold and where investors use the Capital Asset Pricing
Model to price securities. In this world we know that leverage has
no impact on firm value. Now, researchers at the Wharton Business
School discover that the true pricing model is one with three
factors. If everyone uses this new model to price securities, firms
may find that changes in leverage will affect firm value. True or
False.

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...

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 4 minutes ago

asked 11 minutes ago

asked 17 minutes ago

asked 36 minutes ago

asked 42 minutes ago

asked 45 minutes ago

asked 48 minutes ago

asked 59 minutes ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago