Question

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 equity financing is considered as the last recourse.

b) It is a continuity of the static theory and assumes the optimal capital structure hypothesis.

c) There is no target debt-to-equity ratio.

3 - The financial risk refers to the risk related to :

a) The company's operations.

b) The company's bankruptcy.

c) The company's financial leverage

4 - Under the theory of Modigliani & Miller with taxes, the WACC of the levered company is less than that of the unlevered company, because :

a) The cost of equity is perpetually increasing.

b) There is a tax shield.

c) The financial leverage is detrimental for the company.

5- Under the theory of Modigliani & Miller with taxes and bankruptcy costs, which of the following statements is false?

a) As banckruptcy costs increase, the cost of capital increases.

b) As bankruptcy costs increase, the leverage becomes less optimal.

c) As bankruptcy costs increase, the cost of debt decreases.

Answer 1

1. Option b is correct . Cost of equity is not linear function of equity to debt ratio. In fact it has a negative relation.

2. Option a is correct . Equity is first required to generated from internal sources and external source is last.

3. Option c is correct. Higher the leverage higher is the financial risk.

4. Option b is correct. There is a tax shiedl on interest payments

5. Option c is correct. Higher is the bankruptcy cost higher is the cost of debt