Question

#1. A firm should use as much non-financial liability financing as it can if

A) a firm should try to limit the amount of non-financial liability financing it uses

B) there is an operational linkage involved

C) arbitrageurs can easily and quickly undo choices that are suboptimal

D)its risk-adjusted cost of capital is below that of other sources of financing

#2. A bondʹs promised rate of return will be

A) greater than or equal to the firmʹs overall weighted average cost of capital

B)less than its expected rate of return, but greater than the expected return on equity

C)less than or equal to its expected rate of return, but greater than the expected return on equity        

D) greater than or equal to its expected rate of return  

#3. The M&M dividend proposition states that

A) the higher a firmʹs dividends, the greater the shareholder value

B) the higher a firmʹs dividends, the greater the firm value

C)a firm should borrow money if necessary to maintain a stable dividend policy

D) shareholder value is unaffected by a firmʹs dividend policy        

#4. A firm is financed with debt that has a market beta of 0.3 and equity that has a market beta of 1.2. The risk-free rate is 3%, and the equity premium is 5%. The overall cost of capital for the firm is 8%. What is the firmʹs debt-equity ratio?

A) 74.8%

B) 25.2%

C) 25.0%

D) 28.6%     

            

#5. A firm is worth $100 million and has a cost of capital of 11%. It is all equity financed. If the firm sells $30 million of debt with a 7% promised return and uses it to repurchase part of the firmʹs stock, what will the firmʹs cost of capital then be?

A) Not determinable

B) 11.0%                                                       

C) 10.4%

D) 9.8%

Answer 1

1.

2. D-greater than or equal to its expected rate of return

3. D-greater than or equal to its expected rate of return

4.

5. d-9.8%

Intial Cost of Capital = Equity cost +Debt Cost

11% + 0% =11%

Revised Scenario, where are Debt capital of 30$ million was issued and buyback of equivalent amount in stock of 100$ Million

Therefore Revised Capital Equity =Intial capital-Buy back capital =100-30 =70

Debt Capital = 30

Particular Amount Weightage   Cost of capital Weightage cost of capital

Equity 70 0.7    11% 7.7(11%*0.7)

dEBT 30 0.3 7% 2.1(7%*0.3)

TOTAL WEIGHTAGE COST OF CAPITAL = 7.7+2.1=9.8%