MBA 621 Sample Exam Questions & Answers
Verified 100% Correct
unlevered equity
Equity in a firm with no debt is called:
levered equity.
unlevered equity.
riskless equity.
risky equity.
Modigliani and Miller's conclusion verified the common view, which stated that even with
perfect capital markets, leverage would affect a firm's value.
Which of the following statements is FALSE?
Modigliani and Miller's conclusion verified the common view, which stated that even with
perfect capital markets, leverage would affect a firm's value.
We can evaluate the relationship between risk and return more formally by computing the
sensitivity of each security's return to the systematic risk of the economy.
Investors in levered equity require a higher expected return to compensate for its increased
risk.
Leverage increases the risk of equity even when there is no risk that the firm will default.
I and III only
Which of the following statements is/are FALSE?I) Leverage decreases the risk of the equity of a
firm.II) 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.III) Franco Modigliani and Merton Miller argued that with perfect capital markets,
the total value of a firm depends on its capital structure.
I only
I and II only
,I and III only
All of above
$90,000
PV(equity cash flows)= (.590000 + .5117000)/1.15 = 90,000
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000
in a strong economy, with each outcome being equally likely. The initial investment required for
the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is
5%.Suppose that to raise the funds for the initial investment, the project is sold to investors as
an all-equity firm. The equity holders will receive the cash flows of the project in one year. The
market value of the unlevered equity for this project is closest to:
$94,100
$90,000
$86,250
$98,600
$33,000
$117,000 - $80,000(1.05) = $33,000
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000
in a strong economy, with each outcome being equally likely. The initial investment required for
the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is
5%.Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the
risk free rate, then the cash flow that equity holders will receive in one year in a strong
economy is closest to:
$0
$6000
$33,000
$10,000
$10,000
PV(equity cash flows)= (.590000 + .5117000)/1.15 = 90,000 - 80,000 = 10,000
,Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000
in a strong economy, with each outcome being equally likely. The initial investment required for
the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is
5%.Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the
risk free rate, then the value of the firm's levered equity from the project is closest to:
$0
$10,000
$6000
$8600
I only
Which of the following is NOT one of Modigliani and Miller's set of conditions referred to as
perfect capital markets?I) All investors hold the market portfolio.II) There are no taxes,
transaction costs, or issuance costs associated with security trading.III) A firm's financing
decisions do not change the cash flows generated by its investments, nor do they reveal new
information about them.IV) Investors and firms can trade the same set of securities at
competitive market prices equal to the present value of their future cash flows.
I only
II only
I and II only
I, II and III only
The Law of One Price implies that leverage will affect the total value of the firm under perfect
capital market conditions.
Which of the following statements is FALSE?
The Law of One Price implies that leverage will affect the total value of the firm under perfect
capital market conditions.
In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's
security holders is equal to the total cash flow generated by the firm's assets.
With perfect capital markets, leverage merely changes the allocation of cash flows between
, debt and equity, without altering the total cash flows of the firm.
In a perfect capital market, the total value of a firm is equal to the market value of the total
cash flows generated by its assets and is not affected by its choice of capital structure.
$6.00
Under MM I, the total value of With and Without must be the same.Value(Without) =
1,000,000 × $24 = $24 millionValue(levered equity) = value(With) - debt = $24 M - $12M = $12
MPrice per share = $12M/2M = $6.00
Consider two firms, With and Without, that have identical assets that generate identical cash
flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of
$24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an
interest rate of 5%. According to MM Proposition 1, the stock price for With is closest to:
$8.00
$24.00
$6.00
$12.00
11.0%
re = ru +D/E(ru-rd) = 10% +20%/80%(10%-6%) = 11%
Suppose that Taggart Transcontinental currently has no debt and has an equity cost of capital
of 10%. Taggart is considering borrowing funds at a cost of 6% and using these funds to
repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows until
they achieved a debt-to-value ratio of 20%, then Taggart's levered cost of equity would be
closest to:
8.0%
9.2%
10.0%
11.0%
With perfect capital markets, a firm's WACC is dependent of its capital structure and is equal
to its equity cost of capital only the firm it is unlevered.
Verified 100% Correct
unlevered equity
Equity in a firm with no debt is called:
levered equity.
unlevered equity.
riskless equity.
risky equity.
Modigliani and Miller's conclusion verified the common view, which stated that even with
perfect capital markets, leverage would affect a firm's value.
Which of the following statements is FALSE?
Modigliani and Miller's conclusion verified the common view, which stated that even with
perfect capital markets, leverage would affect a firm's value.
We can evaluate the relationship between risk and return more formally by computing the
sensitivity of each security's return to the systematic risk of the economy.
Investors in levered equity require a higher expected return to compensate for its increased
risk.
Leverage increases the risk of equity even when there is no risk that the firm will default.
I and III only
Which of the following statements is/are FALSE?I) Leverage decreases the risk of the equity of a
firm.II) 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.III) Franco Modigliani and Merton Miller argued that with perfect capital markets,
the total value of a firm depends on its capital structure.
I only
I and II only
,I and III only
All of above
$90,000
PV(equity cash flows)= (.590000 + .5117000)/1.15 = 90,000
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000
in a strong economy, with each outcome being equally likely. The initial investment required for
the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is
5%.Suppose that to raise the funds for the initial investment, the project is sold to investors as
an all-equity firm. The equity holders will receive the cash flows of the project in one year. The
market value of the unlevered equity for this project is closest to:
$94,100
$90,000
$86,250
$98,600
$33,000
$117,000 - $80,000(1.05) = $33,000
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000
in a strong economy, with each outcome being equally likely. The initial investment required for
the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is
5%.Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the
risk free rate, then the cash flow that equity holders will receive in one year in a strong
economy is closest to:
$0
$6000
$33,000
$10,000
$10,000
PV(equity cash flows)= (.590000 + .5117000)/1.15 = 90,000 - 80,000 = 10,000
,Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000
in a strong economy, with each outcome being equally likely. The initial investment required for
the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is
5%.Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the
risk free rate, then the value of the firm's levered equity from the project is closest to:
$0
$10,000
$6000
$8600
I only
Which of the following is NOT one of Modigliani and Miller's set of conditions referred to as
perfect capital markets?I) All investors hold the market portfolio.II) There are no taxes,
transaction costs, or issuance costs associated with security trading.III) A firm's financing
decisions do not change the cash flows generated by its investments, nor do they reveal new
information about them.IV) Investors and firms can trade the same set of securities at
competitive market prices equal to the present value of their future cash flows.
I only
II only
I and II only
I, II and III only
The Law of One Price implies that leverage will affect the total value of the firm under perfect
capital market conditions.
Which of the following statements is FALSE?
The Law of One Price implies that leverage will affect the total value of the firm under perfect
capital market conditions.
In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's
security holders is equal to the total cash flow generated by the firm's assets.
With perfect capital markets, leverage merely changes the allocation of cash flows between
, debt and equity, without altering the total cash flows of the firm.
In a perfect capital market, the total value of a firm is equal to the market value of the total
cash flows generated by its assets and is not affected by its choice of capital structure.
$6.00
Under MM I, the total value of With and Without must be the same.Value(Without) =
1,000,000 × $24 = $24 millionValue(levered equity) = value(With) - debt = $24 M - $12M = $12
MPrice per share = $12M/2M = $6.00
Consider two firms, With and Without, that have identical assets that generate identical cash
flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of
$24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an
interest rate of 5%. According to MM Proposition 1, the stock price for With is closest to:
$8.00
$24.00
$6.00
$12.00
11.0%
re = ru +D/E(ru-rd) = 10% +20%/80%(10%-6%) = 11%
Suppose that Taggart Transcontinental currently has no debt and has an equity cost of capital
of 10%. Taggart is considering borrowing funds at a cost of 6% and using these funds to
repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows until
they achieved a debt-to-value ratio of 20%, then Taggart's levered cost of equity would be
closest to:
8.0%
9.2%
10.0%
11.0%
With perfect capital markets, a firm's WACC is dependent of its capital structure and is equal
to its equity cost of capital only the firm it is unlevered.
