mba 621 exam 2 question with answers.

mba 621 exam 2 question with answers |\ |\ |\ |\ |\ |\




Equity in a firm with no debt is called:
|\ |\ |\ |\ |\ |\ |\ |\


levered equity. |\




- levered equity
|\ |\


-unlevered equity. |\


-riskless equity. |\


-risky equity. |\




unlevered equity |\




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.
|\ |\ |\ |\ |\




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/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
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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
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capital markets, the total value of a firm depends on its capital
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structure.
I and III only
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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-
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equity firm. The equity holders will receive the cash flows of the
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project in one year. The market value of the unlevered equity for
|\ |\ |\ |\ |\ |\ |\ |\ |\ |\ |\ |\


this project is closest to:
|\ |\ |\ |\




$90,000


We have an expert-written solution to this problem!
|\ |\ |\ |\ |\ |\ |\




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:
|\ |\ |\ |\ |\ |\ |\ |\




$33,000


We have an expert-written solution to this problem!
|\ |\ |\ |\ |\ |\ |\

, 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: |\ |\ |\




$10,000
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.
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II) There are no taxes, transaction costs, or issuance costs
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associated with security trading. |\ |\ |\


III) A firm's financing decisions do not change the cash flows
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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
|\




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.
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