MBA 621 Exam 2 Questions and Correct
Answers 100% Verified
Question 1
What kind of corporate debt must be secured by real property?
- Mortgage bonds
- Notes
- Asset-backed bonds
- Debentures
Correct Answer
Mortgage bonds
Question 2
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.
Correct Answer
The Law of One Price implies that leverage will affect the total value of the firm
under perfect capital market conditions.
Page 1 of 77
,Question 3
Which of the following statements is FALSE?
- The data show a clear preference for equity as a source of external financing for the
total population of U.S. firms.
- Debt as a fraction of firm value has varied in a range from 30-45% for the average
firm.
- Capital expenditures greatly exceed firms' external financing, implying that most
investment and growth is supported by internally generated funds, such as retained
earnings.
- Firms in growth industries like biotechnology or high technology carry very little
debt, whereas airlines, auto makers, utilities, and financial firms have high leverage
ratios.
Correct Answer
The data show a clear preference for equity as a source of external financing for the
total population of U.S. firms.
Question 4
Which of the following statements is FALSE?
- With no debt, the WACC is equal to the unlevered equity cost of capital.
- 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.
- As the firm borrows at the low cost of capital for debt, its equity cost of capital rises,
but the net effect is that the firm's WACC is unchanged.
- Although debt has a lower cost of capital than equity, leverage does not lower a
firm's WACC.
Correct Answer
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.
Page 2 of 77
,Question 5
Which of the following statements is TRUE?
- The agency costs of debt can arise only if there is no chance the firm will default and
impose losses on its debt holders.
- Agency costs represent another cost of increasing the firm's leverage that will affect
the firm's optimal capital structure choice.
- An over-investment problem occurs when shareholders choose to not invest in a
positive-NPV project.
- When a firm faces financial distress, there will be no conflict of interest between
shareholders and debtholders.
Correct Answer
Agency costs represent another cost of increasing the firm's leverage that will affect
the firm's optimal capital structure choice.
Question 6
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.
Correct Answer
I only
Page 3 of 77
, Question 7
If it is managed efficiently, Luther industries will have assets with market value of $100
million, $300, million, or $500 million next year, with each outcome being equally
likely. Managers may, however, engage in wasteful empire building which will reduce
the firm's market value by $20 million in all cases. Managers may also increase the risk
of the firm, changing the probability of each outcome to 50%, 20%, and 30%
respectively. If its managers engage in empire building, then the expected market
value of Luther's assets is closest to:
Correct Answer
1/3 x 80 + 1/3 x 280 + 1/3 x 480 = $280 million
Question 8
Using textbook Tables 19.5 and 19.7, if Ideko has an EV/EBITDA multiple of 8.5, then
its continuation value for equity in 2010 is closes to:
Correct Answer
Continuation Enterprise Value = 32,094x 8.5 = 272,799
Its debt in 2010 is projected to be 120,000
Its Continuation Equity Value is 272,799 - 120,000 = 152,799
$152.8 million
Page 4 of 77
Answers 100% Verified
Question 1
What kind of corporate debt must be secured by real property?
- Mortgage bonds
- Notes
- Asset-backed bonds
- Debentures
Correct Answer
Mortgage bonds
Question 2
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.
Correct Answer
The Law of One Price implies that leverage will affect the total value of the firm
under perfect capital market conditions.
Page 1 of 77
,Question 3
Which of the following statements is FALSE?
- The data show a clear preference for equity as a source of external financing for the
total population of U.S. firms.
- Debt as a fraction of firm value has varied in a range from 30-45% for the average
firm.
- Capital expenditures greatly exceed firms' external financing, implying that most
investment and growth is supported by internally generated funds, such as retained
earnings.
- Firms in growth industries like biotechnology or high technology carry very little
debt, whereas airlines, auto makers, utilities, and financial firms have high leverage
ratios.
Correct Answer
The data show a clear preference for equity as a source of external financing for the
total population of U.S. firms.
Question 4
Which of the following statements is FALSE?
- With no debt, the WACC is equal to the unlevered equity cost of capital.
- 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.
- As the firm borrows at the low cost of capital for debt, its equity cost of capital rises,
but the net effect is that the firm's WACC is unchanged.
- Although debt has a lower cost of capital than equity, leverage does not lower a
firm's WACC.
Correct Answer
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.
Page 2 of 77
,Question 5
Which of the following statements is TRUE?
- The agency costs of debt can arise only if there is no chance the firm will default and
impose losses on its debt holders.
- Agency costs represent another cost of increasing the firm's leverage that will affect
the firm's optimal capital structure choice.
- An over-investment problem occurs when shareholders choose to not invest in a
positive-NPV project.
- When a firm faces financial distress, there will be no conflict of interest between
shareholders and debtholders.
Correct Answer
Agency costs represent another cost of increasing the firm's leverage that will affect
the firm's optimal capital structure choice.
Question 6
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.
Correct Answer
I only
Page 3 of 77
, Question 7
If it is managed efficiently, Luther industries will have assets with market value of $100
million, $300, million, or $500 million next year, with each outcome being equally
likely. Managers may, however, engage in wasteful empire building which will reduce
the firm's market value by $20 million in all cases. Managers may also increase the risk
of the firm, changing the probability of each outcome to 50%, 20%, and 30%
respectively. If its managers engage in empire building, then the expected market
value of Luther's assets is closest to:
Correct Answer
1/3 x 80 + 1/3 x 280 + 1/3 x 480 = $280 million
Question 8
Using textbook Tables 19.5 and 19.7, if Ideko has an EV/EBITDA multiple of 8.5, then
its continuation value for equity in 2010 is closes to:
Correct Answer
Continuation Enterprise Value = 32,094x 8.5 = 272,799
Its debt in 2010 is projected to be 120,000
Its Continuation Equity Value is 272,799 - 120,000 = 152,799
$152.8 million
Page 4 of 77
