Finance 425 Exam 2

True or False? President Trump has signaled the intention to lower corporate tax rates. The direct impact of this action should be an increase in optimal leverage for the average firm - False. It will increase as a reduction in tax rates leads to a decrease in the optimal leverage ratio, all else equal. True or false? A relatively small decrease in WACC (i.e., 1%) typically results in a large increase in firm value. - True True or False? The market value of a firm's assets which could be used as collateral for their debt suddenly increases. As a result, the firm's optimal leverage ratio decreases. - False. This lowers the expected cost in bankruptcy and they can raise additional debt True or false? The cost of equity, cost of debt, and the weighted average cost of capital each will increase when leverage increases - False, the relation between leverage and WACC is non-linear (negative relation for low levels of leverage and positive relation for high levels of leverage). True or false? Firms A and B produce identical products and have operations that are the same except firm A pays its employees based on production levels while firm B pays its employees a fixed annual amount. Firm A has a higher optimal leverage ratio. - True True or false? A firm would always use covenants in their debt contracts to lower their weighted average cost of capital despite the costs covenants might impose on the firm. - False. Costly contracting says these firms are willing to introduce these covenants as long as the benefit of a reduced WACC is lower than the cost of the covenants. Firms can credibly signal future expected profitability by increasing leverage. - True True or false? Firms with more potential for agency problems have a higher optimal leverage ratio. - True True or false? Tesla would make an ideal target for an LBO buyout by a private equity firm - False. Tesla is a high growth company and does not have stable cash flows. True or false? Being acquired by a venture capital firm is a clear sign that a company will be successful. - False. About 50% of VC portfolio companies fail. True