MBA 621 Questions & Answers Verified
100% Correct
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
Which of the following statements is FALSE?
1)The Law of One Price implies that leverage will affect the total value of the firm under
perfect capital market conditions.
2)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.
3)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.
4)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.
1
, Which of the following statements is FALSE?
1)With no debt, the WACC is equal to the unlevered equity cost of capital.
2)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.
3)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.
4)Although debt has a lower cost of capital than equity, leverage does not lower a
firm's WACC.
2
Which of the following statements is FALSE?
1)An important consequence of leverage is the risk of bankruptcy.
2)Whether default occurs depends on the cash flows, not on the relative values of the firm's
assets and liabilities.
3)Economic distress is a significant decline in the value of a firm's assets, whether or not
it experiences financial distress due to leverage.
4)Modigliani and Miller's results continue to hold in a perfect market even when debt is
risky and the firm may default.
2
Which of the following statements is/are TRUE?
I) When a firm fails to make a required payment to debt holders, it is in bankruptcy.
II) With perfect capital markets, the risk of bankruptcy is not a disadvantage of debt-
bankruptcy simply shifts the ownership of the firm from equity holders to debt
holders without changing the total value available to all investors.
III) Bankruptcy is a long and complicated process that imposes both direct and indirect costs
on the firm and its investors that the assumption of perfect capital markets ignores.
IV) Bankruptcy is rarely simple and straightforward-equity holders don't just "hand the keys"
to debt holders the moment the firm defaults on a debt payment.
2,3,&4
100% Correct
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
Which of the following statements is FALSE?
1)The Law of One Price implies that leverage will affect the total value of the firm under
perfect capital market conditions.
2)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.
3)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.
4)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.
1
, Which of the following statements is FALSE?
1)With no debt, the WACC is equal to the unlevered equity cost of capital.
2)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.
3)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.
4)Although debt has a lower cost of capital than equity, leverage does not lower a
firm's WACC.
2
Which of the following statements is FALSE?
1)An important consequence of leverage is the risk of bankruptcy.
2)Whether default occurs depends on the cash flows, not on the relative values of the firm's
assets and liabilities.
3)Economic distress is a significant decline in the value of a firm's assets, whether or not
it experiences financial distress due to leverage.
4)Modigliani and Miller's results continue to hold in a perfect market even when debt is
risky and the firm may default.
2
Which of the following statements is/are TRUE?
I) When a firm fails to make a required payment to debt holders, it is in bankruptcy.
II) With perfect capital markets, the risk of bankruptcy is not a disadvantage of debt-
bankruptcy simply shifts the ownership of the firm from equity holders to debt
holders without changing the total value available to all investors.
III) Bankruptcy is a long and complicated process that imposes both direct and indirect costs
on the firm and its investors that the assumption of perfect capital markets ignores.
IV) Bankruptcy is rarely simple and straightforward-equity holders don't just "hand the keys"
to debt holders the moment the firm defaults on a debt payment.
2,3,&4
