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TRUE OR FALSE
Answer as either true or false and provide a reason for why.
- When a company pays dividends, its share price falls.
- Modigliani and Miller proposition II (without taxes) implies that the weighed average cost of capital increases as more debt is issued, since debt make the firm more risky
- The empirical findings that more profitable firms have lower debt ratios is consistent with the trade-off theory regarding capital structure.
- The WACC formula assumes that the amount of debt issued remains constant.
- Other things being equal, buying a put option is the same as selling a call option
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- Explain why the following statement is true: "All else the same, firms with relatively stable sales are able to carry relatively high debt/assets ratios." If a firm went from zero debt to successively higher levels of debt, why would you expect its stock price to first rise, then hit a peak, and then begin to decline? Explain how a firm might shift its capital structure so as to change its weighted average cost of capital (WACC). What would be the impact on the value of the firm?For each statement indicate whether it is true or false and briefly explain why. a) In a perfect capital market with no corporate taxes, as a firm takes on more and more debt its weighted average cost of capital remains unchanged while its required return on equity rises. b) If a firm issues riskfree debt the risk of the firm’s equity will not change. So, risk-free debt allows the firm to get the benefit of a low cost of debt without raising its cost of equity. c) In the context of firms’ capital structure decisions, the theory predicts that the value of a firm’s equity will rise in direct proportion to the level of debt in its capital structure.S1. Although the exact relationship between a firm's degree of financial leverage and its beta is difficult to estimate, it has been shown both theoretically and empirically that a firm's beta increases with its degree of financial leverage. S2. As the debt ratio rises, the WACC is reduced because the after-tax cost of debt is usually lower than the cost of equity. What limits the substitution of debt for equity in the capital structure is that as the debt ratio rises the costs of both components eventually increase. Group of answer choices Statement 2 is true Both statements are false Statement 1 is true Both statements are true
- S1. Although the exact relationship between a firm's degree of financial leverage and its beta is difficult to estimate, it has been shown both theoretically and empirically that a firm's beta increases with its degree of financial leverage. S2. As the debt ratio rises, the WACC is reduced because the after-tax cost of debt is usually lower than the cost of equity. What limits the substitution of debt for equity in the capital structure is that as the debt ratio rises the costs of both components eventually increase. Both statements are true Statement 2 is true Statement 1 is true Both statements are falseWhich one of the followings is incorrect regarding to cost of equity: On average, it is higher than cost of debt. It moves in the same direction with tax rates. It is affected by return on market portfolio. For a dividend paying company, it is sensitive to growth expectations for future dividends. It is highly dependent on risk level of the firm and growth rate. For calculating cost of equity, we can rely on dividend growth model or SML approach. Both models might suffer from the assumption that past is a good predictor of future. True False Percy's Wholesale Supply has earnings before interest and taxes of €106,000. Both the book and the market value of debt is €170,000. The unlevered cost of equity is 15.5 per cent while the pre-tax cost of debt is 8.6 per cent. The tax rate is 28 per cent. What is the firm's weighted average cost of capital? Show your steps.Is the debt level that maximizes a firm's expected EPS the same as the one that maximizes its stock price? Explain. Explain how a firm might shift its capital structure so as to change its weighted average cost of capital (WACC). What would be the impact on the value of the firm?
- If the debt component in the capital structure is predominant – a. Earnings per share (EPS) will be very low. b. Dividend expectations of equity shareholders are also and P/E Ratio may decrease. c. The fixed interest cost of the firm will be minimum thereby decreasing its risk. d. The fixed interest cost of the firm increases thereby increasing its risk.Which of the following statements is CORRECT? * A company can use its retained earnings without incurring a flotation cost. As a O result, while the cost of retained earnings is not zero, it is usually less expensive than the after-tax cost of debt. The capital structure that minimizes a company's weighted average cost of capital often maximizes its stock price. The capital structure that minimizes the firm's weighted average cost of capital often maximizes its earnings per share. If everything else is stable, and corporate tax rates drops, the Modigliani-Miller tax- adjusted tradeoff principle implies that companies should expand their use of debt. When a corporation learns that the cost of debt is less than the cost of equity, rising the debt ratio would lower the WACC.Is this statement true or false? Give a reason for your answer. "The bird-in-hand theory suggests that a company can reduce its cost of equity capital by reducing its dividend payout ratio."
- According to MM propositions, which of the following statements best describes the consequence of increasing debt-to-value ratio for a firm? Group of answer choices The weighted average cost of capital can decrease. The weighted average cost of capital can increase. The cost of equity capital can decrease. The weighted average cost of capital must not stay constant.Assume that there is corporate tax, but no other frictions. Based on the propositions of Modigliani and Miller, which statement is the least accurate? Oa. The weighted cost of capital decreases as the leverage ratio increases. D. The cost of debt increases as the leverage ratio increases. C. Firm value increases as the firm takes on more debts. d. The cost of equity increases as the leverage ratio increases. O e. The optimal structure is 100% debt.Explain what this statement means: "One type of leverage affects both EBIT and EPS. The other type affects only EPS." Explain why the following statement is true: "All else the same, firms with relatively stable sales are able to carry relatively high debt/assets ratios." If a firm went from zero debt to successively higher levels of debt, why would you expect its stock price to first rise, then hit a peak, and then begin to decline? Is the debt level that maximizes a firm's expected EPS the same as the one that maximizes its stock price? Explain. Explain how a firm might shift its capital structure so as to change its weighted average cost of capital (WACC). What would be the impact on the value of the firm?