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Multiple Choice Quiz
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1

Suppose we wish to draw a graph illustrating M&M Proposition II. Let the vertical axis represent the cost of capital and the firm's debt-to-equity ratio represent the horizontal axis; then if the slope of the line representing the firm's WACC has a negative slope, we must be incorporating taxes into the analysis.
A)True
B)False
2

The effect of financial leverage depends on a company's EBIT.
A)True
B)False
3

Homemade leverage is the use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed.
A)True
B)False
4

Because investors can use homemade leverage to create any level of financial leverage they desire, the capital structure of a firm does not matter.
A)True
B)False
5

According to the M&M propositions without taxes, there is an optimal amount of leverage for a firm.
A)True
B)False
6

According to the static theory of capital structure, because financial distress costs exist there is an optimal capital structure.
A)True
B)False
7

According to the extended pie model, the value of all of the claims against a firm's cash flows is not affected by capital structure, but the relative values of claims within the pie change as the amount of debt financing is increased.
A)True
B)False
8

Which of the following would result in an increase in the debt-to-equity ratio? (Assume there are no flotation costs.)
A)A firm issues common stock and uses the proceeds to repurchase an equal amount of preferred stock
B)A firm issues preferred stock and uses the proceeds to repurchase an equal amount of bonds
C)A firm with positive additions to retained earnings uses the cash it generates to retire existing debt
D)A firm uses excess cash to repurchase common stock in an amount equal to additions to retained earnings for the year
E)A firm issues bonds and uses the proceeds to purchase short-term assets
9

Which of the following statements is correct?
A)Decisions regarding a firm's debt and equity can be called capital budgeting decisions
B)The asset beta is a measure of the unsystematic risk of a firm's assets
C)In a pure capital restructuring, the composition of the assets of the firm will change
D)The value of the overall firm will not change as a result of a capital restructuring unless the NPV of the restructuring is negative
E)The use of personal leverage by an investor to alter the degree of financial leverage to which the investor is exposed is called homemade leverage
10

Which of the following is true about the WACC?
A)The WACC is the appropriate discount rate for all new projects being considered by the existing firm
B)The optimal capital structure is the one that maximizes the WACC
C)The value of the firm will be maximized when the WACC is minimized
D)The WACC is virtually impossible to compute for a firm that has multiple divisions
E)Since discount rates and values move in the same direction, minimizing the WACC will minimize the value of the firm's cash flows





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