Corporate-Finance---Berk-DeMarzo--Test-Bank-Chapte

1Copyright©2014PearsonEducation,Inc.CorporateFinance,3e(Berk/DeMarzo)Chapter14CapitalStructureinaPerfectMarket14.1EquityVersusDebtFinancingUsethefollowinginformationtoanswerthequestion(s)below.NielsonMotors(NM)hasnodebt.Itsassetswillbeworth$600millioninoneyeariftheeconomyisstrong,butonly$300millioniftheeconomyisweak.Botheventsareequallylikely.ThemarketvaluetodayofNielson'sassetsis$400million.1)TheexpectedreturnforNielsonMotorsstockwithoutleverageisclosestto:A)-25.0%B)-17.5%C)-12.5%D)12.5%Answer:DExplanation:D)E[rNM]==Diff:1Section:14.1EquityVersusDebtFinancingSkill:Analytical2)Supposetherisk-freeinterestrateis4%.IfNielsonborrows$150milliontodayatthisrateandusestheproceedstopayanimmediatecashdividend,thenaccordingtoMM,themarketvalueofitsequityjustafterthedividendispaidwouldbeclosestto:A)$0millionB)$150millionC)$250millionD)$400millionAnswer:CExplanation:C)Valueofequity=Totalvalue-valueofdebt=$400-150=$250Diff:1Section:14.1EquityVersusDebtFinancingSkill:Analytical2Copyright©2014PearsonEducation,Inc.3)Supposetherisk-freeinterestrateis4%.IfNielsonborrows$150milliontodayatthisrateandusestheproceedstopayanimmediatecashdividend,thenaccordingtoMM,theexpectedreturnofNielson'sstockjustafterthedividendispaidwouldbeclosestto:A)-17.5%B)-12.5%C)12.5%D)17.5%Answer:DExplanation:D)Valueofequity=Totalvalue-valueofdebt=$400-150=$250E[rNM]===17.6%Diff:2Section:14.1EquityVersusDebtFinancingSkill:Analytical4)WhichofthefollowingstatementsisFALSE?A)Therelativeproportionsofdebt,equity,andothersecuritiesthatafirmhasoutstandingconstituteitscapitalstructure.B)Themostcommonchoicesarefinancingthroughequityaloneandfinancingthroughacombinationofdebtandequity.C)Theproject'sNPVrepresentsthevaluetothenewinvestorsofthefirmcreatedbytheproject.D)Whencorporationsraisefundsfromoutsideinvestors,theymustchoosewhichtypeofsecuritytoissue.Answer:CExplanation:C)Theproject'sNPVrepresentsthevaluetotheexistingshareholdersofthefirmcreatedbytheproject.Diff:1Section:14.1EquityVersusDebtFinancingSkill:Conceptual5)Equityinafirmwithdebtiscalled:A)leveredequity.B)risklessequity.C)unleveredequity.D)riskyequity.Answer:ADiff:1Section:14.1EquityVersusDebtFinancingSkill:Definition3Copyright©2014PearsonEducation,Inc.6)Equityinafirmwithnodebtiscalled:A)leveredequity.B)unleveredequity.C)risklessequity.D)riskyequity.Answer:BDiff:1Section:14.1EquityVersusDebtFinancingSkill:Definition7)WhichofthefollowingstatementsisFALSE?A)ModiglianiandMiller'sconclusionverifiedthecommonview,whichstatedthatevenwithperfectcapitalmarkets,leveragewouldaffectafirm'svalue.B)Wecanevaluatetherelationshipbetweenriskandreturnmoreformallybycomputingthesensitivityofeachsecurity'sreturntothesystematicriskoftheeconomy.C)Investorsinleveredequityrequireahigherexpectedreturntocompensateforitsincreasedrisk.D)Leverageincreasestheriskofequityevenwhenthereisnoriskthatthefirmwilldefault.Answer:AExplanation:A)ModiglianiandMiller'sconclusionwentagainstthecommonviewthatevenwithperfectcapitalmarkets,leveragewouldaffectafirm’svalue.Diff:2Section:14.1EquityVersusDebtFinancingSkill:Conceptual8)WhichofthefollowingstatementsisFALSE?A)Leveragedecreasestheriskoftheequityofafirm.B)Becausethecashflowsofthedebtandequitysumtothecashflowsoftheproject,bytheLawofOnePricethecombinedvaluesofdebtandequitymustbeequaltothecashflowsoftheproject.C)FrancoModiglianiandMertonMillerarguedthatwithperfectcapitalmarkets,thetotalvalueofafirmshouldnotdependonitscapitalstructure.D)Itisinappropriatetodiscountthecashflowsofleveredequityatthesamediscountratethatweuseforunleveredequity.Answer:AExplanation:A)Leverageincreasestheriskoftheequityofafirm.Diff:2Section:14.1EquityVersusDebtFinancingSkill:Conceptual4Copyright©2014PearsonEducation,Inc.Usetheinformationforthequestion(s)below.Consideraprojectwithfreecashflowsinoneyearof$90,000inaweakeconomyor$117,000inastrongeconomy,witheachoutcomebeingequallylikely.Theinitialinvestmentrequiredfortheprojectis$80,000,andtheproject'scostofcapitalis15%.Therisk-freeinterestrateis5%.9)TheNPVforthisprojectisclosestto:A)$6,250B)$14,100C)$10,000D)$18,600Answer:CExplanation:C)NPV=-$80,000=$10,000Diff:2Section:14.1EquityVersusDebtFinancingSkill:Analytical10)Supposethattoraisethefundsfortheinitialinvestment,theprojectissoldtoinvestorsasanall-equityfirm.Theequityholderswillreceivethecashflowsoftheprojectinoneyear.Themarketvalueoftheunleveredequityforthisprojectisclosestto:A)$94,100B)$90,000C)$86,250D)$98,600Answer:BExplanation:B)PV(equitycashflows)==$90,000Diff:2Section:14.1EquityVersusDebtFinancingSkill:Analytical11)Supposethattoraisethefundsfortheinitialinvestmentthefirmborrows$80,000attheriskfreerate,thenthecashflowthatequityholderswillreceiveinoneyearinaweakeconomyisclosestto:A)$6,000B)$10,000C)$0D)$33,000Answer:AExplanation:A)$90,000-$80,000(1.05)=$6,000Diff:2Section:14.1EquityVersusDebtFinancingSkill:Analytical5Copyright©2014PearsonEducation,Inc.12)Supposethattoraisethefundsfortheinitialinvestmentthefirmborrows$80,000attheriskfreerate,thenthecashflowthatequityholderswillreceiveinoneyearinastrongeconomyisclosestto: