The cost of debt is generally lower than the cost of equity.
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True
False
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M&M’s Proposition I states that a company’s value is independent of its capital structure.
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True
False
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A higher level of leverage generally reduces managerial discretion.
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True
False
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The Pecking Order Theory of capital structure implies a unique optimum capital structure.
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True
False
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As EBIT drops, the return on equity (ROE) of a levered firm drops ______ the ROE of an otherwise identical unlevered firm.
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the same as
relatively more than
relatively less than
more or less than (it cannot be determined)
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Shareholders prefer high risk projects when facing a high probability of bankruptcy because
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High risk projects usually bring high rewards.
Shareholders have the residual claim on a company.
Creditors have the residual claim on a company, and therefore bear the risk.
There is a good chance the government will rescue them in bankruptcy.
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The _________ states that the value of the firm is determined solely by the value of its assets.
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Static Tradeoff Model
M&M proposition I
The Pecking Order Model
Agency Theory
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Which of the following expresses the value of a levered firm (VL) in the Static Tradeoff model of optimal capital structure? [Note: VU denotes the value of the unlevered firm; CFD denotes expected costs of financial distress; and PV denotes present value.]
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VL = PV(Tax Shield) – PV(CFD)
VL = VU + PV(Tax Shield) / PV(CFD)
VL = VU + PV(Tax Shield) – PV(CFD)
VL = VU + PV(Tax Shield)
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A example of indirect costs of bankruptcy is
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Court costs
Attorney and advisor fees
Lost sales due to costumers and suppliers lost trust
All of the above
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Which of the following are equivalent under M&M proposition I?
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Maximizing firm value and maximizing firm profit
Maximizing firm value and minimizing the cost of capital
Minimizing firm’s cost of capital and minimizing firm’s debt burden
Maximizing profit and minimizing taxes
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