45. The weighted average cost of capital is defined as the weighted average of a firm’s: A. return on its investments. B. cost of equity and its after-tax cost of debt. C. pretax cost of debt and equity securities. D. bond coupon rates. E. dividend and capital gains yields.

45. The weighted average cost of capital is defined as the weighted average of a firm’s: A. return on its investments. B. cost of equity and its after-tax cost of debt. C. pretax cost of debt and equity securities. D. bond coupon rates. E. dividend and capital gains yields. 46. Which of the following will increase the cost of equity for a firm with a beta of 1.1? I. Decrease in the security’s beta II. Decrease in the market risk premium III. Decrease in the risk-free rate IV. Increase in the risk-free rate A. II only B. III only C. I and II only D. II and III only E. I and IV only 47. All else constant, which of the following will increase the after-tax cost of debt for a firm? I. Increase in the yield to maturity of the firm’s outstanding debt II. Decrease in the yield to maturity of the firm’s outstanding debt

III. Increase in the firm’s tax rate IV. Decrease in the firm’s tax rate A. I only B. I and III only C. I and IV only D. II and III only E. II and IV only 48. Which one of the following will affect the capital structure weights used to compute a firm’s weighted average cost of capital? A. Decrease in the book value of a firm’s equity B. Decrease in a firm’s tax rate C. Increase in the market value of the firm’s common stock D. Increase in the market risk premium E. Increase in the firm’s beta 49. A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an after-tax cost of debt of 6 percent. Given this, which one of the following will increase the firm’s weighted average cost of capital? A. Increasing the firm’s tax rate B. Issuing new bonds at par C. Redeeming shares of common stock D. Increasing the firm’s beta E. Increasing the debt-equity ratio 50. Bermuda Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of 0.65. The cost of equity is 18.3 percent and the pretax cost of debt is 9.9 percent. What is the capital structure weight of the firm’s equity if the firm’s tax rate is 34 percent? A. 46.75 percent B. 49.97 percent C. 52.93 percent D. 59.08 percent E. 60.61 percent 51. M & M proposition I states that the capital structure problem is irrelevant

A. True,

B. False.

52. The WACC of the firm is 13%. You know that the firm’s cost of debt is 10% and the cost of equity 20%.

What proportion of the firm is financed with debt?

53. Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship? A. Static theory of interest rates B. M&M Proposition I C. Financial risk D. Interest tax shield E. Homemade leverage

54. No separation in the capital markets:

A. Provides support to the pecking order theory of Myers and Majluf,

B. Means that there is only one big global market,

C. Builds from Akerlof’s lemons problem,

D. [A] and [C].

55. Which one of the following is a direct bankruptcy cost? A. Loss of customer goodwill resulting from a bankruptcy filing B. Legal and accounting fees related to a bankruptcy proceeding C. Management time spent on a bankruptcy proceeding D. Any financial distress cost E. Costs a firm spends trying to avoid bankruptcy 56. Given the lemons problem:

A. One can observe a market breakdown,

B. Information asymmetries are crucial to explain the efficiency of the markets,

C. Cross-subsidization may happen,

D. All of the above.

57. Two determinants of the optimal debt ratio are:

A. Depreciation,

B. Operating risk,

C. Marginal tax rate,

D. [B] and [C].

58. Which one of the following statements is the core principle of M&M Proposition I (without taxes)? A. A firm’s cost of equity is directly related to the firm’s debt-equity ratio. B. A firm’s WACC is directly related to the firm’s debt-equity ratio. C. The interest tax shield increases the value of a firm. D. The capital structure of a firm is totally irrelevant. E. Levered firms have greater value than unlevered firms. 59. Which one of the following is an implication of M&M Proposition II (with taxes)? A. A firm’s optimal capital structure is 100 percent debt. B. WACC is unaffected by the capital structure of a firm. C. WACC decreases as the debt-equity ratio increases. D. A firm’s capital structure is irrelevant. E. The risk of equity depends on financial leverage and the riskiness of the firm’s operations. 60. Which one of the following represents the present value of the interest tax shield? A. D × (1 – Tc) B. D/(1 – Tc) C. D/Tc D. D – D(Tc) E. Tc × D

61. Which one of the following factors favors a high-dividend payout? A. Low transaction costs on stock trades B. Lower taxes on capital gains than on dividends C. Tax deferment on capital gains, but not on dividend income D. Flotation costs E. Corporate shareholders 62. Cash dividends send which two of the following signals to the market? I. Agency costs will be lowered since less cash will be held by the firm. II. The firm is planning on downsizing. III. The firm is currently, and expects to continue to be, profitable. IV. The firm will no longer conduct stock repurchases. A. I and II only B. II and III only C. III and IV only D. II and IV only E. I and III only 63. The winners’ curse in IPOs refers to:

A. The negative price reaction after going public because of overvaluation.

B. The negative price reaction after going public because of colluding between the syndicate of

underwriters and the issuer.

64. The beta of the stock is 1.25, the marginal tax rate of the firm is 36%, and the debt equity ratio is 0.30.

What is the value of the unlevered beta?

65. Explain briefly the pecking order theory of funds developed by Myers and Majluf (1984)? What is Ross

(1977) argument for separation in the capital markets?