Deck 17: Dynamic Capital Structures and Corporate Valuation

Question 1

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

A)The value of a growing tax shield is greater than the value of a constant tax shield.
B)For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions.
C)For a given D/S, the WACC is greater than the WACC under MM's original (with tax) assumptions.
D)The total value of the firm is independent of the amount of debt it uses.
E)The tax shields should be discounted at the unlevered cost of equity.

Answer 1

D

Question 2

MM showed that in a world without taxes,a firm's value is not affected by its capital structure.

Answer 2

True

Question 3

Other things held constant,an increase in financial leverage will increase a firm's market (or systematic)risk as measured by its beta coefficient.

Answer 3

True

Question 4

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

Question 5

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

A)The value of a growing tax shield is greater than the value of a constant tax shield.
B)For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions.
C)For a given D/S, the WACC is less than the WACC under MM's original (with tax) assumptions.
D)The total value of the firm increases with the amount of debt.
E)The tax shields should be discounted at the unlevered cost of equity.

Question 6

The major contribution of the Miller model is that it demonstrates that

A)personal taxes decrease the value of using corporate debt.
B)financial distress and agency costs reduce the value of using corporate debt.
C)equity costs increase with financial leverage.
D)debt costs increase with financial leverage.
E)personal taxes increase the value of using corporate debt.

Question 7

The market value of Firm L's debt is $200,000 and its yield is 9%.The firm's equity has a market value of $300,000,its earnings are growing at a rate of 5%,and its tax rate is 40%.A similar firm with no debt has a cost of equity of 12%.Under the MM extension with growth,what is Firm L's cost of equity?

A)11.4%
B)12.0%
C)12.6%
D)13.3%
E)14.0%

Question 8

Which of the following statements concerning capital structure theory is NOT CORRECT?

A)Under MM with zero taxes, financial leverage has no effect on a firm's value.
B)Under MM with corporate taxes, the value of a levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt.
C)Under MM with corporate taxes, r_s increases with leverage, and this increase exactly offsets the tax benefits of debt financing.
D)Under MM with corporate taxes, the effect of business risk is automatically incorporated because r_sL is a function of r_sU.
E)The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt.

Question 9

When a firm has risky debt,its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.

Question 10

In the MM extension with growth,the appropriate discount rate for the tax shield is the after-tax cost of debt.

Question 11

In the MM extension with growth,the appropriate discount rate for the tax shield is the WACC.

Question 12

MM showed that in a world with taxes,a firm's optimal capital structure would be almost 100% debt.

Question 13

The MM model with corporate taxes is the same as the Miller model,but with zero personal taxes.

Question 14

When a firm has risky debt,its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.

Question 15

The Miller model begins with the MM model with taxes and then adds personal taxes.

Question 16

According to MM,in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.

Question 17

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

A)The value of a growing tax shield is greater than the value of a constant tax shield.
B)For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions.
C)For a given D/S, the WACC is greater than the WACC under MM's original (with tax) assumptions.
D)The total value of the firm increases with the amount of debt.
E)The tax shields should be discounted at the cost of debt.

Question 18

In the MM extension with growth,the appropriate discount rate for the tax shield is the unlevered cost of equity.

Question 19

In a world with no taxes,MM show that a firm's capital structure does not affect the firm's value.However,when taxes are considered,MM show a positive relationship between debt and value,i.e.,its value rises as its debt is increased.

Question 20

The MM model is the same as the Miller model,but with zero corporate taxes.

Question 21

Refer to Exhibit 17.2.According to the MM extension with growth,what is Kitto's value of equity?

A)$1,492,000
B)$1,529,300
C)$1,567,533
D)$1,606,721
E)$1,646,889

Question 22

The market value of Firm L's debt is $200,000 and its yield is 9%.The firm's equity has a market value of $300,000,its earnings are growing at a 5% rate,and its tax rate is 40%.A similar firm with no debt has a cost of equity of 12%.Under the MM extension with growth,what would Firm L's total value be if it had no debt?

A)$358,421
B)$377,286
C)$397,143
D)$417,000
E)$437,850

Question 23

Refer to Exhibit 17.1.What is the firm's cost of equity?

A)21.0%
B)23.3%
C)25.9%
D)28.8%
E)32.0%

Question 24

Refer to Exhibit 17.3.What is the yield on Wilson Dover's debt?

A)6.04%
B)6.36%
C)6.70%
D)7.05%
E)7.42%

Question 25

Refer to Exhibit 17.2.According to the MM extension with growth,what is the value of Kitto's tax shield?

A)$156,385
B)$164,616
C)$173,280
D)$182,400
E)$192,000

Question 26

A local firm has debt worth $200,000,with a yield of 9%,and equity worth $300,000.It is growing at a 5% rate,and its tax rate is 40%.A similar firm with no debt has a cost of equity of 12%.Under the MM extension with growth,what is the value of your firm's tax shield,i.e.,how much value does the use of debt add?

A)$92,571
B)$102,857
C)$113,143
D)$124,457
E)$136,903

Question 27

Refer to Exhibit 17.3.What is the value (in millions)of Wilson Dover's debt if its equity is viewed as an option?

A)$167.57
B)$186.19
C)$204.81
D)$225.29
E)$247.82

Question 28

Refer to Exhibit 17.1.Assume that the firm's gain from leverage according to the Miller model is $126,667.If the effective personal tax rate on stock income is T_S = 20%,what is the implied personal tax rate on debt income?

A)16.4%
B)18.2%
C)20.2%
D)22.5%
E)25.0%

Question 29

Refer to Exhibit 17.3.What is the value (in millions)of Wilson Dover's equity if it is viewed as an option?

A)$228.77
B)$254.19
C)$282.43
D)$313.81
E)$345.19

Question 30

Refer to Exhibit 17.2.According to the MM extension with growth,what is Kitto's unlevered value?

A)$1,296,000
B)$1,440,000
C)$1,600,000
D)$1,760,000
E)$1,936,000

Question 31

Refer to Exhibit 17.1.What is the value of the firm according to MM with corporate taxes?

A)$475,875
B)$528,750
C)$587,500
D)$646,250
E)$710,875