Question 1

The law of conservation of value implies that

Accepted Answer

The law of conservation of value states that the total value of an asset is preserved regardless of the nature of the claims against it. This means that the value of an asset will remain the same whether it is financed by debt, equity or a combination of both. This law is important in finance as it ensures that any changes in a company's capital structure do not affect the overall value of the firm.

Question 2

For a levered firm,

Accepted Answer

A levered firm has debt which requires interest payments, so as EBIT increases, the interest payments remain constant while earnings available to equity holders increase by a larger percentage, leading to a larger increase in EPS.

Question 3

If an investor buys a portion (X)of an unlevered firm's equity, then his/her payoff is

Accepted Answer

If an investor buys a portion of an unlevered firm's equity, their payoff will be a portion of the profits of the firm. Hence, (X) × (profits) is the correct choice.

Question 4

When a firm has no debt, then such a firm is known as
I.an unlevered firm;
II.a levered firm;
III.an all-equity firm

Accepted Answer

An unlevered firm is a firm with no debt, so option I is correct. An all-equity firm is also a firm with no debt, so option III is also correct. Option II is incorrect as it refers to a firm with debt, so the correct answer is choice letter D, I and III only.

Question 5

Modigliani and Miller's Proposition I states that

Accepted Answer

Modigliani and Miller's Proposition I states that the value of a firm is determined by its earning power and the risk of its underlying assets, and is independent of its capital structure. In other words, the market value of any firm is not affected by how it chooses to finance its operations, whether it is through issuing equity or debt. Therefore, option A is the correct answer. Option B is incorrect because the market value of a firm's debt is affected by its capital structure, as the riskiness of debt increases with its proportion in the capital structure. Option C is also incorrect because the market value of a firm's common stock is affected by its capital structure, as the risk and return expectations of shareholders are affected by the firm's capital structure decisions.

Question 6

The law of conservation of value implies that
I.the mix of common stock and preferred stock does not affect the value of the firm;
II.the mix of long-term and short-term debt does not affect the value of the firm;
III.the mix of secured and unsecured debt does not affect the value of the firm

Accepted Answer

The law of conservation of value holds that the overall value of a firm remains constant regardless of the specific mix of financing it employs. This implies that the cost of capital is not affected by the proportion of different types of equity or debt in the firm's capital structure. Therefore, all three statements (I, II, and III) are true.

Question 7

Value additivity works for
I.combining assets;
II.splitting up of assets;
III.the mix of debt securities issued by the firm

Accepted Answer

Value additivity principle applies to all three scenarios: combining assets, splitting up assets, and the mix of debt securities issued by the firm. It states that the value of a set of assets is equal to the sum of the values of the individual assets, regardless of how they are combined or split.

Question 8

If a firm is financed with both debt and equity, the firm's equity is known as

Accepted Answer

When a firm is financed with both debt and equity, the equity is known as levered equity because it is affected by the use of debt or leverage. This is in contrast to unlevered equity, which refers to the equity of a firm that is financed solely by equity capital without any debt. Preferred equity is a specific type of equity that has priority over common equity in terms of dividends and liquidation preference.

Question 9

Under what conditions would a policy of maximizing the value of the firm not be the same as a policy of maximizing shareholders' wealth?

Accepted Answer

If an issue of debt affects the market value of existing debt, it could alter the firm's overall value without necessarily aligning with maximizing shareholders' wealth, as it may impact the risk and return profile differently for shareholders.

Question 10

The total market value (V)of the securities of a firm that has both debt (D)and equity (E)is

Accepted Answer

The total market value (V) of a firm that has both debt (D) and equity (E) is the sum of the market values of its debt and equity. Therefore, V = D + E.

Question 11

If an investor buys a portion (X)of both the debt and equity of a levered firm, then his/her payoff is

Accepted Answer

The answer of If an investor buys a portion (X)of...

Question 12

The law of conservation of value implies that
I.the mix of senior and subordinated debt does not affect the value of the firm;
II.the mix of convertible and nonconvertible debt does not affect the value of the firm;
III.the mix of common stock and preferred stock does not affect the value of the firm

Accepted Answer

The law of conservation of value states that the total value of a company remains the same regardless of the mix of securities used to finance it. Therefore, all three statements are true, and the mix of senior and subordinated debt, convertible and nonconvertible debt, and common and preferred stock does not affect the overall value of the firm.

Question 13

If an individual wants to borrow with limited liability, he/she should

Accepted Answer

Investing in the equity of a levered firm allows an individual to benefit from the use of debt (leverage) while maintaining limited liability. The liability of equity investors is limited to the amount they have invested in the firm, protecting their personal assets beyond their investment in the event of the firm's financial distress.

Question 14

An investor can undo the effect of leverage on his/her own account by
I.investing in the equity of an unlevered firm;
II.borrowing on his/her own account;
III.investing in risk-free debt like T-bills

Accepted Answer

I is a correct choice because investing in the equity of an unlevered firm means that there is no debt involved and therefore no leverage, which would undo the effect of leverage on the investor's account.

II is not a correct choice because borrowing on one's own account would further increase leverage and worsen the effect.

III is also a correct choice because investing in risk-free debt like T-bills involves no risk of default and therefore no leverage effect.

Question 15

Capital structure is irrelevant if
I.capital markets are efficient;
II.each investor can borrow/lend on the same terms as the firm;
III.there are no tax benefits to debt

Accepted Answer

According to Modigliani-Miller's theorem, under the assumptions of efficient capital markets, equal access to borrowing/lending, and no tax benefits to debt, the capital structure of a firm does not affect its value. Therefore, all three conditions must be met for capital structure to be irrelevant.

Question 16

The capital structure of the firm can be defined as
I.the firm's mix of different debt securities;
II.the firm's mix of different securities used to finance assets;
III.the market imperfection that the firm's managers can exploit

Accepted Answer

The capital structure of the firm is defined as the mix of different securities used to finance assets (II). The other options are not part of the definition of capital structure.

Question 17

If firm U is unlevered and firm L is levered, then which of the following is true? I.V_U = E_U. II.V_L = E_L + D_L. III.V_L = E_U + D_L.

Accepted Answer

- I is true for both unlevered and levered firms as it represents the value of equity with no debt.
- II is only true for levered firms as it takes into account the value of debt and the associated tax shield.
- III is not true as it tries to equate the value of levered and unlevered firms, which cannot be done without making further assumptions.

Question 18

An investor can create the effect of leverage on his/her account by
I.buying equity of a levered firm;
II.investing in risk-free debt like T-bills;
III.borrowing on his/her own account

Accepted Answer

Buying equity of a levered firm allows an investor to benefit from the firm's leverage. Borrowing on his/her own account creates leverage as well, as the borrowed funds can be used to invest in other assets, potentially increasing the return on investment. Investing in risk-free debt like T-bills does not create leverage, as the returns on such investments are typically low and not influenced by the investor's own capital.

Question 19

If an investor buys a portion (X)of the equity of a levered firm, then his/her payoff is

Accepted Answer

The investor's payoff is based on their portion (X) of the equity of the levered firm. Therefore, the investor's share of profits would be (X)× (profits), but they would also have to account for the interest payments owed to debt holders, which would reduce their share of profits. Therefore, the most accurate representation of the investor's payoff would be (X)× (profits − interest), which is answer choice C.

Question 20

A policy of maximizing the value of the firm is the same as a policy of minimizing the weighted average cost of capital providing that
I.the firm's investment policy is settled;
II.there are no taxes;
III.an issue of new debt does not affect the market value of existing debt

Accepted Answer

All three conditions must hold in order for maximizing the value of the firm to be equivalent to minimizing the weighted average cost of capital. If the firm's investment policy is not settled, then maximizing the value of the firm may lead to investments that require a higher cost of capital. If there are taxes, the cost of debt financing and the value of the firm may be affected. If an issue of new debt affects the market value of existing debt, then the cost of debt financing and the value of the firm may also be affected.

Quiz 17: Does Debt Policy Matter

The law of conservation of value implies that

For a levered firm,

If an investor buys a portion (X) of an unlevered firm's equity, then his/her payoff is

When a firm has no debt, then such a firm is known as I.an unlevered firm; II.a levered firm; III.an all-equity firm

Modigliani and Miller's Proposition I states that

The law of conservation of value implies that I.the mix of common stock and preferred stock does not affect the value of the firm; II.the mix of long-term and short-term debt does not affect the value of the firm; III.the mix of secured and unsecured debt does not affect the value of the firm

Value additivity works for I.combining assets; II.splitting up of assets; III.the mix of debt securities issued by the firm

If a firm is financed with both debt and equity, the firm's equity is known as

Under what conditions would a policy of maximizing the value of the firm not be the same as a policy of maximizing shareholders' wealth?

The total market value (V) of the securities of a firm that has both debt (D) and equity (E) is

If an investor buys a portion (X) of both the debt and equity of a levered firm, then his/her payoff is

If an individual wants to borrow with limited liability, he/she should

An investor can undo the effect of leverage on his/her own account by I.investing in the equity of an unlevered firm; II.borrowing on his/her own account; III.investing in risk-free debt like T-bills

Capital structure is irrelevant if I.capital markets are efficient; II.each investor can borrow/lend on the same terms as the firm; III.there are no tax benefits to debt

The capital structure of the firm can be defined as I.the firm's mix of different debt securities; II.the firm's mix of different securities used to finance assets; III.the market imperfection that the firm's managers can exploit

If firm U is unlevered and firm L is levered, then which of the following is true? I.V_U = E_U. II.V_L = E_L + D_L. III.V_L = E_U + D_L.

An investor can create the effect of leverage on his/her account by I.buying equity of a levered firm; II.investing in risk-free debt like T-bills; III.borrowing on his/her own account

If an investor buys a portion (X) of the equity of a levered firm, then his/her payoff is

A policy of maximizing the value of the firm is the same as a policy of minimizing the weighted average cost of capital providing that I.the firm's investment policy is settled; II.there are no taxes; III.an issue of new debt does not affect the market value of existing debt

Quiz 17: Does Debt Policy Matter

The law of conservation of value implies that

For a levered firm,

If an investor buys a portion (X) of an unlevered firm's equity, then his/her payoff is

When a firm has no debt, then such a firm is known as I.an unlevered firm; II.a levered firm; III.an all-equity firm

Modigliani and Miller's Proposition I states that

The law of conservation of value implies that I.the mix of common stock and preferred stock does not affect the value of the firm; II.the mix of long-term and short-term debt does not affect the value of the firm; III.the mix of secured and unsecured debt does not affect the value of the firm

Value additivity works for I.combining assets; II.splitting up of assets; III.the mix of debt securities issued by the firm

If a firm is financed with both debt and equity, the firm's equity is known as

Under what conditions would a policy of maximizing the value of the firm not be the same as a policy of maximizing shareholders' wealth?

The total market value (V) of the securities of a firm that has both debt (D) and equity (E) is

If an investor buys a portion (X) of both the debt and equity of a levered firm, then his/her payoff is

If an individual wants to borrow with limited liability, he/she should

An investor can undo the effect of leverage on his/her own account by I.investing in the equity of an unlevered firm; II.borrowing on his/her own account; III.investing in risk-free debt like T-bills

Capital structure is irrelevant if I.capital markets are efficient; II.each investor can borrow/lend on the same terms as the firm; III.there are no tax benefits to debt

The capital structure of the firm can be defined as I.the firm's mix of different debt securities; II.the firm's mix of different securities used to finance assets; III.the market imperfection that the firm's managers can exploit

If firm U is unlevered and firm L is levered, then which of the following is true? I.VU = EU. II.VL = EL + DL. III.VL = EU + DL.

An investor can create the effect of leverage on his/her account by I.buying equity of a levered firm; II.investing in risk-free debt like T-bills; III.borrowing on his/her own account

If an investor buys a portion (X) of the equity of a levered firm, then his/her payoff is

A policy of maximizing the value of the firm is the same as a policy of minimizing the weighted average cost of capital providing that I.the firm's investment policy is settled; II.there are no taxes; III.an issue of new debt does not affect the market value of existing debt

If firm U is unlevered and firm L is levered, then which of the following is true? I.V_U = E_U. II.V_L = E_L + D_L. III.V_L = E_U + D_L.