Question 1

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

Accepted Answer

False

Question 2

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

Accepted Answer

Financial leverage refers to a company's use of debt to finance its operations. As debt increases, the company's interest payments increase, which can lead to a decrease in earnings and cash flows. This can cause the market (or systematic) risk of the company to increase, as measured by its beta coefficient. Beta measures the sensitivity of a stock or portfolio to changes in the overall stock market. A higher beta indicates higher market risk, while a lower beta indicates lower market risk. Therefore, an increase in financial leverage would lead to a higher beta, and thus, an increase in a firm's market risk.

Question 3

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

Accepted Answer

The MM model refers to the Modigliani-Miller theorem, which includes propositions about capital structure with and without taxes. The Miller model, however, incorporates personal taxes into the analysis of capital structure.

Question 4

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

Accepted Answer

The Modigliani-Miller theorem with taxes suggests that because interest payments are tax-deductible, firms can maximize their value by using more debt, potentially leading to an optimal capital structure with nearly 100% debt.

Question 5

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

Accepted Answer

In the MM extension with growth, the appropriate discount rate for the tax shield is the cost of debt, not the WACC.

Question 6

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

Accepted Answer

Without the presence of taxes, the interest paid on debt financing is not deductible, making the cost of debt equal to the cost of equity. As a result, a firm's value is not affected by its capital structure. This is known as Modigliani-Miller proposition I. However, in a world with taxes, the presence of debt financing can provide tax shields, making the cost of debt lower than the cost of equity, thus affecting a firm's value.

Question 7

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.

Accepted Answer

The answer of Which of the following statements concerning the...

Question 8

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.

Accepted Answer

This is known as the "option analogy" and is a commonly used concept in finance. The equity holders have the right to the residual value of the firm after the debt holders have been paid off, similar to the way a call option gives the holder the right to purchase a stock at an exercise price.

Question 9

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

Accepted Answer

The MM model with corporate taxes assumes that the corporate tax rate is the only tax, while the Miller model assumes that there are no personal taxes. Therefore, the MM model with corporate taxes is the same as the Miller model, but with zero personal taxes.

Question 10

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

Accepted Answer

According to MM, in a world without taxes, the optimal capital structure for a firm is irrelevant and should not affect the value of the firm. However, in the real world, taxes and other market imperfections make it more optimal for a firm to have a mix of debt and equity financing rather than 100% debt financing.

Question 11

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

Accepted Answer

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

Question 12

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%

Accepted Answer

The answer of market value of Firm L's debt is...

Question 13

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.

Accepted Answer

The answer of Which of the following statements concerning the...

Question 14

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, rs 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 rsL is a function of rsU.
E) The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt.

Accepted Answer

Under MM with corporate taxes, the tax benefits of debt financing are not exactly offset by the increase in rs (cost of equity) with leverage. The tax shield from debt increases the value of the firm.

Question 15

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.

Accepted Answer

The Miller model shows that personal taxes can offset the tax benefits of corporate debt, thus decreasing its value.

Question 16

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

Accepted Answer

The answer of the MM extension with growth, the appropriate...

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 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.

Accepted Answer

The answer of Which of the following statements concerning the...

Question 18

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.

Accepted Answer

This is the basic principle of MM's theory of capital structure, which states that the value of a firm is independent of its capital structure in the absence of taxes and other market imperfections. When taxes are introduced, the optimal capital structure involves a trade-off between the tax advantages of debt financing and the costs of financial distress. As a result, a firm's value can be maximized by increasing its debt level up to a certain point, beyond which the costs of financial distress start to outweigh the tax benefits.

Question 19

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

Accepted Answer

According to the MM extension with growth, the appropriate discount rate for the tax shield is the unlevered cost of equity. This is because the tax shield is a result of debt financing and does not depend on the firm's leverage. Therefore, the cost of debt does not need to be incorporated into the discount rate for the tax shield.

Question 20

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.

Accepted Answer

The firm's risky debt can be viewed as an option on the firm's assets, with the exercise price equal to the face value of the debt, not the equity.

Quiz 16: Cap Structure II

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

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

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

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

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

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

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

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.

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

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

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

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

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

major contribution of the Miller model is that it demonstrates that

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

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

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.

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

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.