Part 7 (ch14) Questions T/F & Multiple Choice
Mark T (True) or F (False) in each of the following sentences.
1 With perfect capital markets, financial transactions are a zero-NPV activity that neither add nor destroy value on their own.
2 When equity is used without debt, the firm is said to be levered.
3 Leverage can raise a firm’s expected earnings per share and its return on equity, but it also increases the volatility of earnings per share and the riskiness of its equity.
4 Leverage increases the risk of equity and raises the equity cost of capital.
5 A firm can change its capital structure at any time by issuing new securities and using the funds to pay its existing investors.
6 According to MM Proposition I, with perfect capital markets, the value of a firm is independent of its capital structure.
7 A firm’s net debt is equal to its debt plus its holdings of cash and other risk-free securities.
8 The owner of a firm should choose the capital structure that maximizes the total value of the securities issued.
9 The relative proportions of debt, equity, and other securities make up a firm’s investment policy.
10 The premium that investors demand for holding the company’s equity increases as the company’s D/E ratio increases, which leads to an increase in the cost of capital of levered equity.
11 Leverage refers to the practice of using debt or other financial instruments to magnify returns on equity investments, while unlevered equity means using only equity capital without debt.
12 According to Modigliani-Miller and the Law of One Price, in a world of perfect capital markets, two identical firms with the same cash flows should have the same market value, regardless of their capital structures.
13 Debt financing is a less expensive source of capital for a firm compared to equity financing.