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FIN 134 - Capital Structure

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The proposition that the cost of equity is a positive linear function of capital structure is called the MM Proposition II.
The proposition that the cost of equity is a positive linear function of capital structure is called the MM Proposition II.
The cost of capital for a firm, rWACC, in a zero tax environment is:

- Equal to the expected earnings divided by market value of the unlevered firm
- Equal to the rate of return for that business risk class
- Equal to the overall rate of return required on the levered firm
- Is constant regardless of the amount of leverage
The cost of capital for a firm, rWACC, in a zero tax environment is:

- Equal to the expected earnings divided by market value of the unlevered firm
- Equal to the rate of return for that business risk class
- Equal to the overall rate of return required on the levered firm
- Is constant regardless of the amount of leverage
The Modigliani-Miller Proposition I without taxes states that a firm cannot change the total value of its outstanding securities by changing its capital structure proportions.
The Modigliani-Miller Proposition I without taxes states that a firm cannot change the total value of its outstanding securities by changing its capital structure proportions.
MM Proposition I without taxes is used to illustrate:

- The value of an unlevered firm equals that of a levered firm
- That one capital structure is as good as another
- Leverage does not affect the value of the firm
- Capital structure changes have no effect on stockholder's welfare.
MM Proposition I without taxes is used to illustrate:

- The value of an unlevered firm equals that of a levered firm
- That one capital structure is as good as another
- Leverage does not affect the value of the firm
- Capital structure changes have no effect on stockholder's welfare.
A key assumption of MM's proposition I without taxes is that individuals must be able to borrow on their own account at rates equal to the firm.
A key assumption of MM's proposition I without taxes is that individuals must be able to borrow on their own account at rates equal to the firm.
When comparing levered vs. un-levered capital structures, leverage works to increase EPS for high levels of EBIT because: interest payments on the debt stay fixed, leaving more income to be distributed over less shares.
When comparing levered vs. un-levered capital structures, leverage works to increase EPS for high levels of EBIT because: interest payments on the debt stay fixed, leaving more income to be distributed over less shares.
Financial leverage impacts the performance of the firm by:

Increasing the volatility of the firm's net income.
Financial leverage impacts the performance of the firm by:

Increasing the volatility of the firm's net income.
The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

Levered firms pay less taxes compared with identical unlevered firms.
The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

Levered firms pay less taxes compared with identical unlevered firms.
A firm should select the capital structure which:

Maximizes the value of the firm
A firm should select the capital structure which:

Maximizes the value of the firm
Bryan invested in company when the firm was financed solely with equity. The firm is now utilizing debt in its capital structure. To un-lever his position, Bryan needs to:

Sell some shares of Bryco stock and loan it out such that he created debt-equity ratio equal to that of the firm.
Bryan invested in company when the firm was financed solely with equity. The firm is now utilizing debt in its capital structure. To un-lever his position, Bryan needs to:

Sell some shares of Bryco stock and loan it out such that he created debt-equity ratio equal to that of the firm.
The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:

MM Proposition I with no tax
The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:

MM Proposition I with no tax
The concept of homemade leverage is most associated with:

MM Proposition I with no tax
The concept of homemade leverage is most associated with:

MM Proposition I with no tax
The following statements are correct in relation to MM Proposition II with no tax:

- The required return on assets is equal to the weighted average cost of capital
- Financial risk is determined by the debt-equity ratio
The following statements are correct in relation to MM Proposition II with no tax:

- The required return on assets is equal to the weighted average cost of capital
- Financial risk is determined by the debt-equity ratio
MM Proposition 1 with taxes is based on the concept that:

The value of the firm increases as total debt increases because of the interest tax shield.
MM Proposition 1 with taxes is based on the concept that:

The value of the firm increases as total debt increases because of the interest tax shield.
MM Proposition 2 with taxes:

Has the same general implications as MM proposition 2 without taxes.
MM Proposition 2 with taxes:

Has the same general implications as MM proposition 2 without taxes.
The interest-tax shield has no value for a firm when:

- Tax rate is equal to 0
- The firm is unlevered
- A firm elects 100% equity as its capital structure
The interest-tax shield has no value for a firm when:

- Tax rate is equal to 0
- The firm is unlevered
- A firm elects 100% equity as its capital structure
The interest tax shield is a key reason why:

- The next cost of debt to a firm is generally less than the cost of equity
The interest tax shield is a key reason why:

- The next cost of debt to a firm is generally less than the cost of equity
Given a progressive tax rate structure, the following will tend to diminish the benefit of the interest tax shield:

- A reduction in tax rates
- A large tax loss carry forward
- A large depreciation tax deduction
Given a progressive tax rate structure, the following will tend to diminish the benefit of the interest tax shield:

- A reduction in tax rates
- A large tax loss carry forward
- A large depreciation tax deduction
In a world with taxes and financial distress, when a firm is operating with the optimal capital structure:

- The Debt-Equity ratio will also be optimal
- The weighted average cost of capital will be at its minimal point
- The increased benefit from additional debt is equal to the increased bankruptcy costs of that debt.
In a world with taxes and financial distress, when a firm is operating with the optimal capital structure:

- The Debt-Equity ratio will also be optimal
- The weighted average cost of capital will be at its minimal point
- The increased benefit from additional debt is equal to the increased bankruptcy costs of that debt.
The MM Theory with taxes implies that firms should issue maximum debt. In practice, this is not true because:

Bankruptcy is a disadvantage to debt.
The MM Theory with taxes implies that firms should issue maximum debt. In practice, this is not true because:

Bankruptcy is a disadvantage to debt.
Given realistic estimates of the probability and costs of bankruptcy, the future costs of a possibly bankruptcy are borne by:

Shareholders because debt holders will pay less for the debt providing less cash for the shareholders.
Given realistic estimates of the probability and costs of bankruptcy, the future costs of a possibly bankruptcy are borne by:

Shareholders because debt holders will pay less for the debt providing less cash for the shareholders.
When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends, these will result in:

Positive agency costs, as bondholders impose various restrictions and covenants which will diminish firm value.
When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends, these will result in:

Positive agency costs, as bondholders impose various restrictions and covenants which will diminish firm value.
When firms issue more debt, the tax shield on debt "increases," the agency costs on debt (cost of financial distress) "increases," and the agency costs on equity "decreases."
When firms issue more debt, the tax shield on debt "increases," the agency costs on debt (cost of financial distress) "increases," and the agency costs on equity "decreases."
Growth opportunities decrease the advantage of debt financing.
Growth opportunities decrease the advantage of debt financing.
The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

Personal tax rate on the distribution of income to stockholders is less than the personal tax rate on interest income.
The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

Personal tax rate on the distribution of income to stockholders is less than the personal tax rate on interest income.
In Miller's model, when the quantity [(1-Tc)(1-Ts)=(1-Tb)], then

The tax shield on debt is exactly offset by higher personal taxes paid on interest income.
In Miller's model, when the quantity [(1-Tc)(1-Ts)=(1-Tb)], then

The tax shield on debt is exactly offset by higher personal taxes paid on interest income.
When comparing levered vs. un-levered capital structures, leverage works to increase EPS for high levels of EBIT because: interest payments on the debt stay fixed, leaving more income to be distributed over less shares.
When comparing levered vs. un-levered capital structures, leverage works to increase EPS for high levels of EBIT because: interest payments on the debt stay fixed, leaving more income to be distributed over less shares.
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