Question

20. Conflicts of interest between stockholders and bondholders are known as:

1. dealer costs.

2. trustee costs.

3. agency costs.

4. underwriting costs.

5. financial distress costs.

21. MM's proposition II states that the:

1. greater the proportion of equity, the higher the expected return on debt.

2. firm's capital structure is irrelevant to value determination.

3. expected return on assets decreases as expected return on debt decreases.

4. expected return on equity increases as financial leverage increases.

22. One of the indirect costs to bankruptcy is the incentive toward underinvestment. Following this strategy may result in:

1. the firm turning down positive NPV projects that it would clearly accept in an all equity firm.

2. Both B and C.

3. the firm always choosing projects with the positive NPVs.

4. Both A and C.

5. stockholders contributing the full amount of the investment, but both stockholders and bondholders sharing in the benefits of the project.

23. The optimal capital structure:

1. is identical for all firms in the same industry.

2. will remain constant over time unless the firm makes an acquisition.

3. places more emphasis on the operations of a firm rather than the financing of a firm.

4. is unaffected by changes in the financial markets.

5. of a particular firm can change if tax rates change.

24. Alexandria's Dance Studio is currently an all-equity firm with earnings before interest and taxes of $338,000 and a cost of equity of 14.2 percent. Assume the tax rate is 22 percent. The firm is considering adding $400,000 of debt with a coupon rate of 7 percent to its capital structure. The debt will be sold at par value. What is the levered value of the equity?

1. $986,420

2. $1,944,620

3. $1,987,408

4. $2,038,519

5. $1,544,620

Answer 1

Q. 20). Answer :- Option 3). Agency costs.

Q. 21). Answer :- Option 4). Expected return on equity increases as financial leverage increases.

Q. 22). Answer :- The strategy mentioned in given question will result in both the statements as mentioned in options (1) and options (5). (The statement three is incorrect i.e., not the result of any strategy as mentioned in above question).

Q. 23). Answer :- Option 5). of a particular firm can change if tax rates change.