W6 - Online Quiz

Question 1

Multiple Choice

MM Proposition I (no taxes) relies on a key arbitrage logic. Which statement is MOST accurate?

A. With perfect capital markets and investors able to borrow/lend on the same terms as firms, two firms with identical assets but different capital structures must have the same total value.

B. Capital structure is irrelevant only if the firm’s debt is risk-free; otherwise MM does not apply.

C. If a firm increases D/E, its total value rises because debt is cheaper than equity.

D. MM says leverage increases EPS, therefore shareholders are always better off with more debt.

Question 2

Multiple Choice

Which statement correctly compares the company cost of capital rA (opportunity cost of capital) and the after-tax WACC when corporate interest is tax-deductible?

A. Both rA and after-tax WACC fall as leverage increases because interest is tax-deductible.

B. rA is the after-tax cost of capital; WACC is the pre-tax cost of capital.

C. After-tax WACC equals the expected return required by all investors (debt + equity) in the same way rA does.

D. rA is the expected return on the firm’s assets and (in MM’s no-tax world) is invariant to leverage; after-tax WACC can be lower than rA because it includes the tax shield via rD(1−Tc).

Question 3

Multiple Choice

No taxes. Nordic Tools has market D/E = 0.80, cost of debt rD = 6.0%, and cost of equity rE = 14.0%. What is the unlevered (asset) cost of capital rU (= rA)?

A. 9.60%

B. 10.44%

C. 11.20%

D. 12.08%

Question 4

Multiple Choice

Continue Nordic Tools (no taxes). Assume rU stays constant at 10.44%. The firm recapitalises to D/E = 1.20 and the cost of debt rises to rD = 7.0%. Using MM Proposition II, what is the new cost of equity rE?

A. 13.52%

B. 14.57%

C. 15.86%

D. 17.20%

Question 5

Multiple Choice

With corporate taxes. A firm has perpetual EBIT = €1.0m, corporate tax rate Tc = 35%, and unlevered cost of capital rU = 12% (no growth). Under Plan II it issues permanent debt D = €4.0m. Assuming the debt is risk-free and MM with taxes applies, what is the value of the levered firm VL?

A. €5.42m

B. €6.02m

C. €6.82m

D. €7.58m

Question 6

Multiple Choice

With corporate taxes and a target capital structure. A firm expects FCF1 = £2.4m next year, growing at g = 4% thereafter. Costs: rE = 13%, rD = 7%, tax rate Tc = 25%. Target D/E = 1.5 (constant rebalancing). What are (i) after-tax WACC and (ii) firm value V = FCF1/(WACC−g)?

A. WACC=7.55%, V=£67.6m

B. WACC=8.35%, V=£55.2m

C. WACC=9.10%, V=£47.1m

D. WACC=10.00%, V=£40.0m