Q.1.
The proposition that the value of a firm is independent of the firm's capital structure is called:
A. the capital asset pricing model.
B. M&M Proposition I.
C. M&M Proposition II.
D. the law of one price.
Q.2. The proposition that a firm's cost of equity capital is a positive linear function of the firm's
capital structure is called:
A. the capital asset pricing model.
B. M&M Proposition I.
C. M&M Proposition II.
D. the law of one price.
Q.3. The equity risk derived from a firm's capital structure policy is called _____ risk.
A. market
B. systematic
C. extrinsic
D. financial
Q.4. M&M Proposition I with no tax supports the argument that:
A. business risk determines the return on assets.
B. the cost of equity rises as leverage rises.
C. it is completely irrelevant how a firm arranges its finances.
D. a firm should borrow money to the point where the tax benefit from debt is equal to the
cost of the increased probability of financial distress.
Q.5. The capital structure that maximizes the value of a firm also:
A. minimizes financial distress costs.
B. minimizes the cost of capital.
C. maximizes the present value of the tax shield on debt.
D. maximizes the value of the debt.
Q.6. JKC Landscaping is an all equity firm that has 1,40,000 shares of stock outstanding. The company
is in the process of borrowing Rs. 1.2 million at 8 percent interest to repurchase 30,000 shares of the
outstanding stock. What is the value of this firm (in Rs.) if you ignore taxes?
A. 2.57 million
B. 4.14 million
C. 5.60 million
D. 7.00 million
Q.7. Appu Feed has a cost of equity of 11.9 percent and a pre-tax cost of debt of 9 percent. The
required return on the assets is 11 percent. What is the firm's debt-equity ratio based on M&M II with
no taxes?
A. .40
B. .45
C. .50
D. .60
Q.8. Rosy’s Kitchen has a debt-equity ratio of .60. The firm's required return on assets is 11 percent
and its cost of equity is 14.7 percent. What is the pre-tax cost of debt based on M&M II with no taxes?
A. 4.83 percent
B. 5.39 percent
C. 5.70 percent
D. 6.17 percent
Q.9. Amit Dry Goods has expected earnings before interest and taxes of Rs. 14,600, an unlevered cost
of capital of 15 percent, and a tax rate of 35 percent. The company also has Rs. 3,500 of debt that
carries a 6 percent coupon. The debt is selling at par value. What is the value of this firm (Rs.)?
A. 63,267
B. 64,184
C. 64,492
D. 66,267
Q.10. An unlevered firm has a cost of capital of 16 percent and earnings before interest and taxes of
Rs. 225,000. A levered firm with the same operations and assets has both a book value and a face
value of debt of Rs. 850,000 with an 8 percent annual coupon. The applicable tax rate is 34 percent.
What is the value of the levered firm?
A. Rs. 928,125
B. Rs. 1,110,125
C. Rs. 1,217,125
D. Rs. 1,778,125
Q.11. The Himani Fabric Mill has debt with both a face and a market value of Rs. 6,500. This debt has
a coupon rate of 8 percent and pays interest annually. The expected earnings before interest and taxes
are Rs. 1,400, the tax rate is 35 percent, and the unlevered cost of capital is 14 percent. What is the
firm's cost of equity?
A. 17.90 percent
B. 22.40 percent
C. 23.59 percent
D. 25.14 percent
Q.12. Surbhi's BBQ Grill has Rs. 21,000 of debt outstanding that is selling at par and has a coupon
rate of 6.5 percent. The tax rate is 35 percent. What is the present value of the tax shield?
A. Rs. 790
B. Rs. 365
C. Rs. 4,780
D. Rs. 7,350
ANSWERS
Q.1 Q.2 Q.3 Q.4 Q.5 Q.6 Q.7 Q.8 Q.9 Q.10 Q.11 Q.12
B C D C B C B A C C D D
