16) Consider the following statements: The traditional view of capital structure with no taxation or bankruptcy costs is: I. At low levels of debt there is a gain to the firm from taking on more debt II. There is an optimal capital structure III. The weighted average cost of capital is unaffected by the debt-equity ratio Which of the following is correct? a. I, II and III b. I and II only c. I and III only d. II and III only e. I only. 17) In relation to the efficient markets hypothesis, consider the following observations: I. Mutual fund managers do not on average make superior returns. II. In any year approximately 50 percent of all pension funds outperform the market. III. It is possible to make superior returns by buying or selling stocks after the announcement of an abnormal rise in earnings. IV. Managers who trade in their own stocks make superior returns. Which of the following statements is TRUE? a. I does not provide evidence against semi-strong form efficiency, but II does provide evidence against semi-strong form efficiency. b. II does not provide evidence against semi-strong form efficiency, but I does provide evidence against semi-strong form efficiency. c. Both I and II provide evidence against the semi-strong form of market efficiency d. III provides evidence against semi-strong form efficiency and IV provides evidence against strong form efficiency. e. III and IV provide evidence against semi-strong form efficiency. Use the following information to answer questions 18-20 Holmes electronics has 800,000 shares of common stock outstanding with a par value of £1.00 per share. The current share price is £12.50 per share. The firm has outstanding debt with a par value of £4 million, which is selling at 150% of par. The risk-free rate of interest is 6% and the required return on the firm’s debt is 12%. The risk premium on the market is 14% and the firm has an equity beta of 1.3. Where a tax rate is required in the questions below, assume that debt interest payments are tax deductible. 18) What is Holmes’ cost of debt capital (i) if there are no taxes and (ii) if there is a corporation tax rate of 35%? a. (i) 12% and (ii) 7.8% b. (i) 12% and (ii) 8.6% c. (i) 6% and (ii) 4.3% d. (i) 6% and (ii) 3.9% e. None of the above 19) What is Holmes’ cost of equity capital (i) if there are no taxes and (ii) if there is a corporation tax rate of 35%? a. (i) 20.6% and (ii) 18% b. (i) 20.6% and (ii) 20.6% c. (i) 24.2% and (ii) 19.8% d. (i) 24.2% and (ii) 24.2% e. None of the above 20) What is Holmes’ WACC (i) if there are no taxes and (ii) if there is a corporation tax rate of 35%? a. (i) 18.45% and (ii) 18.05% b. (i) 18.45% and (ii) 16.825% c. (i) 19.625% and (ii) 16.825% d. (i) 19.625% and (ii) 18.05% e. None of the above

16) Consider the following statements: The traditional view of capital structure with no taxation or bankruptcy costs is: I. At low levels of debt there is a gain to the firm from taking on more debt II. There is an optimal capital structure III. The weighted average cost of capital is unaffected by the debt-equity ratio Which of the following is correct? a. I, II and III b. I and II only c. I and III only d. II and III only e. I only. 17) In relation to the efficient markets hypothesis, consider the following observations: I. Mutual fund managers do not on average make superior returns. II. In any year approximately 50 percent of all pension funds outperform the market. III. It is possible to make superior returns by buying or selling stocks after the announcement of an abnormal rise in earnings. IV. Managers who trade in their own stocks make superior returns. Which of the following statements is TRUE? a. I does not provide evidence against semi-strong form efficiency, but II does provide evidence against semi-strong form efficiency. b. II does not provide evidence against semi-strong form efficiency, but I does provide evidence against semi-strong form efficiency. c. Both I and II provide evidence against the semi-strong form of market efficiency d. III provides evidence against semi-strong form efficiency and IV provides evidence against strong form efficiency. e. III and IV provide evidence against semi-strong form efficiency. Use the following information to answer questions 18-20 Holmes electronics has 800,000 shares of common stock outstanding with a par value of £1.00 per share. The current share price is £12.50 per share. The firm has outstanding debt with a par value of £4 million, which is selling at 150% of par. The risk-free rate of interest is 6% and the required return on the firm’s debt is 12%. The risk premium on the market is 14% and the firm has an equity beta of 1.3. Where a tax rate is required in the questions below, assume that debt interest payments are tax deductible. 18) What is Holmes’ cost of debt capital (i) if there are no taxes and (ii) if there is a corporation tax rate of 35%? a. (i) 12% and (ii) 7.8% b. (i) 12% and (ii) 8.6% c. (i) 6% and (ii) 4.3% d. (i) 6% and (ii) 3.9% e. None of the above 19) What is Holmes’ cost of equity capital (i) if there are no taxes and (ii) if there is a corporation tax rate of 35%? a. (i) 20.6% and (ii) 18% b. (i) 20.6% and (ii) 20.6% c. (i) 24.2% and (ii) 19.8% d. (i) 24.2% and (ii) 24.2% e. None of the above 20) What is Holmes’ WACC (i) if there are no taxes and (ii) if there is a corporation tax rate of 35%? a. (i) 18.45% and (ii) 18.05% b. (i) 18.45% and (ii) 16.825% c. (i) 19.625% and (ii) 16.825% d. (i) 19.625% and (ii) 18.05% e. None of the above

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter13: Capital Structure Concepts

Section: Chapter Questions

Problem 5P

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Question

16) Consider the following statements:

The traditional view of capital structure with no taxation or bankruptcy costs is:

I. At low levels of debt there is a gain to the firm from taking on more debt

II. There is an optimal capital structure

III. The weighted average cost of capital is unaffected by the debt-equity ratio

Which of the following is correct?

a. I, II and III

b. I and II only

c. I and III only

d. II and III only

e. I only.

17) In relation to the efficient markets hypothesis, consider the following observations:

I. Mutual fund managers do not on average make superior returns.

II. In any year approximately 50 percent of all pension funds outperform the market.

III. It is possible to make superior returns by buying or selling stocks after the announcement

of an abnormal rise in earnings.

IV. Managers who trade in their own stocks make superior returns.

Which of the following statements is TRUE?

a. I does not provide evidence against semi-strong form efficiency, but II does provide

evidence against semi-strong form efficiency.

b. II does not provide evidence against semi-strong form efficiency, but I does provide

evidence against semi-strong form efficiency.

c. Both I and II provide evidence against the semi-strong form of market efficiency

d. III provides evidence against semi-strong form efficiency and IV provides evidence against

strong form efficiency.

e. III and IV provide evidence against semi-strong form efficiency.

Use the following information to answer questions 18-20

Holmes electronics has 800,000 shares of common stock outstanding with a par value of £1.00 per

share. The current share price is £12.50 per share. The firm has outstanding debt with a par value of

£4 million, which is selling at 150% of par. The risk-free rate of interest is 6% and the required return

on the firm’s debt is 12%. The risk premium on the market is 14% and the firm has an equity beta of

1.3.

Where a tax rate is required in the questions below, assume that debt interest payments are tax

deductible.

18) What is Holmes’ cost of debt capital (i) if there are no taxes and (ii) if there is a corporation tax

rate of 35%?

a. (i) 12% and (ii) 7.8%

b. (i) 12% and (ii) 8.6%

c. (i) 6% and (ii) 4.3%

d. (i) 6% and (ii) 3.9%

e. None of the above

19) What is Holmes’ cost of equity capital (i) if there are no taxes and (ii) if there is a corporation

tax rate of 35%?

a. (i) 20.6% and (ii) 18%

b. (i) 20.6% and (ii) 20.6%

c. (i) 24.2% and (ii) 19.8%

d. (i) 24.2% and (ii) 24.2%

e. None of the above

20) What is Holmes’ WACC (i) if there are no taxes and (ii) if there is a corporation tax rate of 35%?

a. (i) 18.45% and (ii) 18.05%

b. (i) 18.45% and (ii) 16.825%

c. (i) 19.625% and (ii) 16.825%

d. (i) 19.625% and (ii) 18.05%

e. None of the above

Definition Definition Degree to which financial markets incorporate all available information into the prices of assets. In a more efficient market, the prices reflect the available information more than that in a weak efficient market. It is difficult for investors to outperform the market in a strong efficient market. This is because all the available information is already discounted in the asset's price. However, in a weak-form efficiency, the market does not reflect all information in the asset's price. As a result, it becomes easier to generate better returns in a weak form or an inefficient market.

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