Assume that Modigliani-Miller Propositions 1 and 2 hold. Ex- plain carefully why the conclusion of each of the following argu- ments is incorrect: (i) As a firm borrows more and debt becomes risky, both share- holder and bondholders demand higher rates of return. Thus, reducing its debt ratio, a firm can reduce both the cost of debt and the cost of equity. ii) As leverage increases, the ratio of the market value of a firm's equity to income (after debt interest) increases.
Q: All else held constant, which one of these is most apt to increase the WACC of a leveraged firm?…
A: Weighted Average Cost of Capital =Kd1-T×DD+E+Ke×ED+E where Kd=Cost of Debt Ke=Cost of Equity T=Tax…
Q: If the debt component in the capital structure is predominant –
A: Debt: It is a part of the capital structure that involves bonds, loans, etc. Introducing debt to the…
Q: Which one of the following statements is correct if the pecking order theory holds? a. Firms with…
A: According to the pecking order theory, managers prefer to fund investment options using the firm's…
Q: which one is correct please confirm? QUESTION 21 Finance researcher Myron Gordon argues that ____.…
A: According to Myron Gordon a company’s stock is worth sum of all its future dividend’s present value.…
Q: Suppose a firm maintains its preferred debt-equity and pays dividends only after meeting its…
A: Company with growth opportunities available distribute dividend after meeting the requirements of…
Q: Explain what this statement means: "One type of leverage affects both EBIT and EPS. The other type…
A: Since you have asked multiple questions, we will solve the first question for you. IF you want any…
Q: Explain Why you agree or disagree with the following statements: A firm should select the capital…
A: Capital structure of a company defines the financing pattern or the way the company used to finance…
Q: 4. If a higher ROE is desirable, why don't companies take on large amounts of debt? a. Additional…
A: The return on equity is used to evaluate the profit earned on an investment considering the profit…
Q: tatement is true b. The above sta
A: Explanation : In simple words, fixed incomes instruments like bonds and notes pays their holders a…
Q: According to Modigliani and Miller, in a perfect market the total value of the firm will be Group of…
A: Modigliani & Miller believes that the value of a firm or its cost of capital is not dependent at…
Q: We understand that the market will be inefficient at times, and we can try to beat the market by…
A: Dividends are the distribution of a portion of a company's earnings to its shareholder class, as…
Q: Suppose that the yield of bonds issued by firms XYZ decreased. Which of the following the scenario…
A: when YEILD on bond decrease than means interest rates are going down that will increase the price of…
Q: 12. Which of the following statements is FALSE? A) The Law of One Price implies that leverage will…
A: Leverage is referred as the usage of the debt or borrowed capital, which helps in undertaking the…
Q: Which of the following statements is FALSE? A. Equity cost of capital is normally higher then…
A: The Modigliani Miller propositions: In their paper on Capital Structure, Modigliani and Miller (MM)…
Q: Consider the following statements: The Trade-off theory of capital structure cannot explain the…
A: The Trade-off theory of capital structure cannot explain the following: I. Why profitable firms have…
Q: A company will prefer debt in its capital structure, if (tick the most appropriate alternative) (a)…
A: Any capital structure is composed of debt and equity. Both have their own pros and cons which affect…
Q: Which one of the following is correct about security offerings? The costs of selling equity are less…
A: Security offerings are the instruments offered by companies for raising capital from financial…
Q: According to theory, the value of a firm is maximized by: Issuing no debt Issuing the maximum amount…
A: The value of a corporation is the total market value of the corporation which reflects the claims by…
Q: Consider the trade-off theory of capital structure and the market timing theory in answering this…
A: The capital structure theories are related to the issuing of debt and equity. The ratio between debt…
Q: Which one of the following statements is NOT CORRECT? o Investors may interpret a stock repurchase…
A: The question is related to Dividend Policy.
Q: Suppose your firm’s credit rating is B-, and outlook is negative, not easy to raise finance through…
A: Equity and debts are the two sources of financing available in capital markets. It is generally…
Q: the cost of debt is cheaper than the cost of equity. Does it imply that a firm should increase its…
A: Answer: Introduction: If a corporation raises capital through issuing debt securities like bonds it…
Q: the interest rate on debt is lower than ROA, then a firm will __________ by increasing the use of…
A: Solution Return on Equity is a measure of financial performance calculated by dividing net income…
Q: When the yield curve becomes inverted and slopes downard, it is an indicator of: a) A coming…
A: Yield curve is very important in telling that how would be future interest rate in the market and…
Q: Finance Which one of the following statements is not correct? a) Market timing theory argues that…
A: The wrong statement is b) According to static trade-off theory agency costs of equity increase when…
Q: Concerning the EBIT-EPS indifference analysis, which of the following statements is accurate? If…
A: EBIT-EPS analysis is the financial tool used to evaluated different alternatives of project…
Q: Assume that there is corporate tax, but no other frictions. Based on the propositions of Modigliani…
A: MM proposition with tax: value of levered firm = value of unlevered firm + gain frm leverage
Q: Which of the following statements is INCORRECT? Cutting the firm's dividend to increase…
A: Statement 3"A firm will increase its share price by reducing the total payout to shareholders." is…
Q: he concept of market efficiency underpins almost all financial theory and decision models. When…
A: Market efficiency is the degree to which current prices accurately represent all available, relevant…
Q: Consider the following statements about a firm: I. The debt beta of a firm is usually quite low. If…
A: Weighted Average Cost of Capital is referred to as the common method for determining the required…
Q: firm’s cost of equity, cost of debt, and cost of capital when the firm increases the amount of debt…
A: Note : As per the guidelines, only first question will be answered. Kindly post the remaining…
Q: Identify the corect statement: O H EBIT is expected to be below the indifference point, the firm…
A: EBIT - EPS indifferent point is the EBIT level at which EPS is same
Q: If a firm uses a conservative financial plan, It will usually have marketable securities at the…
A: Conservative investment prefers to conserve one's purchasing power of capital with a small amount of…
Q: Which of the following statements is correct? With all else held constant, a firm will have a…
A: The P/E ratio is based on price and earning. Any news about an increase in return on equity will…
Q: Which of the following statements is correct? A. If a firm’s assets are growing at a positive…
A: AFN stands for “additional funds needed,” and it refers to the additional resources that will be…
Q: 16) Consider the following statements: The traditional view of capital structure with no taxation or…
A: Since there are more than one question is posted at a time, the answer for only first question is…
Q: ens to the firm’s cost of equity, cost of debt, and cost of capital when the firm increases the…
A: Note : As per the guidelines, only first question will be answered. Kindly post the remaining…
Q: 9.Which of the following are true according to the Modigliani and Miller propositions? i.In a world…
A: Merton Miller as well as Franco Modigliani had conceptualized as well as developed this theorem as…
Q: Which statement is false regarding the Capital Asset Pricing Model?
A: CAPM Return Formula: Expected Return= Rf+ β(Rf- Rm) where, Rf is Risk free return…
Q: Although the exact relationship between a firm's degree of financial leverage and its beta is…
A: Beta is a measure of volatility or systematic risk higher the beta higher will be the risk. The beta…
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
- Which of the below statements does the MM Proposition I predict? A. In a perfect market, the value of a firm is independent of its capital structure B.In a perfect market, the discount rate depends on the capital structure C.In a perfect market, the value of a firm decreases in leverage D.In a perfect market, the NPY of investments depends on the existing debt/equity mixWhich of the following statements is FALSE? A. Equity cost of capital is normally higher then cost of debt, thus cost of debt can be examined in isolation. B. No matter if a firm is unlevered or levered, there is no difference in the market value of the firms total securities and market value of the firm’s assets. C. Introducing debt increases the risk even though it may be cheap and consequently increases firms equity cost of capital. D. Cost of Capital of equity and Leverage can be explicitly explained by first proposition that Modigliani and Miller introduced.Which statement is most correct? * A. Since debt financing raises the firm’s financial risk, increasing debt ratio will increase WACC. B. Since debt financing is cheaper than equity financing, increasing debt ratio will reduce WACC. C. Increasing a firm’s debt ratio will typically reduce the marginal costs of both debt and equity financing; however, it still may raise the firm’s WACC. D. Statements a and c are correct. E. None of the above
- Which of the following statements is correct?(a) The quickest way to determine whether the firmhas too much debt is to calculate the Timesinterest-earned ratio.(b) The best rule of thumb for determining the firm’sliquidity is to calculate the current ratio.(c) From an investor’s point of view, the price-toearnings ratio is a good indicator of whether ornot a firm is generating an acceptable return tothe investor.(d) The operating margin is determined by subtracting all operating and non-operating expensesfrom the gross margin.Which of the following statements are CORRECT? Check all that apply: The aftertax cost of debt decreases when the market price of a bond increases. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. Cost of capital is also known as the minimum expected or required return an investment must offer to be attractive.Indicate whether each of the following statements is true or false. Support your answers with the relevant explanations. a) Modigliani and Miller’s Proposition II assumes that increased borrowing does not affect the interest rate on the firm’s debt. (Explain your reasoning.) b) Under the conditions of perfect capital markets, the cost of capital of a company financed fully by equity is expected to be equal to that of the same company but financed with 50% equity and 50% debt. (Explain your reasoning.) c) The higher the systematic risk of a company’s stock, the higher the value of its beta. The higher the beta, the higher the return required by the investors. (Explain your reasoning.)
- Consider two firms that are alike in every way except that Firm A has fixed rate debt in its capital structure and Firm B has variable rate debt. Which firm has riskier equity? Why?According to MM propositions, which of the following statements best describes the consequence of increasing debt-to-value ratio for a firm? Group of answer choices The weighted average cost of capital can decrease. The weighted average cost of capital can increase. The cost of equity capital can decrease. The weighted average cost of capital must not stay constant.Which one of the following statements related to the Security Market Line approach to equity valuation is correct? Assume the firm includes debt in its capital structure. Group of answer choices This model considers a firm's rate of growth. The model will never produce the same cost of equity as the dividend growth model. The model is dependent upon a reliable estimate of the market risk premium. This approach generally produces a cost of equity that equals the firm's overall cost of capital. The model applies only to non-dividend-paying firms.
- Indicate whether each of the following statements is true or false. Support your answers with the relevant explanations. Modigliani and Miller’s Proposition II assumes that increased borrowing does not affect the interest rate on the firm’s debt. (Explain your reasoning.) Under the conditions of perfect capital markets, the cost of capital of a company financed fully by equity is expected to be equal to that of the same company but financed with 50% equity and 50% debt. (Explain your reasoning.) 3. The higher the systematic risk of a company’s stock, the higher the value of its beta. The higher the beta, the higher the return required by the investors. (Explain your reasoning.) 4. The higher the proportion of equity in a company’s overall capital structure, the higher return required by its debtholders. (Explain your reasoning – in your explanation, provide a numerical example supporting your answer.) 5.In the presence of corporate taxes, a company would prefer to raise…According to Modigliani & Miller M Proposition II (MM Il), as a firm's debt-equity ratio decreases, what happens to the required rate of return on equity? Briefly explain including the key aspect of MM II.For each statement indicate whether it is true or false and briefly explain why. a) In a perfect capital market with no corporate taxes, as a firm takes on more and more debt its weighted average cost of capital remains unchanged while its required return on equity rises. b) If a firm issues riskfree debt the risk of the firm’s equity will not change. So, riskfree debt allows the firm to get the benefit of a low cost of debt without raising its cost of equity. c) In the context of firms’ capital structure decisions, the theory predicts that the value of a firm’s equity will rise in direct proportion to the level of debt in its capital structure.