M&M Proposition I, without taxes, is referred to as the pie model. Explain why the size of the pie remains constant as the debt-equity ratio of a firm increases.
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M&M Proposition I, without taxes, is referred to as the pie model. Explain why the size of the pie remains constant as the debt-equity ratio of a firm increases.
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- WHICH OF THE FOLLOWING STATEMENTS IS MOST CORRECT? A. IF A FIRM'S EXPECTED BASIC EARNING POWER (BEP) IS CONSTANT FOR ALL ITS ASSETS AND EXCEES INTEREST RATE ON ITS DEBT, THEN ADDING ASSETS FINANCING THEM WITH DEBT WILL RAISE THE FIRM'S EXPECTED RATE OF RETURN ON COMMON EQUITY (ROE)? B. THE HIGHER ITS TAX RATE, THE LOWER A FIRM'S BEP RATIO WILL BE, OTHER THINGS HELD CONSTANT. C. THE HIGHER THE INTEREST RATE ON ITS DEBT, THE LOWER THE FIRM'S BEP RATIO WILL BE, OTHER THINGS HELD CONSTANT. D. THE HIGHER ITS DEBT RATIO, THE LOWER THE FIRM'S BEP RATIO WILL BE, OTHER THINGS HELD CONSTANT. E. STATEMENT A IS FALSE, BUT B, C AND D ARE ALL TRUE.Consider the following statements:The interest tax shield for a firm:I. Is the tax benefit a firm derives from paying interestII. Will decrease as the corporate income tax rate is increasedIII. Is the yield to maturity on a firm’s bonds multiplied by the market value of the bonds outstandingWhich of the statements is trueConsider the following statements: The interest tax shield for a firm: I. Is the tax benefit a firm derives from paying interest II. Will decrease as the corporate income tax rate is increased III. Is the yield to maturity on a firm’s bonds multiplied by the market value of the bonds outstanding Which of the statements is TRUE? a. I only b. II only c.III d. I, II and II only e. None of the above
- According to theory, the value of a firm is maximized by: Issuing no debt Issuing the maximum amount of debt absorbed by the market place Increasing debt until the marginal tax benefit of debt is offset by distress costs Keeping the debt equity mix at 50/50Suppose that a new government is elected and it changes the law applying to firms to:• Allow dividend payments to be tax deductible• Stop interest expense on debt from being tax deductibleHolding other factors constant, and assuming that firms seek to maintain an optimal capital structure in accordance with trade-off theory, what would you expect to happen to the debt ratio of a firm with both equity and debt in its capital structure?a. An increase in the debt ratiob. A decrease in the debt ratioc. The debt ratio would be unchangedd. The debt ratio would doublee. None of the above or it is not possible to sayFor a typical firm, assumes that all rates are after taxes and that the firm operates at its target capital structure. So cost of equity > after tax cost of debt > WACC. True False
- 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.9.Which of the following are true according to the Modigliani and Miller propositions? i.In a world without taxes, all else equal, the value of a firm with a low debt-to-equity ratio is higher than the value of a firm with a high debt-to-equity ratio.ii.In a world without taxes, a firm's cost of equity capital increases as the firm takes on more debt.iii.In a world with taxes, firm value is maximized when the firm has a low debt-to-equity ratio. iv.In a world with taxes, a firm's cost of equity capital increases as the firm takes on more debt.a.ii, iii, and iv, but not ib.i, iii, and iv, but not iic.ii and iv, but not i or iiid.i, ii, and iii, but not ivSuppose Goodyear Tire and Rubber Company has an equity cost of capital of 8.6%, a debt cost of capital of 7.1%, a marginal corporate tax rate of 24%, and a debt-equity ratio of 2.5. Assume that Goodyear maintains a constant debt-equity ratio. a. What is Goodyear's WACC? b. What is Goodyear's unlevered cost of capital? c. Explain, intuitively, why Goodyear's unlevered cost of capital is less than its equity cost of capital and higher than its WACC. Question content area bottom Part 1 a. What is Goodyear's WACC? The WACC is enter your response here%. (Round to two decimal places.)
- 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.Which one of the following factors would likely cause a firm to increase its use of debt financing as measured by the debt to total capital ratio? A.Increased economic uncertainty. B.An increase in the degree of operating leverage. C.An increase in the corporate income tax rate. D.An increase in the price-earnings ratio.Suppose Goodyear Tire and Rubber Company has an equity cost of capital of 8.1%, a debt cost of capital of 6.6%, a marginal corporate tax rate of 22%, and a debt-equity ratio of 2.5. Assume that Goodyear maintains a constant debt-equity ratio. a. What is Goodyear's WACC? b. What is Goodyear's unlevered cost of capital? c. Explain, intuitively, why Goodyear's unlevered cost of capital is less than its equity cost of capital and higher than its WACC. Question content area bottom a. What is Goodyear's WACC? The WACC is enter your response here%. (Round to two decimal places.)