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Question 1

When do changes in capital structure benefit shareholders

Answer 1

If value of firm increases

Question 2

What type of capital structure should managers choose

Answer 2

One with highest firm value because this capital structure will be most beneficial to firms shareholders

Question 3

What is Modigliani Miller proposition I (no taxes)

Answer 3

Value of levered firm is same as value of unlevered firm VU = VL

Individuals and corporations can borrow at same rate

Capital markets are efficient

No transaction costs

No risk of bankruptcy

Question 4

What does homemade leverage strategy mean

Answer 4

Debt shouldn’t affect firm value

Question 5

What is Modigliani Miller proposition II (no taxes)

Answer 5

Cost of equity rises with leverage because risk to equity rises with leverage

Question 6

Why do firms with debt pay less tax

Answer 6

Interest is an expense in income statement leading to lower profit and less tax

Question 7

What is Modigliani Miller proposition I (with taxes)

Answer 7

Value of levered firm is greater than unlevered firm by present value of tax shield from debt

Question 8

What is Modigliani Miller proposition II (with taxes)

Answer 8

Cost of equity rises with leverage because risk to equity rises with leverage