Chapter 14

Question 1

The law of one price meaning

Answer 1

identical goods sold at different locations should be sold for the same price

Question 2

Capital structure meaning

Answer 2

The relative proportions of debt, equity and the securities that a firm has outstanding

Question 3

Cost of capital meaning

Answer 3

The return required by the investors who provide capital to the firm

Question 4

Leverage ratio

Answer 4

Debt/(Debt+Equity)

Question 5

Debt-to-equity ratio

Answer 5

Debt/Equity

Question 6

Equity cost of capital equation

Answer 6

Re = Ru + (D/E)*(Ru - Rd)

R - cost of capital
D - debt
E - equity
U -

Question 7

Levered vs unlevered firm

Answer 7

Levered - Financial obligations are paid
Unlevered - Financial obligations still need to be dealt with

Question 8

EPS fallacy

Answer 8

False belief that increased EPS (Earnings per share) associated with a stock repurchase creates value for a firm’s shareholders.

Question 9

Standard deviation and variance formulas

Answer 9

SD = SQRT(Varience)

Var = Sum of (X - E(x))² * P(x)

X - individual variable
E(x) - expected value
P(x) - probability of X

Question 10

Modigliani-Miller I argument

Answer 10

In perfect markets the value of firm is not affected by the structure

Question 11

Modigliani-Miller II theorem

Answer 11

In perfect markets