Chapter 2

Question 1

EPS

Answer 1

Net income/Number of shares

Question 2

ROE

Answer 2

Net income/Equity

Question 3

Business risk

Answer 3

size of fixed costs, input cost variability, demand variability, sale price variability …etc
(uncertainty in EBIT)

Question 4

Financial risk

Answer 4

associated with the risk of debt

Question 5

Leverage … risks and returns

Answer 5

Magnifies

Question 6

Under MM prop. 1

Answer 6

VL=VU capital structure does not change the value of the firm.

Question 7

Under MM with no taxes ro=

Answer 7

wacc

Question 8

Under MM with no taxes what are the advantages and disadvantages of debt?

Answer 8

Adv: cheaper
Disadv: increasing cost of equity
NO impact on the value of the share because they cancel out.

Question 9

Under MM with taxes as debt increases

Answer 9

VL increases (unlimited benefits)

Question 10

Under MM with taxes as debt increases what happens to Wacc?

Answer 10

Wacc deacreases.

Question 11

Under MM with taxes what are the benefits and costs of debt?

Answer 11

Benefits: cheaper, tax shield (tc x B)
Costs: Increasing cost of equity
Impact on value? Debt adds value therefore the benefits are better than the costs.