Debt Policy Quizz

Question 1

The return on assets is independent of financial leverage only as long as debt is assumed to be risk free and the MM assumptions apply.

Answer 1

False

Question 2

According to the MM propositions, as the debt-to-equity ratio increases, shareholder value and the expected return on equity increase.

Answer 2

False

Question 3

MM proposition 2 states that a firm with a return on assets of 5%, a return on debt of 2% and a leverage ratio of 40% has a return on equity of …

Answer 3

7%

Question 4

In an MM world, the cost of equity decreases at an increasing rate if leverage increases.

Answer 4

False

Question 5

MM Proposition I is violated if investors have different preferences on leverage.

Answer 5

False

Question 6

A leveraged recapitalization leads to an increase in the share price and thus creates value for the shareholders.

Answer 6

False

Question 7

The existence of bankruptcy costs does not violate the assumptions of MM.

Answer 7

False

Question 8

President Trump cut the federal corporate tax from 35% to 21% in the US, effective from 2018. This change, all else equal, increases the WACC (after-tax cost of capital) of corporations.

Answer 8

True

Question 9

Suppose a company has a debt-to-equity ratio of 0.5, a cost of equity of 10%, a cost of debt of 4%. What is the pre-tax cost of capital?

Answer 9

8%

Question 10

Suppose a company has a debt-to-equity ratio of 0.5, a cost of equity of 10%, a cost of debt of 4%. Now, all else equal, suppose that the company plans to reduce its debt-to-equity ratio to 0.3. What will its cost of equity be after the change in the capital structure?

Answer 10

9,8%