How much leverage? Quizz 05

Question 1

Apex Co. has a required rate of return on assets equal to 5%. If the cost of debt is 2% and the debt-to-equity ratio is 1/3, what is Apex cost of equity?

Answer 1

6%

Question 2

Assume r_A, r_e, r_d, r_WACC represent, respectively, the pre-tax cost of capital, cost of equity, cost of debt, and after-tax cost of capital. Which of the following is correct?

Answer 2

r_e ≥ r_A ≥ r_WACC > r_d

Question 3

Gambling for resurrection is independent of the limited liability assumption.

Answer 3

False

Question 4

Asymmetry of information explains why equity is issued before debt (pecking order theory).

Answer 4

False

Question 5

Interest tax shields belong exclusively to the equity holders.

Answer 5

True

Question 6

Firm A goes into a leveraged recapitalization with a known debt repayment schedule. In order to value its tax shields, we should discount them with cost of capital.

Answer 6

False

Question 7

Excessive leverage might cause conflicts of interest between shareholders and bondholders.

Answer 7

True

Question 8

All else equal, a company with more growth opportunities has lower cost of financial distress.

Answer 8

False

Question 9

In order to minimize the cost of capital, a firm should aim to maximize its debt-to-equity ratio.

Answer 9

False

Question 10

According to the pecking order theory, the management announcing to issue new equity would signal the market that they think the company’s shares are underpriced.

Answer 10

False