Lecture 2

Question 1

MM (Modigliani-Miller) proposition I and II

Answer 1

in the absence of taxes, a company’s market value is not influenced by its capital structure

Question 2

The law of one price meaning

Answer 2

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

Question 3

Capital structure meaning

Answer 3

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

Question 4

Cost of capital meaning

Answer 4

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

Question 5

Leverage ratio

Answer 5

Debt/(Debt+Equity)

Question 6

Debt-to-equity ratio

Answer 6

Debt/Equity

Question 7

Equity cost of capital equation

Answer 7

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

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

Question 8

Levered vs unlevered firm

Answer 8

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

Question 9

EPS fallacy

Answer 9

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

Question 10

Standard deviation and variance formulas

Answer 10

SD = SQRT(Varience)

Var = Sum of (X - E(x))² * P(x)

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