Use The Following Information To Answer The Question(s) Below

Corporate Finance, 2e, Global Edition (Berk/DeMarzo)
Chapter 14 Capital Structure in a Perfect Market
14.1 Equity Versus Debt Financing
Use the following information to answer the question(s) below.
Nielson Motors (NM) has no debt. Its assets will be worth $600 million in one year if the
economy is strong, but only $300 million if the economy is weak. Both events are equally likely.
The market value today of Nielson's assets is $400 million.
1) The expected return for Nielson Motors stock without leverage is closest to:
A) -25.0%
B) -17.5%
C) -12.5%
D) 12.5%
Answer: D
Explanation: D)
Diff: 1
Section: 14.1 Equity Versus Debt Financing
Skill: Analytical
2) Suppose the risk-free interest rate is 4%. If Nielson borrows $150 million today at this rate
and uses the proceeds to pay an immediate cash dividend, then according to MM, the market
value of its equity just alter the dividend is paid would be closest to:
A) $0 million
B) $150 million
C) $250 million
D) $400 million
Answer: C
Explanation: C) Value of equity = Total value - value of debt = $400 - 150 = $250
Diff: 1
Skill: Analytical
1
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3) Suppose the risk-free interest rate is 4%. If Nielson borrows $150 million today at this rate
and uses the proceeds to pay an immediate cash dividend, then according to MM, the expected
return of Nielson's stock just alter the dividend is paid would be closest to:
A) -17.5%
B) -12.5%
C) 12.5%
D) 17.5%
Answer: D
Explanation: D) Value of equity = Total value - value of debt = $400 - 150 = $250
Diff: 2
Skill: Analytical
4) Which of the following statements is false?

A) The relative proportions of debt, equity, and other securities that a firm has outstanding
constitute its capital structure.
B) The most common choices are financing through equity alone and financing through a
combination of debt and equity.
C) The project's NPV represents the value to the new investors of the firm created by the project.
D) When corporations raise funds from outside investors, they must choose which type of
security to issue.
Answer: C
Explanation: C) The project's NPV represents the value to the existing shareholders of the firm
created by the project.
Diff: 1
Skill: Conceptual
5) Equity in a firm with debt is called

A) levered equity.
B) riskless equity.
C) unlevered equity.
D) risky equity.
Answer: A
Diff: 1
Skill: Definition
2
6) Equity in a firm with no debt is called
A) levered equity.
B) unlevered equity.
C) riskless equity.
D) risky equity.
Answer: B
Diff: 1
Skill: Definition

A) Modigliani and Miller's conclusion verified the common view, which stated that even with
perfect capital markets, leverage would affect a firm's value.
B) We can evaluate the relationship between risk and return more formally by computing the
sensitivity of each security's return to the systematic risk of the economy.
C) Investors in levered equity require a higher expected return to compensate for its increased
risk.
D) Leverage increases the risk of equity even when there is no risk that the firm will default.
Answer: A
Explanation: A) Modigliani and Miller's conclusion went against the common view that even
with perfect capital markets, leverage would affect a firm’s value.
Diff: 2
Skill: Conceptual

A) Leverage decreases the risk of the equity of a firm.
B) Because the cash flows of the debt and equity sum to the cash flows of the project, by the
Law of One Price the combined values of debt and equity must be equal to the cash flows of the
project.
C) Franco Modigliani and Merton Miller argued that with perfect capital markets, the total value
of a firm should not depend on its capital structure.
D) It is inappropriate to discount the cash flows of levered equity at the same discount rate that
we use for unlevered equity.
Answer: A
Explanation: A) Leverage increases the risk of the equity of a firm.
Diff: 2
Skill: Conceptual
3
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000
in a strong economy, with each outcome being equally likely. The initial investment required for
the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.
9) The NPV for this project is closest to:

A) $6,250
B) $14,100
C) $10,000
D) $18,600
Answer: C
Explanation: C)
Diff: 2
Skill: Analytical
10) Suppose that to raise the funds for the initial investment, the project is sold to investors as an
all-equity firm. The equity holders will receive the cash flows of the project in one year. The
market value of the unlevered equity for this project is closest to:
A) $94,100
B) $90,000
C) $86,250
D) $98,600
Answer: B
Explanation: B)
Diff: 2
Skill: Analytical
11) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk
free rate, then the cash flow that equity holders will receive in one year in a weak economy is
closest to:
A) $6,000
B) $10,000
C) $0
D) $33,000
Answer: A
Explanation: A) $90,000 - $80,000(1.05) = $6,000
Diff: 2
Skill: Analytical
4
free rate, then the cash flow that equity holders will receive in one year in a strong economy is
closest to:
A) $0
B) $6,000
C) $33,000
D) $10,000
Answer: C
Explanation: C) $117,000 - $80,000(1.05) = $33,000
Diff: 2
Skill: Analytical
free rate, then the value of the firm's levered equity from the project is closest to:
A) $0
B) $10,000
C) $6,000
D) $8,600
Answer: B
Explanation: B)
Diff: 2
Skill: Analytical
free rate, then the cost of capital for the firm's levered equity is closest to:
A) 45%
B) 25%
C) 15%
D) 95%
Answer: D
Explanation: D)
So,
So,
So, x = .95
Diff: 2
Skill: Analytical
5
free rate and issues new equity to cover the remainder. In this situation, the cash flow that equity
holders will receive in one year in a weak economy is closest to:
A) $90,000
B) $0
C) $50,000
D) $48,000
Answer: D
Explanation: D) $90,000 - $40,000(1.05) = $48,000
Diff: 2
Skill: Analytical
free rate and issues new equity to cover the remainder. In this situation, the cash flow that equity
holders will receive in one year in a strong economy is closest to:
A) $117,000
B) $75,000
C) $50,000
D) $0
Answer: B
Explanation: B) $117,000 - $40,000(1.05) = $75,000
Diff: 2
Skill: Analytical
free rate and issues new equity to cover the remainder. In this situation, the value of the firm's
levered equity from the project is closest to:
A) $0
B) $50,000
C) $90,000
D) $40,000
Answer: B
Explanation: B)
Diff: 2
Skill: Analytical
6
free rate and issues new equity to cover the remainder. In this situation, the cost of capital for
the firm's levered equity is closest to:
A) 23%
B) 25%
C) 15%
D) 18%
Answer: A
Explanation: A)
So,
So,
So, × = .23
Diff: 3
Skill: Analytical
free rate and issues new equity to cover the remainder. In this situation, calculate the value of
the firm's levered equity from the project. What is the cost of capital for the firm's levered
equity?
Answer:
90,000 - 45,000(1.05) = $42,770

117,000 - 45,000(1.05) = $69,750
So,
So,
So, × = .25
Diff: 2
Skill: Analytical
7
20) Two separate firms are considering investing in this project. Firm unlevered plans to fund
the entire $80,000 investment using equity, while firm levered plans to borrow $45,000 at the
risk-free rate and use equity to finance the remainder of the initial investment. Construct a table
detailing the percentage returns to the equity holders of both the levered and unlevered firms for
both the weak and strong economy.
Answer:
C/F
Initial Strong C/F Weak Returns Strong Returns Weak
Value Economy Economy Economy Economy
Debt $45,000 $ 47,250 $47,250 5% 5%
Levered Equity $45,000 $ 69,750 $42,750 55% -5%
Unlevered
Equity $90,000 $117,000 $90,000 30% 0%
C/F (weak economy) = $90,000 (unlevered) - $45,000(1.05) (debt) = $42,750 (levered)

C/F (strong economy) = $117,000 (unlevered) - $45,000(1.05) (debt) = $69,750 (levered)
Returns
Diff: 3
Skill: Analytical
8
risk-free rate and use equity to finance the remainder of the initial investment. Calculate the
expected returns for both the levered and unlevered firm.
Answer:
C/F C/F Returns Returns
Strong Weak Strong Weak
Initial Econom Econom Econom Econom Expected
Value y y y y Return
Debt $45,000 $47,250 $47,250 5% 5% 5%
Levered
Equity $45,000 $69,750 $42,750 55% -5% 25%
Unlevered
Equity $90,000$117,000 $90,000 30% 0% 15%
C/F (weak economy) = $90,000(unlevered) - $45,000(1.05) (debt) = $42,750(levered)

C/F (strong economy) = $117,000(unlevered) - $45,000(1.05) (debt) = $69,750(levered)
Returns
Expected return = .5(strong return) + .5(weak return)
Diff: 3
Skill: Analytical
9
risk-free rate and use equity to finance the remainder of the initial investment. Calculate the risk
premiums for both the levered and unlevered firm.
Answer:
C/F C/F Returns Returns
Initial Strong Weak Strong Weak Expected
Value Economy Economy Economy Economy Return
Debt $45,000 $47,250 $47,250 5% 5% 5%
Levered
Equity $45,000 $69,750 $42,750 55% -5% 25%
Unlevered
Equity $90,000 $117,000 $90,000 30% 0% 15%
C/F (weak economy) = $90,000 (unlevered) - $45,000(1.05) (debt) = $42,750 (levered)

C/F (strong economy) = $117,000 (unlevered) - $45,000(1.05) (debt) = $69,750 (levered)
Returns
Expected return = .5(strong return) + .5(weak return)
Risk premium = expected return - risk free rate
Diff: 3
Skill: Analytical
14.2 Modigliani-Miller I: Leverage, Arbitrage, and Firm Value
Galt Industries has 50 million shares outstanding and a market capitalization of $1.25 billion. It
also has $750 million in debt outstanding. Galt Industries has decided to delever the firm by
issuing new equity and completely repaying all the outstanding debt. Assume perfect capital
markets.
1) The number of shares that Galt must issue is closest to:

A) 15 million
B) 25 million
C) 30 million
D) 40 million
Answer: C
Explanation: C)
Diff: 2
Section: 14.2 Modigliani-Miller I: Leverage, Arbitrage, and Firm Value
10
Skill: Analytical
2) Suppose you are a shareholder in Galt industries holding 100 shares, and you disagree with
this decision to delever the firm. You can undo the effect of this decision by
A) borrowing $1500 and buying 60 shares of stock.
B) selling 32 shares of stock and lending $800.
C) borrowing $1000 and buying 40 shares of stock.
D) selling 40 shares of stock and lending $1000.
Answer: A
Explanation: A)
Galt's pre-delevered Debt/Equity = = .60 => for every $1 equity need $0.60 debt, so you
need to borrow $0.60 × $2,500 = $1,500 and then buy $1,500/$25 = 60 more shares of stock.
Diff: 2
Skill: Analytical
3) Suppose you are a shareholder in Galt industries holding 600 shares, and you disagree with
this decision to delever the firm. You can undo the effect of this decision by:
A) Borrow $6,000 and buy 240 shares of stock
B) Sell 240 shares of stock and lend $6,000
C) Borrow $9,000 and buy 360 shares of stock
D) Sell 360 shares of stock and lend $9,000
Answer: C
Explanation: C)
Galt's pre-delevered Debt/Equity = = .60 => for every $1 equity need $0.60 debt, so
you need to borrow $0.60 × $15,000 = $9,000 and then buy $9,000/$25 = 360 more shares of
stock.
Diff: 2
Skill: Analytical
11
d'Anconia Copper is an all-equity firm with 60 million shares outstanding, which are currently
trading at $20 per share. Last month, d'Anconia announced that it will change its capital
structure by issuing $300 million in debt. The $200 million raised by this issue, plus another
$200 million in cash that d'Anconia already has, will be used to repurchase existing shares of
stock. Assume that capital markets are perfect.
4) The market capitalization of d'Anconia Copper before this transaction takes place is closest to:
A) $800 million
B) $900 million
C) $1,100 million
D) $1,200 million
Answer: D
Explanation: D) Market Cap = 60 million shares × $20 share = $1,200 million
Diff: 1
Skill: Analytical
5) The market capitalization of d'Anconia Copper after this transaction takes place is closest to:
A) $800 million
B) $900 million
C) $1,100 million
D) $1,200 million
Answer: A
Explanation: A) Market Cap = 60 million shares × $20 share - $200 Debt - $200 Cash = $800
million
Diff: 1
Skill: Analytical
6) At the conclusion of this transaction, the number of shares that d'Anconia Copper will
repurchase is closest to:
A) 5 million
B) 15 million
C) 20 million
D) 40 million
Answer: C
Explanation: C)
Number of shares repurchased
Diff: 1
Skill: Analytical
12
7) At the conclusion of this transaction, the number of shares that d'Anconia Copper will have
outstanding is closest to:
A) 5 million
B) 15 million
C) 20 million
D) 40 million
Answer: D
Explanation: D)
Number of Shares outstanding = 60 million - 20 million repurchased = 40 million shares
Diff: 1
Skill: Analytical
8) At the conclusion of this transaction, the value of a share of d'Anconia Copper will be closest
to:
A) $18.33
B) $20.00
C) $25.00
D) $27.50
Answer: B
Explanation: B)
Number of Shares outstanding = 60 million - 20 million repurchased = 40 million shares
Price per share =($1,200 million - $300 million - $100 million)/ 40 million shares = $20 share
Diff: 2
Skill: Analytical
9) Suppose you are a shareholder in d'Anconia Copper holding 300 shares, and you disagree with
the decision to lever the firm. You can undo the effect of this decision by
A) borrowing $2,000 and buying 100 shares of stock.
B) selling 100 shares of stock and lending $2,000.
C) borrowing $1,200 and buying 60 shares of stock.
D) selling 60 shares of stock and lending $1,200.
Answer: D
Explanation: D) d'Anconia Copper's => for every $1 invested you need
$0.80 in equity and $0.20 in debt
Pre levering your portfolio consisted of 300 shares × $20 = $6000 in stock. Of this you need to
sell 20% to reinvest into bonds so you need to sell ($6,000 × .2 = $1,200 / $20 per share = 60
shares of stock and then lend this money out.
Diff: 2
Skill: Analytical
13
10) Suppose you are a shareholder in d'Anconia Copper holding 500 shares, and you disagree
with the decision to lever the firm. You can undo the effect of this decision by
A) borrowing $2,000 and buying 100 shares of stock.
B) selling 100 shares of stock and lending $2,000.
C) borrowing $1,200 and buying 60 shares of stock.
D) selling 60 shares of stock and lending $1,200.
Answer: B
Explanation: B) d'Anconia Copper's
d'Anconia Copper's Debt/Equity = $200/$800 = .20
=> for every $1 invested you need $0.80 in equity and $0.20 in debt
Pre levering your portfolio consisted of 500 shares × $20 = $10,000 in stock. Of this you need to
sell 20% to reinvest into bonds so you need to sell ($10,0000 × .2 = $2,00 / $20 per share = 100
shares of stock and then lend this money out.
Diff: 2
Skill: Analytical
11) Which of the following is not one of Modigliani and Miller's set of conditions referred to as
perfect capital markets?
A) All investors hold the efficient portfolio of assets.
B) There are no taxes, transaction costs, or issuance costs associated with security trading.
C) A firm's financing decisions do not change the cash flows generated by its investments, nor
do they reveal new information about them.
D) Investors and firms can trade the same set of securities at competitive market prices equal to
the present value of their future cash flows.
Answer: A
Diff: 2
Skill: Conceptual

A) The Law of One Price implies that leverage will affect the total value of the firm under
perfect capital market conditions.
B) In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's
security holders is equal to the total cash flow generated by the firm's assets.
C) With perfect capital markets, leverage merely changes the allocation of cash flows between
debt and equity, without altering the total cash flows of the firm.
D) In a perfect capital market, the total value of a firm is equal to the market value of the total
cash flows generated by its assets and is not affected by its choice of capital structure.
Answer: A
Explanation: A) The Law of One Price implies that leverage will not affect the total value of the
firm under perfect capital market conditions.
Diff: 2
Skill: Conceptual
14
A) As long as the firm's choice of securities does not change the cash flows generated by its
assets, the capital structure decision will not change the total value of the firm or the amount of
capital it can raise.
B) If securities are fairly priced, then buying or selling securities has an NPV of zero and,
therefore, should not change the value of a firm.
C) The future repayments that the firm must make on its debt are equal in value to the amount of
the loan it receives up front.
D) An investor who would like more leverage than the firm has chosen can lend and add
leverage to his or her own portfolio.
Answer: D
Explanation: D) An investor who would like more leverage than the firm has chosen can borrow
and add leverage to his or her own portfolio.
Diff: 2
Skill: Conceptual

A) As long as investors can borrow or lend at the same interest rate as the firm, homemade
leverage is a perfect substitute for the use of leverage by the firm.
B) When investors use leverage in their own portfolios to adjust the leverage choice made by the
firm, we say that they are using homemade leverage.
C) The value of the firm is determined by the present value of the cash flows from its current and
future investments.
D) The investor can re-create the payoffs of unlevered equity by borrowing and using the
proceeds to purchase the equity of the firm.
Answer: D
Explanation: D) The investor can re-create the payoffs of levered equity by borrowing and using
the proceeds to purchase the equity of the firm.
Diff: 2
Skill: Conceptual

A) When a firm issues new shares that account for a significant percentage of its outstanding
shares, the transaction is called a leveraged recapitalization.
B) MM Proposition I applies to capital structure decisions made at any time during the life of the
firm.
C) By choosing positive-NPV projects that are worth more than their initial investment, the firm
can enhance its value.
D) Holding fixed the cash flows generated by the firm's assets, however, the choice of capital
structure does not change the value of the firm.
Answer: A
Explanation: A) When a firm borrows money to repurchase shares that account for a significant
percentage of its outstanding shares, the transaction is called a leveraged recapitalization.
Diff: 3
Skill: Conceptual
15
A) Investors can alter the leverage choice of the firm to suit their personal tastes either by
borrowing and reducing leverage or by holding bonds and adding more leverage.
B) On the market value balance sheet the total value of all securities issued by the firm must
equal the total value of the firm's assets.
C) The market value balance sheet captures the idea that value is created by a firm's choice of
assets and investments.
D) One application of MM Proposition I is the useful device known as the market value balance
sheet of the firm.
Answer: A
Explanation: A) Investors can alter the leverage choice of the firm to suit their personal tastes
either by borrowing and increasing leverage or by holding bonds and reducing leverage.
Diff: 3
Skill: Conceptual
Consider two firms, With and Without, that have identical assets that generate identical cash
flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of
$24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an
interest rate of 5%.
17) According to MM Proposition 1, the stock price for With is closest to:
A) $8.00
B) $24.00
C) $6.00
D) $12.00
Answer: C
Explanation: C) Under MM I, the total value of With and Without must be the same.
Value(Without) = 1,000,000 × $24 = $24 million

Value(levered equity) = value(With) - debt = $24 M - $12M = $12 M
Price per share =
Diff: 1
Skill: Analytical
16
18) Assume that MM's perfect capital markets conditions are met and that you can borrow and
lend at the same 5% rate as with. You have $5000 of your own money to invest and you plan on
buying Without stock. Using homemade leverage, how much do you need to borrow in your
margin account so that the payoff of your margined purchase of Without stock will be the same
as a $5000 investment in With stock?
A) $10,000
B) $5000
C) $2,500
D) $0
Answer: B
Explanation: B) Under MM I, the total value of With and Without must be the same.

So, the leverage ratio of with is 50% equity to 50% debt. To duplicate this in homemade
leverage we need to have equal proportions in out portfolio, this means we need 50% equity and
50% from a margin loan. So $5000 is our equity, and we need to match it with $5000 in a
margin loan.
Diff: 2
Skill: Analytical
buying Without stock. Using homemade leverage you borrow enough in your margin account so
that the payoff of your margined purchase of Without stock will be the same as a $5000
investment in with stock. The number of shares of Without stock you purchased is closest to:
A) 425
B) 1650
C) 2000
D) 825
Answer: B

Price per share =
50% from a margin loan. So $5000 is our equity we need to match it with $5000 in a margin
loan. So the total invested is $10,000/$6 per share = 1667 shares
Diff: 3
Skill: Analytical
17
buying With stock. Using homemade (un)leverage, how much do you need to invest at the risk-
free rate so that the payoff of your account will be the same as a $5000 investment in Without
stock?
A) $5000
B) $0
C) $2,500
D) $4,000
Answer: C
Explanation: A) Under MM I, the total value of With and Without must be the same.

50% fin the risk free asset. So $5000 is our total portfolio we need $2500 in equity (With stock)
and $2500 in the risk free asset.
Diff: 2
Skill: Analytical
buying With stock. Using homemade (un)leverage you invest enough at the risk-free rate so that
the payoff of your account will be the same as a $5000 investment in Without stock? The
number of shares of With stock you purchased is closest to:
A) 100
B) 425
C) 1650
D) 825
Answer: B

Price per share =
So the leverage ratio of with is 50% equity to 50% debt. To duplicate this in homemade leverage
we need to have equal proportions in out portfolio, this means we need 50% equity and 50% fin
the risk free asset. So $5000 is our total portfolio we need $2500 in equity (With stock) and
$2500 in the risk free asset.
Diff: 3
Skill: Analytical
18
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has
decided to use this cash to repurchase shares from its investors, and has already announced the
stock repurchase plan. Currently Luther is an all equity firm with 1.25 billion shares
outstanding. Luther's shares are currently trading at $20 per share.
22) The market value of Luther's non-cash assets is closest to:

A) $20 billion
B) $19 billion
C) $25 billion
D) $24 billion
Answer: A
Explanation: A) = 1.25B × $20 per share = $25 billion - $5 billion cash = $20 billion
Diff: 1
Skill: Analytical
23) After the repurchase how many shares will Luther have outstanding?
A) 0.75 billion
B) 1.0 billion
C) 1.1 billion
D) 1.2 billion
Answer: B
Explanation: B) $5 billion / $20 Share = .250 billion shares repurchased.
Shares outstanding = 1.25 - .25 = 1.0 billion

Diff: 1
Skill: Analytical
24) With perfect capital markets, what is the market value of Luther's equity after the share
repurchase?
A) $15 billion
B) $10 billion
C) $25 billion
D) $20 billion
Answer: D
Explanation: D) = 1.25B × $20 per share = $25 billion - $5 billion cash = $20 billion
Diff: 2
Skill: Analytical
19
25) With perfect capital markets, what is the market price per share of Luther's stock after the
share repurchase?
A) $25
B) $24
C) $15
D) $20
Answer: D
Explanation: D) = 1.25B × $20 per share = $25 billion - $5 billion cash = $20 billion / 1 billion
shares = $20
Diff: 2
Skill: Analytical
26) Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options
given to employees valued at $2 billion. The market value of Luther's non-cash assets is closest
to:
A) $22 billion
B) $20 billion
C) $25 billion
D) $18 billion
Answer: A
Explanation: A) = 1.25B × $20 per share = $25 billion + $2 billion options - $5 billion cash =
$22 billion
Diff: 2
Skill: Analytical
27) Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options
given to employees valued at $2 billion. After the repurchase how many shares will Luther have
outstanding?
A) 1.0 billion
B) 1.2 billion
C) 0.75 billion
D) 1.1 billion
Answer: A
Explanation: A) $5 billion / $20 Share = .250 billion shares repurchased.
Shares outstanding = 1.25 - .25 = 1.0 billion
Diff: 1
Skill: Analytical
20
Consider two firms: firm Without has no debt, and firm With has debt of $10,000 on which it
pays interest of 5% per year. Both companies have identical projects that generate free cash
flows of $1000 or $2000 each year. Suppose that there are no taxes, and after paying any interest
on debt, both companies use all remaining cash free cash flows to pay dividends each year.
28) Fill in the table below showing the payments debt and equity holders of each firm will
receive given each of the two possible levels of free cash flows:
Without With
Free Cash Interest Equity Interest Equity
Flow Payments Dividends Payments Dividends
1000
2000
Answer:
Without With
1000 0 1000 500 500
2000 0 2000 500 1500
Diff: 2
Skill: Analytical
29) Suppose you own 10% of the equity of Without. What is another portfolio you could hold
that would provide you with the same exact cash flows?
Answer: The cash flows for a 10% ownership stake in With and Without are shown below:
Without With
100 0 100 50 50
200 0 200 50 150
To achieve the same payout as Without you would need to invest $1000 in With Bond's paying
5% interest and purchase a 10% stake in With's equity paying $50 or $150 in dividends.
So your payoff when the firm's FCF is 1000 = 50 (interest) + 50 (dividends) = $100 (same as
Without's dividends)
Payoff when firm's FCF is 2000 = 50 (interest) + 150 (dividends) = $200 (same as Without's
dividends)
Diff: 3
Skill: Analytical
21
30) Suppose you own 10% of the equity of With. What is another portfolio you could hold that
would provide you with the same exact cash flows?
Answer: The cash flows for a 10% ownership stake in With and Without are shown below:
Without With
100 0 100 50 50
200 0 200 50 150
To achieve the same payout as Without you would need to borrow $1000 at the risk free rate of
5% interest and purchase a 10% stake in Without's equity paying $100 or $20 in dividends.
So your payoff when the firm's FCF is 1000 = -50 (interest) + 100 (dividends) = $50 (same as
With's dividends)
Payoff when firm's FCF is 2000 = -50 (interest) + 200 (dividends) = $150 (same as With's
dividends)
Diff: 3
Skill: Analytical
31) What is a market value balance sheet and how does it differ from a book value balance
sheet?
Answer: One application of MM Proposition I is the useful device known as the market
value balance sheet of the firm. A market value balance sheet is similar to an accounting balance
sheet, with two important distinctions. First, all assets and liabilities of the firm are included–
even intangible assets such as reputation, brand name, or human capital that are missing from a
standard accounting balance sheet. Second, all values are current market values rather than
historical costs. On the market value balance sheet the total value of all securities issued by the
firm must equal the total value of the firm’s assets.
The market value balance sheet captures the idea that value is created by a firm’s choice of
assets and investments. By choosing positive-NPV projects that are worth more than their initial
investment, the firm can enhance its value. Holding fixed the cash flows generated by the firm’s
assets, however, the choice of capital structure does not change the value of the firm. Instead, it
merely divides the value of the firm into different securities.
Diff: 2
Skill: Conceptual
22
14.3 Modigliani-Miller II: Leverage, Risk, and the Cost of Capital
1) Suppose that Taggart Transcontinental currently has no debt and has an equity cost of capital
of 10%. Taggart is considering borrowing funds at a cost of 6% and using these funds to
repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows until
they achieved a debt -to-value ratio of 20%, then Taggart's levered cost of equity would be
closest to:
A) 8.0%
B) 9.2%
C) 10.0%
D) 11.0%
Answer: D
Explanation: D) re = ru + (ru - rd) = 10% + (10% - 6%) = 11%
Diff: 2
Section: 14.3 Modigliani-Miller II: Leverage, Risk, and the Cost of Capital
Skill: Analytical
2) Suppose that Rearden Metal currently has no debt and has an equity cost of capital of 12%.
Rearden is considering borrowing funds at a cost of 6% and using these funds to repurchase
existing shares of stock. Assume perfect capital markets. If Taggart borrows until they
achieved a debt -to-equity ratio of 50%, then Rearden's levered cost of equity would be closest
to:
A) 10.0%
B) 12.0%
C) 15.0%
D) 16.0%
Answer: C
Explanation: C) re = ru + (ru - rd) = 12% + (12% - 6%) = 15%
Diff: 2
Skill: Analytical
Galt Industries has no debt, total equity capitalization of $600 million, and an equity beta of 1.2.
Included in Galt's assets is $90 million in cash and risk-free securities. Assume the risk-free rate
is 4% and the market risk premium is 6%.
23
3) Galt's enterprise value is closest to:
A) $90 million
B) $510 million
C) $600 million
D) $690 million
Answer: B
Explanation: B) Enterprise value = equity + debt - cash = $600 million - $90 million = $510
million
Diff: 1
Skill: Analytical
4) The beta on Galt's assets is closest to:

A) 1.1
B) 1.2
C) 1.3
D) 1.4
Answer: D
Explanation: D)
Diff: 3
Skill: Analytical
5) Galt's WACC is closest to:

A) 10.6%
B) 11.2%
C) 11.8%
D) 12.5%
Answer: D
Explanation: D)
rwacc = rf + βu(rm - rf) = 4% + 1.411765(6%) = 12.47%

Diff: 3
Skill: Analytical
24
6) Consider the following equation:
E+D=U=A
The E in this equation represents

A) the value of the firm's equity.
B) the value of the firm's debt.
C) the value of the firm's unlevered equity.
D) the market value of the firm's assets.
Answer: A
Diff: 1
Skill: Conceptual
E+D=U=A
The U in this equation represents

A) the value of the firm's equity.
B) the market value of the firm's assets.
C) the value of the firm's unlevered equity.
D) the value of the firm's debt.
Answer: C
Diff: 1
Skill: Conceptual
E+D=U=A
The A in this equation represents

A) the value of the firm's debt.
B) the market value of the firm's assets.
C) the value of the firm's equity.
D) the value of the firm's unlevered equity.
Answer: B
Diff: 1
Skill: Conceptual
25
A) While debt itself may be cheap, it increases the risk and therefore the cost of capital of the
firm's equity.
B) Although debt does not have a lower cost of capital than equity, we can consider this cost in
isolation.
C) We can use Modigliani and Miller's first proposition to derive an explicit relationship
between leverage and the equity cost of capital.
D) The total market value of the firm's securities is equal to the market value of its assets,
whether the firm is unlevered or levered.
Answer: B
Explanation: B) Although debt has a lower cost of capital than equity, we can consider this cost
in isolation.
Diff: 2
Skill: Conceptual

A) The levered equity return equals the unlevered return, plus an extra "kick" due to leverage.
B) By holding a portfolio of the firm’s equity and its debt, we can replicate the cash flows from
holding its levered equity.
C) The cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a
premium that is proportional to the market value debt-equity ratio.
D) If a firm is unlevered, all of the free cash flows generated by its assets are available to be paid
out to its equity holders.
Answer: B
Explanation: B) By holding a portfolio of the firm's equity and its debt, we can replicate the cash
flows from holding its unlevered equity.
Diff: 2
Skill: Conceptual

A) If we can identify a comparison firm whose assets have the same risk as the project being
evaluated, and if the comparison firm is levered, then we can use its equity cost of capital as the
cost of capital for the project.
B) We can calculate the cost of capital of the firm's assets by computing the weighted average of
the firm’s equity and debt cost of capital, which we refer to as the firm’s weighted average cost
of capital (WACC).
C) The portfolio of a firm's equity and debt replicates the returns we would earn if the firm were
unlevered.
D) When evaluating any potential investment project, we must use a discount rate that is
appropriate given the risk of the project’s free cash flow.
Answer: A
Explanation: A) If we can identify a comparison firm whose assets have the same risk as the
project being evaluated, and if the comparison firm is levered, then we can use its unlevered
equity cost of capital as the cost of capital for the project.
Diff: 2
26
Skill: Conceptual

A) With no debt, the WACC is equal to the unlevered equity cost of capital.
B) With perfect capital markets, a firm's WACC is dependent of its capital structure and is equal
to its equity cost of capital only the firm it is unlevered.
C) As the firm borrows at the low cost of capital for debt, its equity cost of capital rises, but the
net effect is that the firm's WACC is unchanged.
D) Although debt has a lower cost of capital than equity, leverage does not lower a firm's
WACC.
Answer: B
Explanation: B) With perfect capital markets, a firm's WACC is independent of its capital
structure and is equal to its equity cost of capital only the firm it is unlevered.
Diff: 2
Skill: Conceptual

A) Holding cash has the opposite effect of leverage on risk and return.
B) We use the market value of the firm's net debt when computing its WACC and unlevered beta
to measure the cost of capital and market risk of the firm’s business assets.
C) Since the WACC does not change with the use of leverage, the value of the firm's free cash
flow evaluated using the WACC does not change, and so the enterprise value of the firm does
not depend on its financing choices.
D) Even if the firm's capital structure is more complex, the WACC is calculated by computing
the weighted average cost of only the firm’s debt and equity.
Answer: D
Diff: 2
Skill: Conceptual

A) The unlevered beta measures the market risk of the firm’s business activities, ignoring any
additional risk due to leverage.
B) If a firm holds $1 in cash and has $1 of risk-free debt, then the interest earned on the cash will
equal the interest paid on the debt. The cash flows from each source cancel each other, just as if
the firm held no cash and no debt.
C) The unlevered beta measures the market risk of the firm without leverage, which is equivalent
to the beta of the firm's assets.
D) When a firm changes its capital structure without changing its investments, its levered beta
will remain unaltered, however, its asset beta will change to reflect the effect of the capital
structure change on its risk.
Answer: D
Explanation: D) When a firm changes its capital structure without changing its investments, its
unlevered beta will remain unaltered, however, its equity beta will change to reflect the effect of
the capital structure change on its risk.
Diff: 2
27
Skill: Conceptual
15) The following equation:

can be used to calculate all of the following except
A) the cost of capital for the firm's assets.
B) the levered cost of equity.
C) the unlevered cost of equity.
D) the weighted average cost of capital.
Answer: B
Diff: 2
Skill: Conceptual
16) Which of the following equations would not be appropriate to use in a firm with risky debt?
A) βE = βU + (βU - βD)
B) βU = βE+ (βU - βD)
C) βE = βU + βU
D)
Answer: C
Diff: 2
Skill: Conceptual
The term in the equation is

A) the required return on the firm's equity.
B) the same as the beta of the firm's assets.
C) equal to zero if the firm's debt is riskless.
D) the proportion of the firm financed with equity.
Answer: D
Diff: 1
Skill: Conceptual
28
The term βD in the equation is

A) the same as the beta of the firm's assets.
B) the required return on the firm's equity.
C) the proportion of the firm financed with equity.
D) equal to zero if the firm's debt is riskless.
Answer: D
Diff: 2
Skill: Conceptual
The term βU in the equation is

A) the same as the beta of the firm's assets.
B) the required return on the firm's equity.
C) the proportion of the firm financed with equity.
D) equal to zero if the firm's debt is riskless.
Answer: A
Diff: 2
Skill: Conceptual
29
You are evaluating a new project and need an estimate for your project's beta. You have
identified the following information about three firms with comparable projects:
Firm Equity Debt Debt to

Name Beta Beta Equity Ratio
Lincoln 1.25 0 0.25
Blinkin 1.6 0.2 1
Nod 2.3 0.3 1.5
20) The unlevered beta for Lincoln is closest to:

A) 0.95
B) 1.00
C) 1.05
D) 0.90
Answer: B
Explanation: B)
Firm Equity Debt Debt to Percent Percent Unlevere
Name Beta Beta Equity Ratio Equity Debt d Beta
Lincoln 1.25 0 0.25 0.8 0.2 1
Blinkin 1.6 0.2 1 0.5 0.5 0.9
Nod 2.3 0.3 1.5 0.4 0.6 1.1
% equity is calculated as
% debt is calculated as
the unlevered beta is calculated as βU = % equity βE + % debt βD

Diff: 2
Skill: Analytical
30
21) The unlevered beta for Blinkin is closest to:
A) 0.95
B) 1.10
C) 1.00
D) 0.90
Answer: D
Explanation: C)
Firm Equity Debt Debt to Percent Percent Unlevere
Name Beta Beta Equity Ratio Equity Debt d Beta
Lincoln 1.25 0 0.25 0.8 0.2 1
Blinkin 1.6 0.2 1 0.5 0.5 0.9
Nod 2.3 0.3 1.5 0.4 0.6 1.1

Diff: 2
Skill: Analytical
31
22) The unlevered beta for Nod is closest to:
A) 1.00
B) 0.90
C) 0.95
D) 1.10
Answer: D
Explanation: A)
Firm Equity Debt Debt to Percent Percent Unlevered
Name Beta Beta Equity Ratio Equity Debt Beta
Lincoln 1.25 0 0.25 0.8 0.2 1
Blinkin 1.6 0.2 1 0.5 0.5 0.9
Nod 2.3 0.3 1.5 0.4 0.6 1.1

Diff: 2
Skill: Analytical
32
23) Based upon the three comparable firms, what asset beta would you recommend using for
your firm's new project?
Answer:
Firm Equity Debt Debt to Percent Percent Unlevered
Name Beta Beta Equity Ratio Equity Debt Beta
Lincoln 1.25 0 0.25 0.8 0.2 1
Blinkin 1.6 0.2 1 0.5 0.5 0.9
Nod 2.3 0.3 1.5 0.4 0.6 1.1
the average unlevered beta for the three comparables , so this is the
recommended beta to use.
Diff: 2
Skill: Analytical
24) Suppose that you borrow only $30,000 in financing the project. According to MM
proposition II, the firm's equity cost of capital will be closest to:
A) 21%
B) 15%
C) 20%
D) 25%
Answer: C
Explanation: C)
Given rE = rU + (rU - rD)
rE = .15 + (.15 - .05) = .20 or 20%

Diff: 2
Skill: Analytical
33
proposition II, the firm's equity cost of capital will be closest to:
A) 45%
B) 30%
C) 25%
D) 35%
Answer: D
Explanation: D)
rE = .15 + (.15 - .05) = .35 or 35%

Diff: 2
Skill: Analytical
Luther Industries has no debt, a total equity capitalization of $20 billion, and a beta of 1.8.
Included in Luther's assets are $4 billion in cash and risk-free securities.
26) What is Luther's enterprise value?

A) $16 billion
B) $10.5 billion
C) $24 billion
D) $20 billion
Answer: A
Explanation: A) Enterprise value = market value - cash = $20 billion - $4 billion = $16 billion
Diff: 1
Skill: Analytical
27) Considering the fact that Luther's Cash is risk-free, Luther's unlevered beta is closest to:
A) 1.90
B) 2.25
C) 1.50
D) 1.45
Answer: B
Explanation: B)
βU = 1.8 + 0 = 2.25
Diff: 2
Skill: Analytical
34
proposition II, calculate the firm's equity cost of capital.
Answer:
rE = .15 + (.15 - .05) = .25 or 25%

Diff: 2
Skill: Analytical
29) Sisyphean Bolder Movers Incorporated has no debt, a total equity capitalization of $50
billion, and a beta of 2.0. Included in Sisyphean's assets are $12 billion in cash and risk-free
securities. Calculate Sisyphean's enterprise value and unlevered cost of equity considering the
fact that Sisyphean's cash is risk-free.
Answer: Enterprise value = market value - cash = $50 billion - $12 billion = $38 billion
Diff: 2
Skill: Analytical
35
14.4 Capital Structure Fallacies
Nielson Motors is currently an all equity financed firm. It expects to generate EBIT of $20
million over the next year. Currently Nielson has 8 million shares outstanding and its stock is
trading at $20.00 per share. Nielson is considering changing its capital structure by borrowing
$50 million at an interest rate of 8% and using the proceeds to repurchase shares. Assume
perfect capital markets.
1) Nielson's EPS if they choose not to change their capital structure is closest to:
A) $2.00
B) $2.30
C) $2.50
D) $2.90
Answer: C
Explanation: C) EPS = NI/shares outstanding = $20 million/8 million = $2.50 note NI = EBIT in
this case
Diff: 1
Section: 14.4 Capital Structure Fallacies
Skill: Analytical
2) Nielson's EPS if they change their capital structure is closest to:

A) $2.00
B) $2.30
C) $2.50
D) $2.90
Answer: D
Explanation: D) Nielson will repurchase $50 million / $20 share = 2.5 million shares
This leaves 8 million - 2.5 million = 5.5 million shares outstanding
NI = EBIT - Interest expense (no taxes) = $20 million - $50 million × 8% = $16 million available
to shareholders. EPS =NI/shares outstanding = $16 million/5.5 million = $2.91
Diff: 2
Skill: Analytical

A) The money taken in by the firm as a result of the share issue exactly offsets the dilution of the
shares.
B) Most analysts prefer to use performance measures and valuation multiples that are based on
the firm’s earnings before interest has been deducted.
C) Because the firm’s earnings per share and price-earnings ratio are affected by leverage
implies that we can always reliably compare these measures across firms with different capital
structures.
D) In general, as long as the firm sells the new shares of equity at a fair price, there will be no
gain or loss to shareholders associated with the equity issue itself.
Answer: C
Diff: 2
36
Skill: Conceptual
Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all
earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate
earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5
million shares outstanding and its stock is trading for a price of $12.00 per share. RC is
considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at
the current price of $12.00.
4) Prior to any borrowing and share repurchase, RC's EPS is closest to:
A) $0.60
B) $1.00
C) $1.20
D) $0.50
Answer: C
Explanation: C) EPS = EBIT / Shares outstanding = $6M / 5M shares = $1.20 EPS
Diff: 1
Skill: Analytical
5) Prior to any borrowing and share repurchase, the equity cost of capital for RC is closest to:
A) 10%
B) 10%
C) 12%
D) 9%
Answer: B
Explanation: B) EPS = EBIT / Shares outstanding = $6M / 5M shares = $1.20 EPS
so rU = .10
Diff: 2
Skill: Analytical
37
6) Following the borrowing of $12 and subsequent share repurchase, the number of shares that
RC will have outstanding is closest to:
A) 4.0 million
B) 6.0 million
C) 4.9 million
D) 4.5 million
Answer: A
Explanation: A) $12 million / $12 per share = 1 million shares repurchased, so 5M shares
initially - 1M shares repurchased = 4M total shares outstanding
Diff: 1
Skill: Analytical
7) Following the borrowing of $12 and subsequent share repurchase, the equity cost of capital for
RC is closest to:
A) 12%
B) 9%
C) 11.0%
D) 10%
Answer: C
Explanation: C) EPS = EBIT / Shares outstanding = $6M / 5M shares = $1.20 EPS
so rU = .10
rE = r U + (rU - rD)
rE = .10 + (.10 - .06) = .11 or 11%

Diff: 2
Skill: Analytical
38
8) Following the borrowing of $12 and subsequent share repurchase, the expected earnings per
share for RC is closest to:
A) $1.32
B) $1.44
C) $1.40
D) $1.20
Answer: A
Explanation: A) EPS = (EBIT) / Shares outstanding = ($6M) / 5M shares = $1.20 EPS
(unlevered)
$12 million / $12 per share = 1 million shares repurchased, so 5M shares initially - 1M shares
repurchased = 4M total shares outstanding.
EPS = (EBIT - Interest) / Shares outstanding = ($6M - .06 × $12) / 4M shares = $1.32 EPS
Diff: 2
Skill: Analytical
9) Following the borrowing of $12 and subsequent share repurchase, the value of a share for RC
is closest to:
A) $14.00
B) $13.20
C) $12.00
D) $10.80
Answer: C
Explanation: C) EPS = (EBIT) / Shares outstanding = ($6M) / 5M shares = $1.20 EPS
(unlevered)
so rU = .10
rE = .10 + (.10 - .06) = .11 or 11%

$12 million / $12 per share = 1 million shares repurchased, so 5M shares initially - 1M shares
repurchased = 4M total shares outstanding.
Diff: 2
Skill: Analytical
39
Rockwood Enterprises is currently an all equity firm and has just announced plans to expand
their current business. In order to fund this expansion, Rockwood will need to raise $100 million
in new capital. After the expansion, Rockwood is expected to produce earnings before interest
and taxes of $50 million per year in perpetuity. Rockwood has already announced the planned
expansion, but has not yet determined how best to fund the expansion. Rockwood currently has
16 million shares outstanding and following the expansion announcement these shares are
trading at $25 per share. Rockwood has the ability to borrow at a rate of 5% or to issue new
equity at $25 per share.
10) If Rockwood finances their expansion by issuing new stock, what will Rockwood's cost of
equity capital be?
A) 12%
B) 15%
C) 8%
D) 10%
Answer: D
Explanation: D) First, since the project is already announced, any positive NPV is already
reflected into Rockwoods current stock price. So, to raise the needed $100 million at $25 per
share, Rockwood will need to issue = 4 million new shares for a total of 16 + 4 = 20
million shares outstanding. So EPS per share = $50/20 = $2.50
$25.00 = , so rU = .10
Diff: 2
Skill: Analytical
40
11) If Rockwood finances their expansion by issuing $100 million in debt at 5%, what will
Rockwood's cost of equity capital be?
A) 11.25%
B) 10.70%
C) 12.50%
D) 12.00%
Answer: A
Explanation: A) FIrst, since the project is already announced, any positive NPV is already
reflected into Rockwoods current stock price. So, to raise the needed $100 million at $25 per
share, Rockwood will need to issue = 4 million new shares for a total of 16 + 4 = 20
million shares outstanding. So EPS per share = $50/20 = $2.50
$25.00 = , so rU = .10
Now
rE = .10 + (.10 - .05) = .1125 or 11.25%

Diff: 2
Skill: Analytical
41
12) Show mathematically that the stock price of Rockwood does not depend on whether they
issue new stock or borrow to fund their expansion.
Answer: First, since the project is already announced, any positive NPV is already reflected into
Rockwoods current stock price. So, to raise the needed $100 million at $25 per share,
Rockwood will need to issue = 4 million new shares for a total of 16 + 4 = 20 million
shares outstanding. So EPS per share = $50/20 = $2.50
$25.00 = , so rU = .10
Remember the price here is $25.00 per share.
Now:
rE = .10 + (.10 - .05) = .1125 or 11.25%
First, since the project is already announced, any positive NPV is already reflected into
Rockwoods current stock price.
same as all equity option.
Diff: 3
Skill: Analytical
42
Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all
earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate
earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5
million shares outstanding and its stock is trading for a price of $12.00 per share. RC is
considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at
the current price of $12.00.
13) Show mathematically that the stock price of RC won't change following the debt issuance
and share repurchase.
Answer: EPS = (EBIT) / Shares outstanding = ($6M) / 5M shares = $1.20 EPS (unlevered)
$12.00 = so rU = .10
rE = .10 + (.10 - .06) = .11 or 11%
which equals the original stock.
Diff: 2
Skill: Analytical
14.5 MM: Beyond the Propositions

A) Since the publication of their original paper, Modigliani and Miller’s ideas have greatly
influenced finance research and practice.
B) Proposition I was one of the first arguments to show that the Law of One Price could have
strong implications for security prices and firm values in a competitive market; it marks the
beginning of the modern theory of corporate finance.
C) The conservation of value principle extends far beyond questions of debt versus equity
or even capital structure.
D) The conservation of value principle for financial markets states that with perfect capital
markets, financial transactions neither add nor destroy value, but instead represent a repackaging
of risk (and therefore return).
Answer: C
Diff: 2
Section: 14.5 MM: Beyond the Propositions
Skill: Conceptual
43

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Corporate Finance, 2e, Global Edition (Berk/DeMarzo)

Chapter 14 Capital Structure in a Perfect Market

14.1 Equity Versus Debt Financing

Use the following information to answer the question(s) below.

4) Which of the following statements is false?

5) Equity in a firm with debt is called

7) Which of the following statements is false?

8) Which of the following statements is false?

9) The NPV for this project is closest to:

90,000 - 45,000(1.05) = $42,770

C/F (weak economy) = $90,000 (unlevered) - $45,000(1.05) (debt) = $42,750 (levered)

C/F (weak economy) = $90,000(unlevered) - $45,000(1.05) (debt) = $42,750(levered)

C/F (weak economy) = $90,000 (unlevered) - $45,000(1.05) (debt) = $42,750 (levered)

14.2 Modigliani-Miller I: Leverage, Arbitrage, and Firm Value

Use the following information to answer the question(s) below.

1) The number of shares that Galt must issue is closest to:

12) Which of the following statements is false?

14) Which of the following statements is false?

15) Which of the following statements is false?

Use the information for the question(s) below.

Value(Without) = 1,000,000 × $24 = $24 million

Value(Without) = 1,000,000 × $24 = $24 million

Value(Without) = 1,000,000 × $24 = $24 million

Value(Without) = 1,000,000 × $24 = $24 million

Value(Without) = 1,000,000 × $24 = $24 million

22) The market value of Luther's non-cash assets is closest to:

Shares outstanding = 1.25 - .25 = 1.0 billion

Use the following information to answer the question(s) below.

4) The beta on Galt's assets is closest to:

5) Galt's WACC is closest to:

rwacc = rf + βu(rm - rf) = 4% + 1.411765(6%) = 12.47%

The E in this equation represents

7) Consider the following equation:

The U in this equation represents

8) Consider the following equation:

The A in this equation represents

10) Which of the following statements is false?

11) Which of the following statements is false?

12) Which of the following statements is false?

13) Which of the following statements is false?

14) Which of the following statements is false?

15) The following equation:

B) βU = βE+ (βU - βD)

17) Consider the following equation:

The term in the equation is

The term βD in the equation is

19) Consider the following equation:

The term βU in the equation is

Firm Equity Debt Debt to

20) The unlevered beta for Lincoln is closest to:

the unlevered beta is calculated as βU = % equity βE + % debt βD

the unlevered beta is calculated as βU = % equity βE + % debt βD

the unlevered beta is calculated as βU = % equity βE + % debt βD

the unlevered beta is calculated as βU = % equity βE + % debt βD

Use the information for the question(s) below.

Given rE = rU + (rU - rD)

rE = .15 + (.15 - .05) = .20 or 20%

Given rE = rU + (rU - rD)

rE = .15 + (.15 - .05) = .35 or 35%

Use the information for the question(s) below.

26) What is Luther's enterprise value?

Given rE = rU + (rU - rD)

rE = .15 + (.15 - .05) = .25 or 25%