Quiz for Lecture 9
1. Financial risk refers to the extra risk stockholders bear as a result of the use of debt as
compared with the risk they would bear if no debt were used.
a. True
b. False
2. Which of the following statements is most correct?
a. Since debt financing raises the firm's financial risk, raising a company’s debt
ratio will always increase the company’s WACC.
b. Since debt financing is cheaper than equity financing, raising a company’s
debt ratio will always reduce the company’s WACC.
c. Increasing a company’s debt ratio will typically reduce the marginal cost of
both debt and equity financing; however, it still may raise the company’s
WACC.
d. Statements a and c are correct.
e. None of the statements above is correct.
3. Which of the following events is likely to encourage a company to raise its debt ratio?
a. An increase in the company’s operating leverage.
b. An increase in the corporate tax rate.
c. A decrease in the company’s marketable fixed assets.
d. All of the above.
4. MM showed that in a world without taxes, a firm’s optimal capital structure would be
almost 100 percent debt.
a. True
b. False
5. MM showed that in a world with taxes but no other market frictions, a firm’s optimal
capital structure would be almost 100 percent debt.
a. True
b. False
(The following information applies to the next two problems.)
The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a
corporate tax rate of 40 %. Kimberly uses $400,000 of 11 % debt financing, and the cost of
equity to an unlevered firm in the same risk class is 15 %.
6. What is the value of the firm according to MM with corporate taxes?
a. $400,000
b. $460,500
c. $560,000
d. $625,000
e. $775,000
