In a world with taxes and bankruptcy costs

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Reference no: EM131618886

1) The return on assets of a typical firm may change over time because of changes in business and economic conditions, but it is unlikely to change based on the financing or capital structure of the firm with reasonable amounts of debt.

a) True

b) False

2) Your firm has been plodding along without much attention from the stock market. Your boss insists that he can (a) increase the return on equity to shareholders by taking on more debt, and (b) attract new investors to the firm due to the higher returns.

a) False

b) Partly true, partly false

c) True

3) In a world with no frictions – that is, taxes, costs of bankruptcy, asymmetric information - there is no optimal capital structure (that, is no optimal mix of debt and equity).

a) True

b) False

4) In a world with taxes and bankruptcy costs, and in which interest on debt is tax deductible, if a firm has some debt:

a) The relationship between return on assets and the WACC is indeterminate and depends on several factors.

b) Its return on assets is always greater than the weighted average cost of capital (WACC).

c) Its return on assets is always is equal to the weighted average cost of capital (WACC).

d) Its return on assets is always less than the weighted average cost of capital (WACC).

5) In the real world, where there are taxes and interest on debt is tax deductible, if two firms have the same cash flows as each other in all possible scenarios in the future, their valuation at any point will:

a) Will depend on the capital structures adopted by the firms.

b) Will depend on the method of valuation used.

c) Will depend on the capital structures adopted by the firms and the valuation method used

d) Will be the same as each other regardless of the method of valuation.

Reference no: EM131618886

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