6. FinancingAssume that you live in the blissful world of perfect capital markets: there are notransaction costs or taxes; bankruptcy costs are zero; individuals can borrow and lend atthe same rate as corporations can; and all agents in the economy have the sameinformation. Let us compare two corporations that are identical except that one is allequity financed and the other is part equity and part debt financed. Denote the value ofthe unlevered (all equity) firm by V and the value of the levered firm by V, . AssumethatV, = $50,000the interest rate on the firm's debt is .10the firms generate identical net revenues of$8,000 in good times$1,000 in bad timesthe levered firm has $20,000 of debtA. Compute the cash flows accruing to an investor who borrows on her personal accountan amount equal to one percent of the debt of the levered firm and purchases onepercent of the unlevered firm,B. Compute the cash flows of an investor who purchases one percent of the equity of thelevered firm.C. Using your results in parts (A) and (B) and the no-arbitrage condition, construct anargument to prove that V, = $50,000. Discuss the relevance of your result to theModigliani-Miller Theorem I.7. OptionsA. How does the price of a call option respond to the following changes, other thingsequal? Does the price go up or down? Explain briefly the intuition for youranswer.(i). Exercise price rises.(ii). Volatility of stock price rises.3

Value of a firm When a firm has both equity and debt as sources of financing, the firm is said to be…

Answered: 6. Financing Assume that you live in…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

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Which of the following is/are NOT true about private equity? (select all that apply) a.Three levers to increase equity value are multiple expansion, EBITDA growth, and cash generation. b. Private equity investors can easily sell or exchange their investments for cash anytime. c. Private equity firms only invest in small companies. d. Everything else stays the same. If a company's gross debt amount increases, its equity value decreases.
Which of the following is most correct about the cost of capital? The cost of debt reflects the interest rates on debt capital before taking into account the tax effects. Cost of capital is affected by the required rates of return of each of the source of capital, regardless of the capital structure. The capital asset pricing model is the most widely used model to estimate the cost of common equity. To minimize the cost of capital, firms should borrow more than their capacity because increasing the lower cost of debt yields the lowest cost of capital, thus, enhances shareholder value.
How does a cost-efficient capital market help reduce the prices of goods and services? Describe the different ways in which capital can be transferred from suppliers of capital to those who are demanding capital. Is an initial public offering an example of a primary or a secondary market transaction? Indicate whether the following instruments are examples of money market or capital market securities. a. US Treasury bills b. Long-term corporate bonds c. Common stocks d. Preferred stocks e. Dealer commercial paper Briefly explain what is meant by the term efficiency continuum.
8. The efficient markets hypothesis True or False: The efficient markets hypothesis holds only if all investors are rational. O False O True Almost all financial theory and decision models assume that the financial markets are efficient. The informational efficiency of financial markets determines the ability of investors to "beat" the market and earn excess (or abnormal) returns on their investments. If the markets are efficient, they will react rapidly as new relevant information becomes available. Financial theorists have identified three levels of informational efficiency that reflect what information is incorporated in stock prices. Identify the form of capital market efficiency under the efficient market hypothesis described in the following statement: Current market prices reflect all relevant information, whether it is known publicly or privately. This statement is consistent with: O Semistrong form efficiency O Strong form efficiency O Weak form efficiency
Consider two firms that are alike in every way except that Firm A has fixed rate debt in its capital structure and Firm B has variable rate debt. Which firm has riskier equity? Why?
Which of these is a main characteristic of debt capital?(a) Investors in debt participate in the ownership of the firm.(b) Investors in debt are paid interest.(c) Debt is more risky for the investor and less risky for the firm.(d) If dividends are not paid, this can lead to foreclosure, legal proceeding and financial distress.
Please help me with this question (picture below) 1. Calculate the weighted average cost of capital of Gamma plc.2. Explain Modigliani and Miller’s argument that in a world of no taxes and no bankruptcy the value of the firm does not depend on its capital structure.3. Explain how a firm's optimal capital structure is determined according to the static theory of capital structure (i.e. the traditional approach).
1. Assume that capital markets are perfect: there are no transactions costs or taxes, no bankruptcy costs, individuals can borrow and lend at the same rate as corporations can, and all agents in the economy have the same information. Let us compare two corporations that are identical except that one is all equity financed and the other is part equity and part debt financed. Denote the value of the unlevered (all equity) firm by VU and the value of the levered firm by VL. Assume that • Vu = $20,000 • Interest rate on the firm's debt is .10 • The firms generate identical net revenues of $2000 in good times $500 in bad times • Levered firm has $5,000 of debt A. Compute the cash flows accruing to an investor who borrows on her personal account an amount equal to one percent of the debt of the levered firm and purchases one percent of the unlevered firm. B. Next compute the cash flows of an investor who purchases one percent of the equity of the levered firm. C. Using your results in parts…
It has been suggested that in a world with only corporate taxation the value of the firm = the value of all equity financed + the present value of tax shield on debt finance How far do existing capital structures of companies compare with the most appropriate structure according to the equation?
How many statements below are correct about the Modigliani-Miller theorem? i. The theorem is not an exact description of reality. ii. The theorem provides a benchmark to understand how the capital structure could affect WACC. iii. The theorem implies that firms have benefited from financing with debt due to a higher required rate of return on debt compared with equity. iv. The value of the firm is not affected by its capital structure under any assumptions.
When a profitable business has no mandated loan capital but there are non-mandated liabilities a. the return on equity always exceeds the return on total capitalb. the return on equity always equals the return on total capitalc. the return on equity may be equal to the return on total capitald. the return on equity always lags behind the return on total capital choose one
5. Financing Assume that you live in the blissful world of perfect capital markets: there are no transaction costs or taxes; bankruptcy costs are zero; individuals can borrow and lend at the same rate as corporations can; and all agents in the economy have the same information. Let us compare two corporations that are identical except that one is all equity financed and the other is part equity and part debt financed. Denote the value of the unlevered (all equity) firm by u and the value of the levered firm by V. Assume that = $20,000 • the interest rate on the firm's debt is .10 • the two firms generate identical net revenues of $1000 in good times and $400 in bad times • the levered firm has $6,000 of debt A. Compute the cash flows accruing to an investor who borrows on her personal account an amount equal to one percent of the debt of the levered firm and purchases one percent of thé unlevered firm. B. Compute the cash flows of an investor who purchases one percent of the equity of…

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