Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
expand_more
expand_more
format_list_bulleted
Videos
Textbook Question
Chapter 17, Problem 5PS
MM’s propositions True or false?
- a. MM’s propositions assume perfect financial markets, with no distorting taxes or other imperfections.
- b. MM’s proposition 1 says that corporate borrowing increases earnings per share but reduces the price–earnings ratio.
- c. MM’s proposition 2 says that the
cost of equity increases with borrowing and that the increase is proportional to D/V, the ratio of debt to firm value. - d. MM’s proposition 2 assumes that increased borrowing does not affect the interest rate on the firm’s debt.
- e. Borrowing does not increase financial risk and the cost of equity if there is no risk of bankruptcy.
- f. Borrowing always increases firm value if there is a clientele of investors with a reason to prefer debt.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Which statement is most correct? *
A. Since debt financing raises the firm’s financial risk, increasing debt ratio will increase WACC.
B. Since debt financing is cheaper than equity financing, increasing debt ratio will reduce WACC.
C. Increasing a firm’s debt ratio will typically reduce the marginal costs of both debt and equity financing; however, it still may raise the firm’s WACC.
D. Statements a and c are correct.
E. None of the above
Which of the following is true regarding a company assuming more debt?
Select one:
a. Assuming more debt is always bad for the company
b. Assuming more debt reduces leverage
c. Assuming more debt can be good for the company as long as they earn a return in excess of the rate charged on the borrowed funds
d. Assuming more debt is always good for the company
(b) Assume that Modigliani-Miller Propositions 1 and 2 hold. Ex-
plain carefully why the conclusion of each of the following argu-
ments is incorrect:
(i) As a firm borrows more and debt becomes risky, both share-
holder and bondholders demand higher rates of return. Thus,
by reducing its debt ratio, a firm can reduce both the cost
of debt and the cost of equity.
(ii) As leverage increases, the ratio of the market value of a firm's
equity to income (after debt interest) increases.
Chapter 17 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 17 - Homemade leverage Ms. Kraft owns 50,000 shares of...Ch. 17 - MM proposition 2 Spam Corp. is financed entirely...Ch. 17 - Prob. 3PSCh. 17 - Corporate leverage Suppose that Macbeth Spot...Ch. 17 - MMs propositions True or false? a. MMs...Ch. 17 - MM proposition 2 Look back to Section 17-1....Ch. 17 - Prob. 8PSCh. 17 - Homemade leverage Companies A and B differ only in...Ch. 17 - Prob. 10PSCh. 17 - Prob. 11PS
Ch. 17 - MM proposition 1 Executive Cheese has issued debt...Ch. 17 - MM proposition 2 Hubbards Pet Foods is financed...Ch. 17 - Prob. 14PSCh. 17 - MMs propositions What is wrong with the following...Ch. 17 - Prob. 16PSCh. 17 - Prob. 17PSCh. 17 - MM proposition 2 Imagine a firm that is expected...Ch. 17 - MM proposition 2 Archimedes Levers is financed by...Ch. 17 - Prob. 20PSCh. 17 - Prob. 21PSCh. 17 - Prob. 22PSCh. 17 - Prob. 23PSCh. 17 - Investor choice People often convey the idea...Ch. 17 - Investor choice Suppose that new security designs...
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- 7. The reason firms care about the amount of debt they use is because a. There are tax benefits to debt, so capital structure can affect the value of the firm b. Firms don't care about their amount of debt c. There are tax benefits of equity, so using debt can replace valuable equity d. None of the above 8. When an economy has a risk-free asset, all risk-averse investors should invest in either the risk-free asset or the highest Sharpe-ratio risky asset (or both) a. True b. False c. Too little information to tell d. None of the above 9. The CAPM equation (Security Market Line) is a useful tool when trying to identify a company's a. Weight Average Cost of Capital b. Required Return on Equity c. Expected Return on Equity d. All of the abovearrow_forwardWhich of the below statements does the MM Proposition I predict? A. In a perfect market, the value of a firm is independent of its capital structure B.In a perfect market, the discount rate depends on the capital structure C.In a perfect market, the value of a firm decreases in leverage D.In a perfect market, the NPY of investments depends on the existing debt/equity mixarrow_forwardWhich of the following statements is FALSE? Question content area bottom Part 1 A. Growth rate of the firm is higher, it is more optimal to have a higher level of debt relative to equity in the firm capital structure. B. Growth will affect the optimal leverage ratio even if the firm has positive earnings. C. When examining tax, the optimal debt level is proportional to its current earnings. D. The more unsure we are of EBIT the more chance that interest will exceed EBIT, if the interest expense is higharrow_forward
- Which of the following statements are CORRECT? Check all that apply: The aftertax cost of debt decreases when the market price of a bond increases. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. Cost of capital is also known as the minimum expected or required return an investment must offer to be attractive.arrow_forward2) Which one of these statements corresponds to MM proposition I without taxes? A) Debt interest reduces equity income and increases firm value. B) The value of a firm increases as its debt-equity ratio increases. C) Debt interest has no effect on either equity income or firm value. D) Debt interest reduces equity income but does not affect firm value.arrow_forwardWhich of the following statements is CORRECT?a.The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share.b.The capital structure that maximizes the stock price is generally the capital structure that also maximizes its WACC.c.The capital structure that maximizes the stock price is generally the capital structure that also minimizes its WACC.d.Since debt is cheaper than equity, increasing the debt ratio will always reduce WACC.e.When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase.arrow_forward
- Both EV-to-EBITDA and PE multiples can be linked to interest rates through the discount rate used in discounted cash flow valuation. Holding all else equal, when discount rates are higher, valuation ratios are lower. Perhaps because of this, we tend to see stock prices as well as, the value of private business transactions decline when interest rates increase. Macroeconomists like to describe interest rates as consisting of two components: the real interest rate component and an expected inflation component. In some situations, increases in interest rates are the result of an increasing real interest rate; in other situations, the cause of an interest rate increase is an increase in expected inflation. How might valuation ratios be expected to respond to an interest rate increase generated by an increase in expected inflation versus an interest rate increase that represents an increase in real interest rates?arrow_forward5. Consider the following two potential transactions: (i) borrow from a bank; and (ii) use the proceeds from borrowing to pay out dividend. Assume this is an NFA firm. The combination of two financial transactions will A. reduce the financial leverage (FLEV) and the firm will continue to be an NFA firm.B. reduce the financial leverage (FLEV) and the firm will switch to an NFO firm.C. increase the financial leverage (FLEV) and the firm may become be an NFO firm.D. increase the financial leverage (FLEV) and the firm cannot be an NFA firm anymore.arrow_forwardIn the MM model, as the proportion of debt in the capital structure increases, the cost of equity a. increases. b. decreases. c. remains unchanged; there is no relationship between the two. d. initially rises rapidly, then increases slowly beyond some point.arrow_forward
- 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 efficiencyarrow_forward"If the firm's ROE is too low, the firm's debt ratio must be too low." True or false? Select one: O a. True O b. Falsearrow_forwardConsider 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?arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Financial Reporting, Financial Statement Analysis...FinanceISBN:9781285190907Author:James M. Wahlen, Stephen P. Baginski, Mark BradshawPublisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
Financial Reporting, Financial Statement Analysis...
Finance
ISBN:9781285190907
Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Publisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
9 Different Types of Stocks | Investing For Beginners; Author: Kiana Danial - Invest Diva;https://www.youtube.com/watch?v=CdJYcjZfCH0;License: Standard Youtube License