Question

QUESTION 24

1. Consider two firms, Firm A and Firm B that have identical assets that generate identical cash flows. Firm A has $10 million in debt and has 3 million shares outstanding. Firm A’s stock is traded at $10 per share. Firm B is all-equity firm with 5 million shares outstanding. Under the M&M world with perfect capital markets, what would be the stock price for Firm B?

   	A.	$8
   	B.	$6
   	C.	$10
   	D.	$5

QUESTION 25

1. Under the M&M world with corporate taxes, a firm’s (post-tax) WACC decreases as financial leverage increases.

   True

   False

QUESTION 26

1. Under the M&M world with corporate taxes, the value of a firm is maximized when the firm is financed with 100% debt.

   True

   False

Answer 1

24. In a perfect competition under MM appraoch the value of an unlevered firm and value of a levered firm are same so,

Value of firm A= Value of firm B

Number of equity shares* Price of equity shares of firm A = Number of equity shares* Price of equity shares of firm B

10*3= 5*price of shares of firm B

So, Price of shares of firm B= (30/5)= 6

So Answer would be (B) $6

25.Under the M&M world with corporate taxes, a firm’s (post-tax) WACC decreases as financial leverage increases.

This statement holds true as according to MM proposition II the amount of leverage taken will increase and it will reduce the overall WACC as it is highly emphasized with replacing equity financing with debt financing

26.Under the M&M world with corporate taxes, the value of a firm is maximized when the firm is financed with 100% debt - This statement also holds true as this approch clearly emphasized on eliminating overall equity and replacing it with complete debt and advocates that optimal capital structure exists at the point where debt is 100%