Corporate Finance Quiz: Debt and Equity Valuation

Debt holders take over the firm at no cost.

Liquidation and reorganization.

Direct costs and indirect costs.

<p>Shareholders bear the costs of financial distress.</p> Signup and view all the answers

<p>It balances the tax benefits of debt against the costs of financial distress.</p> Signup and view all the answers

<p>It refers to the buildup of excessive leverage over time.</p> Signup and view all the answers

<p>Shareholders' actions are unobservable and not contractible.</p> Signup and view all the answers

<p>The NPV of a project is the sum of the NPVs of its individual cash flows.</p> Signup and view all the answers

<p>Greater liquidity for investors and improved access to large amounts of capital for the firm.</p> Signup and view all the answers

<p>'Best efforts' means the underwriter tries to sell the stock but doesn't guarantee sales, while 'firm commitment' guarantees that all stock will be sold at the offer price.</p> Signup and view all the answers

<p>The underwriter manages the security issuance and designs its structure.</p> Signup and view all the answers

<p>It becomes more difficult to monitor management effectively.</p> Signup and view all the answers

<p>A road show involves the company's management and underwriters promoting the company to institutional investors.</p> Signup and view all the answers

<p>MM proposition 2 implies that a firm's weighted average cost of capital (WACC) is independent of its capital structure.</p> Signup and view all the answers

<p>Increasing leverage raises the riskiness of the remaining equity, which leads to an increase in the cost of equity.</p> Signup and view all the answers

<p>The 'debt is cheap fallacy' suggests debt is cheaper than equity due to low interest rates; however, increased leverage ultimately raises both the cost of equity and debt.</p> Signup and view all the answers

<p>While using debt can increase EPS, this does not enhance share price because the underlying risk has also increased, leading to a higher required return on equity.</p> Signup and view all the answers

<p>The equity dilution fallacy claims equity is more expensive than debt due to dilution; however, the value of shares remains stable, and original shareholders are not worse off.</p> Signup and view all the answers

<p>Both share repurchases and dividends result in equivalent decreases in cash balance and share price, thus not altering the firm's overall value.</p> Signup and view all the answers

<p>The cash hoarding fallacy suggests firms should pay out cash instead of investing in low-yield government bonds; however, this can lead to missed investment opportunities.</p> Signup and view all the answers

<p>While this action increases EPS, it does not change the share price as the associated risks and required returns on equity also escalate.</p> Signup and view all the answers

<p>The Modigliani-Miller theorem suggests that in a frictionless market, the choice of capital structure is irrelevant for the value of a firm.</p> Signup and view all the answers

<p>Excessive debt may lead to high interest payments that could become unsustainable, resulting in potential bankruptcy.</p> Signup and view all the answers

<p>Homemade leverage refers to the idea that if investors prefer a different capital structure, they can adjust their personal borrowing and lending to replicate their desired results independently of the firm's structure.</p> Signup and view all the answers

<p>Bond value and stock value combined equal the total firm value.</p> Signup and view all the answers

<p>Equity functions like a call option on the company's assets with a strike price equal to the face value of the debt.</p> Signup and view all the answers

<p>One reason is that excessively high debt could lead to financial distress and increased bankruptcy risk, countering the initial cost benefits.</p> Signup and view all the answers

<p>The weighted average cost of capital is equal to the expected return on unlevered equity and increases with the firm’s debt-to-equity ratio.</p> Signup and view all the answers

<p>Assumptions include no taxes and no financial distress costs.</p> Signup and view all the answers

<p>The mental accounting fallacy occurs when individuals compare their wealth to a reference point and integrate gains from that point with losses from money left on the table, possibly leading to suboptimal financial decisions.</p> Signup and view all the answers

<p>Payouts, such as dividends, may signify a firm's financial health and commitment to returning value to shareholders.</p> Signup and view all the answers

<p>Dividend policy might be irrelevant because investors can create their own cash flow through homemade dividends by selling shares as needed.</p> Signup and view all the answers

<p>Bob achieves his desired dividend income by selling shares to convert the cash into his preferred amount.</p> Signup and view all the answers

<p>Dividend payments can help mitigate agency costs by preventing managers from misusing excess cash for personal interests or poor investments.</p> Signup and view all the answers

<p>Share repurchases allow investors to pay capital gains tax, which is typically lower than the dividend tax incurred on cash distributions.</p> Signup and view all the answers

<p>Firms may pay dividends as a signaling mechanism to convey confidence in their financial stability and to reassure investors of future cash flows.</p> Signup and view all the answers

<p>Transaction costs associated with selling shares to create homemade dividends can make receiving cash dividends more appealing to investors.</p> Signup and view all the answers

<p>Underwriters set the offer price too low to reduce risk and charge high commissions on underpriced shares.</p> Signup and view all the answers

<p>Rights offerings ensure existing shareholders can purchase new shares, preventing dilution of their ownership.</p> Signup and view all the answers

<p>The stock price typically declines following the announcement of an SEO.</p> Signup and view all the answers

<p>Cyclicality in IPOs suggests that the number of issues increases in good times and decreases in bad times.</p> Signup and view all the answers

<p>Firms may prefer to issue less-information sensitive securities to minimize adverse selection risks.</p> Signup and view all the answers

<p>Pre-IPO shareholders bear the costs of underpricing, resulting in a non-optimal share price.</p> Signup and view all the answers

<p>Firms signal quality to investors to reassure them of their value amidst asymmetric information.</p> Signup and view all the answers

<p>The typical spread for an IPO is around 7% of the issue price.</p> Signup and view all the answers

<p>Investor demand is typically rationed when an IPO is perceived as successful, leading to high demand exceeding supply.</p> Signup and view all the answers

<p>Firms often allow their stock price to rise before announcing an SEO to create a favorable perception.</p> Signup and view all the answers