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Week 3
Homewrok Problems Chapter 20 and
21
Which of
the following statements is most CORRECT?
a. By
law in most states, all preferred stock must be cumulative, meaning that the
compounded
total of all unpaid preferred dividends must be paid before any dividends
can be
paid on the firm's common stock.
b. From
the issuer's point of view, preferred stock is less risky than bonds.
c.
Whereas common stock has an indefinite life, preferred stocks always have a
specific
maturity
date, generally 25 years or less.
d.
Unlike bonds, preferred stock cannot have a convertible feature.
e.
Preferred stock generally has a higher component cost of capital to the firm
than does
common
stock.
2. Which
of the following statements about convertibles is most CORRECT?
a. One
advantage of convertibles over warrants is that the issuer receives additional
cash
money
when convertibles are converted.
b.
Investors are willing to accept a lower interest rate on a convertible than on
otherwise
similar
straight debt because convertibles are less risky than straight debt.
c. At
the time it is issued, a convertible's conversion (or exercise) price is
generally set
equal to
or below the underlying stock's price.
d. For
equilibrium to exist, the expected return on a convertible bond must normally
be
between
the expected return on the firm's otherwise similar straight debt and the
expected
return on its common stock.
e. The
coupon interest rate on a firm's convertibles is generally set higher than the
market
yield on
its otherwise similar straight debt.
3. Which
of the following statements concerning warrants is correct?
a.
Warrants are long-term put options that have value because holders can sell the
firm's
common
stock at the exercise price regardless of how low the market price drops.
b.
Warrants are long-term call options that have value because holders can buy the
firm's
common
stock at the exercise price regardless of how high the stock's price has risen.
c. A
firm's investors would generally prefer to see it issue bonds with warrants
than straight
bonds
because the warrants dilute the value of new shareholders, and that value is
transferred
to existing shareholders.
d. A
drawback to using warrants is that if the firm is very successful, investors
will be less
likely
to exercise the warrants, and this will deprive the firm of receiving any new
capital.
e. Bonds
with warrants and convertible bonds both have option features that their
holders
can
exercise if the underlying stock's price increases. However, if the option is
exercised,
the
issuing company's debt declines if warrants were used but remains the same if
it
used
convertibles.
4. Which
of the following statements is most CORRECT?
a. One
important difference between warrants and convertibles is that convertibles
bring in
additional
funds when they are converted, but exercising warrants does not bring in any
additional
funds.
b. The
coupon rate on convertible debt is normally set below the coupon rate that
would be
set on
otherwise similar straight debt even though investing in convertibles is more
risky
than
investing in straight debt.
c. The
value of a warrant to buy a safe, stable stock should exceed the value of a
warrant to
buy a
risky, volatile stock, other things held constant.
d.
Warrants can sometimes be detached and traded separately from the debt with
which
they
were issued, but this is unusual.
e.
Warrants have an option feature but convertibles do not.
5.
Mariano Manufacturing can issue a 25-year, 8.1% annual payment bond at par. Its
investment
bankers
also stated that the company can sell an issue of annual payment preferred
stock to
corporate
investors who are in the 40% tax bracket. The corporate investors require an
after-tax
return
on the preferred that exceeds their after-tax return on the bonds by 1.0%,
which would
represent
an after-tax risk premium. What coupon rate must be set on the preferred in
order to
issue it
at par?
a. 6.66%
b. 6.99%
c. 7.34%
d. 7.71%
e. 8.09%
FIN 540 Week 3 Homework Problems – Strayer NEW
Chapter – 21
Week 3
1.The
major contribution of the Miller model is that it demonstrates that
a.
personal taxes decrease the value of using corporate debt.
b.
financial distress and agency costs reduce the value of using corporate debt.
c.
equity costs increase with financial leverage.
d. debt
costs increase with financial leverage.
e.
personal taxes increase the value of using corporate debt.
2. Which
of the following statements concerning capital structure theory is NOT CORRECT?
a. Under
MM with zero taxes, financial leverage has no effect on a firm's value.
b. Under
MM with corporate taxes, the value of a levered firm exceeds the value of the
unlevered
firm by the product of the tax rate times the market value dollar amount of
debt.
c. Under
MM with corporate taxes, rs increases
with leverage, and this increase exactly
offsets
the tax benefits of debt financing.
d. Under
MM with corporate taxes, the effect of business risk is automatically
incorporated
because
rsL is a function of rsU .
e. The
major contribution of Miller's theory is that it demonstrates that personal
taxes
decrease
the value of using corporate debt.
3. Which
of the following statements concerning the MM extension with growth is NOT CORRECT?
a. The
value of a growing tax shield is greater than the value of a constant tax
shield.
b. For a
given D/S, the levered cost of equity is greater than the levered cost of
equity under
MM's
original (with tax) assumptions.
c. For a
given D/S, the WACC is less than the WACC under MM's original (with tax)
assumptions.
d. The
total value of the firm increases with the amount of debt.
e. The
tax shields should be discounted at the unlevered cost of equity.
4. Which
of the following statements concerning the MM extension with growth is NOT CORRECT?
a. The value
of a growing tax shield is greater than the value of a constant tax shield.
b. For a
given D/S, the levered cost of equity is greater than the levered cost of
equity under
MM's
original (with tax) assumptions.
c. For a
given D/S, the WACC is greater than the WACC under MM's original (with tax)
assumptions.
d. The
total value of the firm increases with the amount of debt.
e. The
tax shields should be discounted at the cost of debt.
5. Which of the following statements
concerning the MM extension with growth is NOT
CORRECT?
a. The
value of a growing tax shield is greater than the value of a constant tax
shield.
b. For a
given D/S, the levered cost of equity is greater than the levered cost of
equity under
MM's
original (with tax) assumptions.
c. For a
given D/S, the WACC is greater than the WACC under MM's original (with tax)
assumptions.
d. The
total value of the firm is independent of the amount of debt it uses.
e. The
tax shields should be discounted at the unlevered cost of equity.
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