ABC reduced its taxes last year by $350 by increasing its interest expense by $1,000.

Which of the
following terms is used to describe this tax savings?

A. interest tax shield

B. interest credit

C. financing shield

D. current tax yield

The unlevered cost of capital refers to the cost of capital for a(n):

A. private entity.

B. all-equity firm.

C. governmental entity.

D. private individual.

Which one of the following statements is correct concerning the relationship between a levered and an
unlevered capital structure? Assume there are no taxes.

A. At the break-even point, there is no advantage to debt.

B. The earnings per share will equal zero when EBIT is zero for a levered firm.

C. The advantages of leverage are inversely related to the level of EBIT.

D. The use of leverage at any level of EBIT increases the EPS.

Which one of the following makes the capital structure of a firm irrelevant?

A. taxes

B. interest tax shield

C. 100 percent dividend payout ratio

D. debt-equity ratio that is greater than 0 but less than 1

E. homemade leverage

Float refers to the following:

A. The immediate cash that a company can withdraw from its bank account.
B. The difference between the cash recorded in the company's books and the actual cash held in the
bank.

C. The alteration in a company's cash balance from one accounting period to another.

D. The quantity of cash that a company currently possesses.

Float : The difference between book cash and bank cash, representing the net effect of checks in the
process of clearing

Cash management primarily involves:

A. optimizing a firm's collections and disbursements of cash.

B. maximizing the income a firm earns on its cash reserves.

C. reconciling a firm's book balance with its bank balance.

D. determining the optimal level of liquidity a firm should maintain.

A cash discount of 2/5, net 30:

A. grants customers 30 days to pay after the discount period expires.

B. offers customers a maximum of 30 days credit.

C. grants free credit for a period of 30 days.

D. charges a higher price to a cash customer than to a customer who pays in 2 days.

Terms of sale : The conditions under which a firm sells its goods and services for cash or credit.

Terms of 5/10, net 45 mean: Take a 5 percent discount from the full price if you pay within 10 days, or
pay the full amount in 45 days.

Under credit terms of 1/5, net 15, customers should:

A. always pay on the 15th day.

B. take the 5 percent discount and pay immediately.

C. take the discount and pay on the day following the day of sale.

D. either take the discount or pay on the 15th day.

E. both take the discount and pay on the 15th day.

A 2/10, net 30 credit policy:

A. is an expensive form of short-term credit if a buyer foregoes the discount.

B. provides cheap financing to the buyer for 30 days.

C. is an inexpensive means of reducing the seller's collection period if every customer takes the
discount.

D. tends to have little effect on the seller's collection period.

Your primary responsibility as a newly hired employee at a prominent retail store is to assess the
likelihood that individual customers will not fulfill their payment obligations for their credit purchases.
Which of the following options is most closely related to your job?

A. terms of sale

B. credit analysis

C. collection policy

D. payables policy

Credit analysis : The process of determining the probability that customers will not pay
CHAPER 13 : RISK & RETURN

1. You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in
a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your
stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent?

A. arithmetic return

B. historical return

C. expected return

D. geometric return

E. required return

2. Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at $82,500 total.
Which one of the following terms most applies to Suzie's investments?

A. index

B. portfolio

C. collection

D. grouping

E. risk-free

3. Steve has invested in twelve different stocks that have a combined value today of $121,300. Fifteen
percent of that total is invested in Wise Man Foods. The 15 percent is a measure of which one of the
following?

A. portfolio return

B. portfolio weight

C. degree of risk

D. price-earnings ratio

E. index value

4. A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20
percent. What type of risk does this news flash represent?

A. portfolio

B. nondiversifiable
C. market

D. unsystematic

E. total

5. Which one of the following measures the amount of systematic risk present in a particular risky asset
relative to the systematic risk present in an average risky asset?

A. beta

B. reward-to-risk ratio

C. risk ratio

D. standard deviation

E. price-earnings ratio

6. Which one of the following is a positively sloped linear function that is created when expected returns
are graphed against security betas?

A. reward-to-risk matrix

B. portfolio weight graph

C. normal distribution

D. security market line

E. market real returns

7. Which one of the following is represented by the slope of the security market line?

A. reward-to-risk ratio

B. market standard deviation

C. beta coefficient

D. risk-free interest rate

E. market risk premium

8. Which one of the following is the formula that explains the relationship between the expected return
on a security and the level of that security's systematic risk?

A. capital asset pricing model

B. time value of money equation

C. unsystematic risk equation

D. market performance equation

E. expected risk formula

9. The expected risk premium on a stock is equal to the expected return on the stock minus the:

A. expected market rate of return.

B. risk-free rate.

C. inflation rate.

D. standard deviation.

E. variance.

10. Standard deviation measures which type of risk?

A. total

B. nondiversifiable

C. unsystematic

D. systematic

E. economic

11. The expected rate of return on a stock portfolio is a weighted average where the weights are based
on the:

A. number of shares owned of each stock.

B. market price per share of each stock.

C. market value of the investment in each stock.

D. original amount invested in each stock.

E. cost per share of each stock held.

12. If a stock portfolio is well diversified, then the portfolio variance:

A. will equal the variance of the most volatile stock in the portfolio.
B. may be less than the variance of the least risky stock in the portfolio.

C. must be equal to or greater than the variance of the least risky stock in the portfolio.

D. will be a weighted average of the variances of the individual securities in the portfolio.

E. will be an arithmetic average of the variances of the individual securities in the portfolio.

13. The standard deviation of a portfolio:

A. is a weighted average of the standard deviations of the individual securities held in the portfolio.

B. can never be less than the standard deviation of the most risky security in the portfolio.

C. must be equal to or greater than the lowest standard deviation of any single security held in the
portfolio.

D. is an arithmetic average of the standard deviations of the individual securities which comprise
the portfolio.

E. can be less than the standard deviation of the least risky security in the portfolio.

14. Which one of the following statements is correct?

A. The unexpected return is always negative.

B. The expected return minus the unexpected return is equal to the total return.

C. Over time, the average return is equal to the unexpected return.

D. The expected return includes the surprise portion of news announcements.

E. Over time, the average unexpected return will be zero.

15. Which one of the following statements related to risk is correct?

A. The beta of a portfolio must increase when a stock with a high standard deviation is added to the
portfolio.

B. Every portfolio that contains 25 or more securities is free of unsystematic risk.

C. The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.

D. Adding five additional stocks to a diversified portfolio will lower the portfolio's beta.

E. Stocks that move in tandem with the overall market have zero betas.

16. Which one of the following risks is irrelevant to a well-diversified investor?

A. systematic risk

B. unsystematic risk

C. market risk

D. nondiversifiable risk

E. systematic portion of a surprise

17. The primary purpose of portfolio diversification is to:

A. increase returns and risks.

B. eliminate all risks.

C. eliminate asset-specific risk.

D. eliminate systematic risk.

E. lower both returns and risks.

18. Which one of the following indicates a portfolio is being effectively diversified?

A. an increase in the portfolio beta

B. a decrease in the portfolio beta

C. an increase in the portfolio rate of return

D. an increase in the portfolio standard deviation

E. a decrease in the portfolio standard deviation

19. Which one of the following is most directly affected by the level of systematic risk in a security?

A. variance of the returns

B. standard deviation of the returns

C. expected rate of return

D. risk-free rate

E. market risk premium

20. The systematic risk of the market is measured by:

A. a beta of 1.0.
B. a beta of 0.0.

C. a standard deviation of 1.0.

D. a standard deviation of 0.0.

E. a variance of 1.0.

21. The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has
3 percent less systematic risk than the market and has an actual return of 12 percent. This stock:

A. is underpriced.

B. is correctly priced.

C. will plot below the security market line.

D. will plot on the security market line.

E. will plot to the right of the overall market on a security market line graph.

22. Which one of the following will be constant for all securities if the market is efficient and securities
are priced fairly?

A. variance

B. standard deviation

C. reward-to-risk ratio

D. beta

E. risk premium

23. Which one of the following should earn the most risk premium based on CAPM?

A. diversified portfolio with returns similar to the overall market

B. stock with a beta of 1.38

C. stock with a beta of 0.74

D. U.S. Treasury bill

E. portfolio with a beta of 1.01

CHAPTER 14 : WACC

1. A group of individuals got together and purchased all of the outstanding shares of common stock of
DL Smith, Inc. What is the return that these individuals require on this investment called?

A. dividend yield

B. cost of equity

C. capital gains yield

D. cost of capital

E. income return

2. You borrow money at a rate of 13.5 percent. This interest rate is referred to as the:

A. compound rate.

B. current yield.

C. cost of debt.

D. capital gains yield.

E. cost of capital.

3. The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's
capital structure is called the:

A. reward to risk ratio.

B. weighted capital gains rate.

C. structured cost of capital.

D. subjective cost of capital.

E. weighted average cost of capital.

4. A firm's cost of capital:

A. will decrease as the risk level of the firm increases.

B. for a specific project is primarily dependent upon the source of the funds used for the project.

C. is independent of the firm's capital structure.

D. should be applied as the discount rate for any project considered by the firm.
E. depends upon how the funds raised are going to be spent.

5. The weighted average cost of capital for a wholesaler:

A. is equivalent to the aftertax cost of the firm's liabilities.

B. should be used as the required return when analyzing a potential acquisition of a retail outlet.

C. is the return investors require on the total assets of the firm.

D. remains constant when the debt-equity ratio changes.

E. is unaffected by changes in corporate tax rates.

6. Which one of the following is the primary determinant of a firm's cost of capital?

A. debt-equity ratio

B. applicable tax rate

C. cost of equity

D. cost of debt

E. use of the funds

7. All else constant, which one of the following will increase a firm's cost of equity if the firm computes
that cost using the security market line approach? Assume the firm currently pays an annual dividend of
$1 a share and has a beta of 1.2.

A. a reduction in the dividend amount

B. an increase in the dividend amount

C. a reduction in the market rate of return

D. a reduction in the firm's beta

E. a reduction in the risk-free rate

8. A firm's overall cost of equity is:

A. is generally less that the firm's WACC given a leveraged firm.

B. unaffected by changes in the market risk premium.

C. highly dependent upon the growth rate and risk level of the firm.
D. generally less than the firm's aftertax cost of debt.

E. inversely related to changes in the firm's tax rate.

9. The cost of equity for a firm:

A. tends to remain static for firms with increasing levels of risk.

B. increases as the unsystematic risk of the firm increases.

C. ignores the firm's risks when that cost is based on the dividend growth model.

D. equals the risk-free rate plus the market risk premium.

E. equals the firm's pretax weighted average cost of capital.

10. The pre-tax cost of debt:

A. is based on the current yield to maturity of the firm's outstanding bonds.

B. is equal to the coupon rate on the latest bonds issued by a firm.

C. is equivalent to the average current yield on all of a firm's outstanding bonds.

D. is based on the original yield to maturity on the latest bonds issued by a firm.

E. has to be estimated as it cannot be directly observed in the market.

11. The cost of preferred stock is computed the same as the:

A. pre-tax cost of debt.

B. return on an annuity.

C. aftertax cost of debt.

D. return on a perpetuity.

E. cost of an irregular growth common stock.

12. The cost of preferred stock:

A. is equal to the dividend yield.

B. is equal to the yield to maturity.

C. is highly dependent on the dividend growth rate.

D. is independent of the stock's price.

E. decreases when tax rates increase.

13. The capital structure weights used in computing the weighted average cost of capital:

A. are based on the book values of total debt and total equity.

B. are based on the market value of the firm's debt and equity securities.

C. are computed using the book value of the long-term debt and the book value of equity.

D. remain constant over time unless the firm issues new securities.

E. are restricted to the firm's debt and common stock.

14. The aftertax cost of debt:

A. varies inversely to changes in market interest rates.

B. will generally exceed the cost of equity if the relevant tax rate is zero.

C. will generally equal the cost of preferred if the tax rate is zero.

D. is unaffected by changes in the market rate of interest.

E. has a greater effect on a firm's cost of capital when the debt-equity ratio increases.

15. Which one of the following statements is correct for a firm that uses debt in its capital structure?

A. The WACC should decrease as the firm's debt-equity ratio increases.

B. When computing the WACC, the weight assigned to the preferred stock is based on the coupon
rate multiplied by the par value of the preferred.

C. The firm's WACC will decrease as the corporate tax rate decreases.

D. The weight of the common stock used in the computation of the WACC is based on the number
of shares outstanding multiplied by the book value per share.

E. The WACC will remain constant unless a firm retires some of its debt.

16. The flotation cost for a firm is computed as:

A. the arithmetic average of the flotation costs of both debt and equity.

B. the weighted average of the flotation costs associated with each form of financing.

C. the geometric average of the flotation costs associated with each form of financing.
D. one-half of the flotation cost of debt plus one-half of the flotation cost of equity.

E. a weighted average based on the book values of the firm's debt and equity.

17. Incorporating flotation costs into the analysis of a project will:

A. cause the project to be improperly evaluated.

B. increase the net present value of the project.

C. increase the project's rate of return.

D. increase the initial cash outflow of the project.

E. have no effect on the present value of the project.

18. Which one of the following statements is correct?

a. The pure play method is most frequently used for projects involving the expansion of a
firm's current operations.
b. Firms should accept low risk projects prior to funding high risk projects.
c. Firms that elect to use the pure play method for determining a discount rate for a project
cannot subjectively adjust the pure play rate.
d. Making subjective adjustments to a firm's WACC when determining project discount rates
unfairly punishes low-risk divisions within a firm.
e. A project that is unacceptable today might be acceptable tomorrow given a change in
market returns
CHAPTER 11 : OPERATING LEVERAGE

1. Scenario analysis is defined as the:

A. determination of the initial cash outlay required to implement a project.

B. determination of changes in NPV estimates when what-if questions are posed.

C. isolation of the effect that a single variable has on the NPV of a project.

D. separation of a project's sunk costs from its opportunity costs.

2. An analysis of the change in a project's NPV when a single variable is changed is called _____ analysis.

A. forecasting

B. scenario

C. sensitivity

D. simulation

E. break-even

3. Variable costs can be defined as the costs that:

A. remain constant for all time periods.

B. remain constant over the short run.

C. vary directly with sales.

D. are classified as non-cash expenses.

E. are inversely related to the number of units sold.

4. Fixed costs:

A. change as a small quantity of output produced changes.

B. are constant over the short-run regardless of the quantity of output produced.

C. are defined as the change in total costs when one more unit of output is produced.

D. are subtracted from sales to compute the contribution margin.

E. can be ignored in scenario analysis since they are constant over the life of a project.

5. The change in revenue that occurs when one more unit of output is sold is referred to as:
A. marginal revenue.

B. average revenue.

C. total revenue.

D. erosion.

E. scenario revenue.

6. The change in variable costs that occurs when production is increased by one unit is referred to as
the:

A. marginal cost.

B. average cost.

C. total cost.

D. scenario cost.

E. net cost.

7. By definition, which one of the following must equal zero at the accounting break-even point?

A. net present value

B. internal rate of return

C. contribution margin

D. net income

E. operating cash flow

8. By definition, which one of the following must equal zero at the cash break-even point?

A. net present value

B. internal rate of return

C. contribution margin

D. net income

E. operating cash flow

9. Which one of the following is defined as the sales level that corresponds to a zero NPV?
A. accounting break-even

B. leveraged break-even

C. marginal break-even

D. cash break-even

E. financial break-even

10. Operating leverage is the degree of dependence a firm places on its:

A. variable costs.

B. fixed costs.

C. sales.

D. operating cash flows.

E. net working capital.

11. Which one of the following is the relationship between the percentage change in operating cash flow
and the percentage change in quantity sold?

A. degree of sensitivity

B. degree of operating leverage

C. accounting break-even

D. cash break-even

E. contribution margin

12. Bell Weather Goods has several proposed independent projects that have positive NPVs. However,
the firm cannot initiate any of the projects due to a lack of financing. This situation is referred to as:

A. financial rejection.

B. project rejection.

C. soft rationing.

D. marginal rationing.

E. capital rationing.

capital rationing The situation that exists if a firm has positive NPV projects but cannot find the
necessary financing.
soft rationing The situation that occurs when units in a business are allocated a certain amount of
financing for capital budgeting

hard rationing The situation that occurs when a business cannot raise financing for a project under any
circumstances

13. The procedure of allocating a fixed amount of funds for capital spending to each business unit is
called:

A. marginal spending.

B. capital preservation.

C. soft rationing.

D. hard rationing.

E. marginal rationing.

14. PC Enterprises wants to commence a new project but is unable to obtain the financing under any
circumstances. This firm is facing:

A. financial deferral.

B. financial allocation.

C. capital allocation.

D. marginal rationing.

E. hard rationing.

scenario analysis The determination of what happens to NPV estimates when we ask what-if questions.

sensitivity analysis Investigation of what happens to NPV when only one variable is changed.

15. Which one of the following will be used in the computation of the best-case analysis of a proposed
project?

A. minimal number of units that are expected to be produced and sold

B. the lowest expected salvage value that can be obtained for a project's fixed assets

C. the most anticipated sales price per unit

D. the lowest variable cost per unit that can reasonably be expected

E. the highest level of fixed costs that is actually anticipated

16. When you assign the lowest anticipated sales price and the highest anticipated costs to a project, you
are analyzing the project under the condition known as:
A. best case sensitivity analysis.

B. worst case sensitivity analysis.

C. best case scenario analysis.

D. worst case scenario analysis.

E. base case scenario analysis.

17. Which one of the following statements concerning scenario analysis is correct?

A. The pessimistic case scenario determines the maximum loss, in current dollars, that a firm could
possibly incur from a given project.

B. Scenario analysis defines the entire range of results that could be realized from a proposed
investment project.

C. Scenario analysis determines which variable has the greatest impact on a project's final
outcome.

D. Scenario analysis helps managers analyze various outcomes that are possible given reasonable
ranges for each of the assumptions.

E. Management is guaranteed a positive outcome for a project when the worst case scenario
produces a positive NPV.

18. Sensitivity analysis is based on:

A. varying a single variable and measuring the resulting change in the NPV of a project.

B. applying differing discount rates to a project's cash flows and measuring the effect on the NPV.

C. expanding and contracting the number of years for a project to determine the optimal project
length.

D. the best, worst, and most expected situations.

E. various states of the economy and the probability of each state occurring.

19. Which one of the following statements concerning variable costs is correct?

A. Variable costs minus fixed costs equal marginal costs.

B. Variable costs are equal to fixed costs when production is equal to zero.

C. An increase in variable costs increases the operating cash flow.

D. Variable costs are inversely related to fixed costs.

E. Variable costs per unit are inversely related to the contribution margin per unit.

20. The contribution margin per unit is equal to the:

A. sales price per unit minus the total costs per unit.

B. variable cost per unit minus the fixed cost per unit.

C. sales price per unit minus the variable cost per unit.

D. pre-tax profit per unit.

E. aftertax profit per unit.

21. You are considering a project that you believe is quite risky. To reduce any potentially harmful results
from accepting this project, you could:

A. lower the degree of operating leverage.

B. lower the contribution margin per unit.

C. increase the initial cash outlay.

D. increase the fixed costs per unit while lowering the contribution margin per unit.

E. lower the operating cash flow of the project.

22. Which one of the following characteristics best describes a project that has a low degree of operating
leverage?

A. high variable costs relative to the fixed costs

B. relatively high initial cash outlay

C. an OCF that is highly sensitive to the sales quantity

D. high level of forecasting risk

E. a high depreciation expense

23. Which of the following variables will be at their highest expected level under a worst case scenario?

I. fixed cost
II. sales price
III. variable cost
IV. sales quantity

A. I only

B. III only

C. II and III only

D. I and III only

E. I, III, and IV only

CHAPTER 16 : FINANCIAL LEVERAGE

1. Homemade leverage is:

A. the incurrence of debt by a corporation in order to pay dividends to shareholders.

B. the exclusive use of debt to fund a corporate expansion project.

C. the borrowing or lending of money by individual shareholders as a means of adjusting their level
of financial leverage.

D. best defined as an increase in a firm's debt-equity ratio.

E. the term used to describe the capital structure of a levered firm.

2. Which one of the following states that the value of a firm is unrelated to the firm's capital structure?

A. Capital Asset Pricing Model

B. M & M Proposition I

C. M & M Proposition II

D. Law of One Price

E. Efficient Markets Hypothesis

3. Which one of the following states that a firm's cost of equity capital is directly and proportionally
related to the firm's capital structure?

A. Capital Asset Pricing Model

B. M & M Proposition I

C. M & M Proposition II

D. Law of One Price

E. Efficient Markets Hypothesis

4. Which one of the following is the equity risk that is most related to the daily operations of a firm?

A. market risk

B. systematic risk

C. extrinsic risk

D. business risk
E. financial risk

5. Which one of the following is the equity risk related to a firm's capital structure policy?

A. market

B. systematic

C. extrinsic

D. business

E. financial

6. Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by $1,000. Which of
the following terms is used to describe this tax savings?

A. interest tax shield

B. interest credit

C. financing shield

D. current tax yield

E. tax-loss interest

7. The unlevered cost of capital refers to the cost of capital for a(n):

A. private entity.

B. all-equity firm.

C. governmental entity.

D. private individual.

E. corporate shareholder.

8. A firm should select the capital structure that:

A. produces the highest cost of capital.

B. maximizes the value of the firm.

C. minimizes taxes.

D. is fully unlevered.
E. equates the value of debt with the value of equity.

9. The value of a firm is maximized when the:

A. cost of equity is maximized.

B. tax rate is zero.

C. levered cost of capital is maximized.

D. weighted average cost of capital is minimized.

E. debt-equity ratio is minimized.

10. AA Tours is comparing two capital structures to determine how to best finance its operations. The
first option consists of all equity financing. The second option is based on a debt-equity ratio of 0.45.
What should AA Tours do if its expected earnings before interest and taxes (EBIT) are less than the break-
even level? Assume there are no taxes.

A. select the leverage option because the debt-equity ratio is less than 0.50

B. select the leverage option since the expected EBIT is less than the break-even level

C. select the unlevered option since the debt-equity ratio is less than 0.50

D. select the unlevered option since the expected EBIT is less than the break-even level

E. cannot be determined from the information provided

11. You have computed the break-even point between a levered and an unlevered capital structure.
Assume there are no taxes. At the break-even level, the:

A. firm is just earning enough to pay for the cost of the debt.

B. firm's earnings before interest and taxes are equal to zero.

C. earnings per share for the levered option are exactly double those of the unlevered option.

D. advantages of leverage exceed the disadvantages of leverage.

E. firm has a debt-equity ratio of .50.

12. Which one of the following statements is correct concerning the relationship between a levered and
an unlevered capital structure? Assume there are no taxes.

A. At the break-even point, there is no advantage to debt.

B. The earnings per share will equal zero when EBIT is zero for a levered firm.

C. The advantages of leverage are inversely related to the level of EBIT.

D. The use of leverage at any level of EBIT increases the EPS.

E. EPS are more sensitive to changes in EBIT when a firm is unlevered.

13. Jessica invested in Quantro stock when the firm was unlevered. Since then, Quantro has changed its
capital structure and now has a debt-equity ratio of 0.30. To unlever her position, Jessica needs to:

A. borrow some money and purchase additional shares of Quantro stock.

B. maintain her current equity position as the debt of the firm did not affect her personally.

C. sell some shares of Quantro stock and hold the proceeds in cash.

D. sell some shares of Quantro stock and loan out the sale proceeds.

E. create a personal debt-equity ratio of 0.30.

14. Which one of the following makes the capital structure of a firm irrelevant?

A. taxes

B. interest tax shield

C. 100 percent dividend payout ratio

D. debt-equity ratio that is greater than 0 but less than 1

E. homemade leverage

15. M & M Proposition I with no tax supports the argument that:

A. business risk determines the return on assets.

B. the cost of equity rises as leverage rises.

C. the debt-equity ratio of a firm is completely irrelevant.

D. a firm should borrow money to the point where the tax benefit from debt is equal to the cost of
the increased probability of financial distress.

E. homemade leverage is irrelevant.

16. The business risk of a firm:

A. depends on the firm's level of unsystematic risk.

B. is inversely related to the required return on the firm's assets.

C. is dependent upon the relative weights of the debt and equity used to finance the firm.

D. has a positive relationship with the firm's cost of equity.

E. has no relationship with the required return on a firm's assets according to M & M Proposition II.

17. M & M Proposition I with tax supports the theory that:

A. a firm's weighted average cost of capital decreases as the firm's debt-equity ratio increases.

B. the value of a firm is inversely related to the amount of leverage used by the firm.

C. the value of an unlevered firm is equal to the value of a levered firm plus the value of the
interest tax shield.

D. a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm.

E. a firm's cost of equity increases as the debt-equity ratio of the firm decreases.

18. M & M Proposition I with taxes is based on the concept that:

A. the optimal capital structure is the one that is totally financed with equity.

B. the capital structure of a firm does not matter because investors can use homemade leverage.

C. a firm's WACC is unaffected by a change in the firm's capital structure.

D. the value of a firm increases as the firm's debt increases because of the interest tax shield.

E. the cost of equity increases as the debt-equity ratio of a firm increases.

19. Based on M & M Proposition II with taxes, the weighted average cost of capital:

A. is equal to the aftertax cost of debt.

B. has a linear relationship with the cost of equity capital.

C. is unaffected by the tax rate.

D. decreases as the debt-equity ratio increases.

E. is equal to Ru × (1 - Tc).