Question1: Ridgefield Enterprises has total assets of 300 million dollar. The company currently has no debt in its capital structure. The company basic earning power is 15%. The company is contemplating a recapitalization where it will issue debt at 10% & use the proceeds to buy back shares of the company common stock. If the company proceeds with the recapitalization, its operating income, total assets, and tax rate will remain the same. Determine which of the following will occur as a result of the recapitalization?
[A] The company's ROA will decline.
[B] The company's ROE will increase.
[C] The company's basic earning power will decline.
[D] Answers A and B are correct.
[E] All of the above answers are correct.
Question2: The big contribution of the Miller model is that it demonstrates that
[A] Financial distress and agency costs reduce the value of corporate debt.
[B] Equity costs increase with financial leverage.
[C] Personal taxes increase the value of corporate debt.
[D] Personal taxes decrease the value of corporate debt.
[E] Debt costs increase with financial leverage.
Question3: Which of the following statements concerning the MM extension with growth is false?
[A] 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.
[B] For a given D/S, the WACC is greater than the WACC under MM's original (with tax) assumptions.
[C] The tax shields should be discounted at the cost of debt.
[D] The value of a growing tax shield is greater than the value of a constant tax shield.
[E] The total value of the firm increases with the amount of debt.