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Which of the following statements is false?

a. Leverage decreases the risk of the equity of a firm.

b. Because the cash flows of the debt and equity sum to the cash flows of the project, by the Law of One Price the combined values of debt and equity must be equal to the cash flows of the project.

c. Franco Modigliani and Merton Miller argued that with perfect capital markets, the total value of a firm should not depend on its capital structure.

d. It is inappropriate to discount the cash flows of levered equity at the same discount rate that we use for unlevered equity.

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Joshua Stredder
Joshua StredderLv10
15 Jan 2021
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Using the following information, write a one page narrative of what is found in the information below:

Please include answers to these two questions in the narrative.

Which firm would have the higher expected return between the unlevered equity holder and the levered equity holder? (show all the team calculations in arriving at the final answer).

2. How does the risk and cost of capital of levered equity compare to that of unlevered equity? Which is the superior capital structure choice for a perfect capital market, and why?

Expected CashFlow =.50(Weak Cash Flows)+.50(strong Cash Flows)
Expected CashFlow 103,500.00
NPV $ 9,224.14 =-B6+(B2/(1+B7+B8))
The investment has a positive NPV
PV $ 89,224.14 =+B2/(1+B9)
Cash Flow-weak economy 90,000.00
Cash Flow-strong economy 117,000.00
Initial Investment 80,000.00
Cost of Capital 16.00%
Risk-free Rate 5.00%
Cash Flows and Returns for Unlevered Equity
Date 1: Cash Flow Date 1: Return
Strong Weak Strong Weak
NPV $ 9,224.14
PV $ 89,224.14 117,000.00 90,000.00 31.13% 0.87%
Values & Cash Flows for Debt & Equity of the Levered Firm (Table 14.3)
Date 0 Date 1: Cash Flow
Initial Value Strong Economy Weak Economy
Debt 45,000 47,250 47,250
Levered equity 69,750 42,750
Firm 89,224 117,000 90,000
Returns to Equity with and without Leverage (Table 14.4)
Date 0 Date 1: Cash Flow Date 1: Returns
Initial Value Strong Economy Weak Economy Strong Economy Weak Economy Expected Return
Debt 45,000 47,250 47,250 5.00% 5.00% 5.00%
Levered Equity 44,224 69,750 42,750 57.72% -3.33% 27.19%
Unlevered equity 89,224 117,000 90,000 31.13% 0.87% 16.00%
Systematic Risk and Risk Premiums for Debt, Unlevered Equity, and Levered Equity (Table 14.5)
Return Sensitivity (Systematic Risk) Risk Premium
Debt 0.00% 0.00%
Levered Equity 61.05% 0.00% 11.00%
Unlevered Equity 30.26% -15.13% 22.19%

Consider a project with a free cash flows in one year of 149,546or 179,003, with each of outcome being equally likely, the initialinvestment required for the project is 93,227 and the project'scost of capital is 17%, the risk-free interest rate is 7%. e fundsf

A) What is the NVP of this project

B) Suppose that to raise the funds for the initial investmentthe project is sold to investors as an all-equity firm. The equityholders will receive the cash flows of the project in one year. Howmuch money can be raised in this way-that is the initial marketvalue of the unlevered equity,

C) Suppose the initial 93,227 is instead raised by borrowing atthe risk-free interest rate. What are the cash flows of the leveredequity, what is its initial value and what is the equity accordingto MM.

Debt Initial value cash flow Strong Economy

93,227 cash flow weak economy

levered equity

1. Which capital structure theory recognizes the fact that investors and managers do not have the same information regarding a firm’s prospects?

2. The capital structure that maximizes the stock price is also the one that the___________ WACC.

3. In Modigliani & Miller’s Proposition I with taxes the value of a levered firm is equal to the value of an unlevered firm plus____________ .

4. In Modigliani & Miller without taxes, what is the optimal debt to equity ratio?

5. The trade-off theory of capital structure states that debt initially adds value. Explain why

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