F2 Q1-5

1.

The return on equity of a typical firm may change over time because of changes in business and economic conditions, but it is unlikely to change based on the financing or capital structure of the firm.

a. False.

b. True.

2.

Your firm has been plodding along without much attention from the stock market. Your boss insists that he can (a) increase the return on assets to shareholders by taking on more debt, and (b) attract new investors to the firm due to the higher returns.

a. False.

b. Partly true, partly false.

c. True.

3.

Even in a world with no frictions that is, taxes, costs of bankruptcy, asymmetric information debt will always be preferred because cost of debt is always lower than cost of equity for a firm.

a. True.

b. False.

c. Partly true, partly false.

4.

In a world with taxes and bankruptcy costs, and in which interest on debt is tax deductible, if a firm has some debt:

a. The return on equity is less than the weighted average cost of capital (WACC).

b. The return on equity is greater than the weighted average cost of capital (WACC).

c. The relationship between return on equity and the WACC cannot be determined because it depends on several factors.

5.

In the real world, where there are taxes and interest on debt is tax deductible, if two firms have the same cash flows as each other in all possible scenarios in the future, the returns on equity of the two firms will:

a. Will depend on the capital structures adopted by the firms.

b. Will depend on the capital structures adopted by the firms and the valuation method used.

c. Always be equal to each other.

d. Will depend on the method of valuation used.