question 1:

Which statement about capital structure is the most correct?

a.

Because the cost of debt is cheaper than the cost of equity, a company should use as much debt as possible to finance their projects

b.

The more the company borrows, the higher will be its tax shields, creating higher after-tax cash flows for distribution to lenders and shareholders.

c.

The more the company borrows, the lower will be the after-tax WACC. This increases the present value of the firm free cash flows which represents the value of the levered firm. Therefore, a firm should always seek to borrow as much debt as possible.

d.

Lenders rank ahead of shareholders when the company goes bankrupt. This increased risk for shareholders means the cost of equity is lower than the cost of debt.

e.

A company should always try to reduce its debt because of the high bankruptcy risk associated with debt. A company should aim to have 100% equity financing if it is possible.

Question 2:

Which of the following would reduce a firm's WACC before tax?

a.

A pharmaceutical research company develops a 100% effective COVID vaccine, which reduces its systematic risk in the market.

b.

A firm invests in an average-risk project using debt, rather than equity financing.

c.

A firm issues shares and uses the proceeds to pay off a bank loan.

d.

A firm issues bonds and uses the proceeds to repurchase stock.

e.

A supermarket chain decides to establish hardware stores which increases its sensitivity to market fluctuations.