6.8 Review Questions: Chapter Six

1. Express the notion of “Homemade Leverage” in words.

2. How, if at all, does the theory of Homemade Leverage affect overall firm valuation?

3. An investor may use Homemade Leverage to either leverage up a low-leveraged firm, or to de-leverage a highly-leveraged firm. Explain how he may do either or both.

4. Explain the notion of the “Leveraged Beta.” In the course of doing so, reference Return-on-Assets.

5. You are given here Modigliani and Miller’s basic formula for firm valuation. Explain what each element means and from whence it comes. V = D + E = EBIT ÷ r. Why is this an equality?

6. Define separately Business- and Financial-Risks. What are the key variables to each?

7. In summary, how does a firm’s capital structure interact with its overall valuation – according to M & M? How does the leverage ratio inter-act with the valuation of each of its individual capital components?

8. What do you make of all this M & M stuff?