Question 1

Your firm has a debt-equity ratio of.60. Your cost of equity is 11% and your after-tax cost of debt is 7%. What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

Accepted Answer

A)   9.50%
B)   10.50%
C)   11.00%
D)   11.25%
E)   12.00%F) B) and D)
G) B) and C)

Question 2

It has been observed that, when firms get into financial trouble, they often find it difficult to attract and retain high-quality employees. The additional costs incurred in this situation would be considered direct bankruptcy costs.

Accepted Answer

A) True 
 B)False

Question 3

A firm has a debt-equity ratio of.40, a WACC of 16%, and a yield-to-maturity on its debt of 13%. Ignoring taxes, what is the cost of equity?

Accepted Answer

A)   7.8%
B)   9.6%
C)   11.8%
D)   15.2%
E)   17.2%F) B) and C)
G) C) and E)

Question 4

When taxes are factored in, debt financing lowers a firm's weighted average cost of capital.

Accepted Answer

A) True 
 B)False

Question 5

Using a graph of firm value against total debt, explain how M&M Proposition I with taxes differs from the static theory of capital structure.

Accepted Answer

Students should duplicate the graph in F...

Question 6

M&M Proposition II is the proposition that:

Accepted Answer

A)   The value of a firm is independent of the firm's capital structure.
B)   States the value of a firm is dependent upon the interest tax shield.
C)   The levered value of a firm is equal to the unlevered value plus the interest tax shield.
D)   A firm's cost of equity capital is a positive linear function of the firm's capital structure.
E)   The levered value of a firm is equal to the unlevered value plus the present value of the interest tax shield.F) A) and D)
G) A) and C)

Question 7

Which of the following is NOT true about bankruptcy and its costs?

Accepted Answer

A)   As the debt/equity ratio falls, the probability that a firm will be able to meet the promised payments on bonds decreases.
B)   If a firm is economically bankrupt, then an ensuing legal bankruptcy will likely result in the bondholders receiving less than what they are owed.
C)   The amount of debt a firm can raise decreases as the probability of bankruptcy increases.
D)   A firm is economically bankrupt when the value of its assets is less than the value of its debt.
E)   Direct bankruptcy costs are a disincentive to debt financing.F) None of the above
G) A) and D)

Question 8

M&M Proposition II with no tax states that a firm's cost of equity is dependent upon the required rate of return on the firm's assets.

Accepted Answer

A) True 
 B)False

Question 9

According to M&M Proposition I with taxes, the interest tax shield:

Accepted Answer

A)   Affects the net earnings, but not the value of a firm.
B)   Increases the pre-tax rate of return on debt.
C)   Increases the value of a firm.
D)   Lowers the firm's cost of equity.
E)   Increases the firm's weighted average cost of capital.F) C) and D)
G) B) and E)

Question 10

Which of the following is the best definition of interest tax shield?

Accepted Answer

A)   The tax saving attained by a firm from interest expense.
B)   Termination of the firm as a going concern.
C)   The value of the firm is independent of its capital structure.
D)   A firm's cost of equity capital is a positive linear function of its capital structure.
E)   Financial restructuring of a failing firm to attempt to continue operations as a going concern.F) None of the above
G) A) and B)

Question 11

When a firm is operating with the optimal capital structure, the increased benefit from additional debt is equal to the increased bankruptcy costs of that debt.

Accepted Answer

A) True 
 B)False

Question 12

Gail's Dance Studio is currently an all equity firm that has 80,000 shares of stock outstanding with a market price of $42 a share. The current cost of equity is 12% and the tax rate is 34%. Gail is considering adding $1 million of debt with a coupon rate of 8% to her capital structure. The debt will be sold at par value. What is the levered value of the equity?

Accepted Answer

A)   $2.4 million
B)   $2.7 million
C)   $3.3 million
D)   $3.7 million
E)   $3.9 millionF) B) and C)
G) A) and C)

Question 13

In a world of corporate taxes only, show that the WACC can be written as WACC = RU * [1 - TC *(D/V)].

Accepted Answer

The student will need to use the M&M pro...

Question 14

Jensen Boat Works is an all equity firm that has 340,000 shares of stock outstanding. The company is in the process of borrowing $4 million at 8% interest to repurchase 80,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes?

Accepted Answer

A)   $15.8 million
B)   $16.4 million
C)   $17.0 million
D)   $17.5 million
E)   $18.1 millionF) C) and D)
G) A) and B)

Question 15

Provide a definition of liquidation.

Accepted Answer

Termination of the firm as a going concern.

Question 16

Calculate the company's cost of equity given the following information: return on assets 10.5%; return on debt 8.75%; total debt $995,000; total equity $1,520,000. Tax rate 40%.

Accepted Answer

A)   11.19%
B)   12.29%
C)   13.39%
D)   14.49%
E)   15.59%F) B) and D)
G) C) and E)

Question 17

The Brassy Co. has expected EBIT of $910, debt with a face and market value of $2,000 paying an 8.5% annual coupon, and an unlevered cost of capital of 12%. If the tax rate is 34%, what is the value of the Brassy's equity?

Accepted Answer

A)   $3,258
B)   $3,685
C)   $5,685
D)   $6,325
E)   $7,005F) A) and B)
G) B) and D) B

Question 18

A Mississauga firm has debt of $18,000, equity of $42,000, a cost of debt of 7.5%, a cost of equity of 11.6%, and a tax rate of 34%. What is the firm's weighted average cost of capital?

Accepted Answer

A)   9.03%
B)   9.11%
C)   9.38%
D)   9.46%
E)   9.61%F) B) and C)
G) A) and D)

Question 19

Prescription Express has a debt-equity ratio of.70. The pre-tax cost of debt is 8.5% while the unlevered cost of capital is 15%. What is the cost of equity if the tax rate is 35%?

Accepted Answer

A)   13.79%
B)   14.28%
C)   17.96%
D)   18.40%
E)   18.87%F) C) and D)
G) All of the above

Question 20

Which one of the following statements concerning financial leverage is correct in a world without taxes?

Accepted Answer

A)   Leverage is beneficial only when EBIT is relatively low.
B)   EPS is decreased when leverage is used and the expected level of EBIT is achieved.
C)   Financial leverage lowers the risk level of a firm.
D)   The amount of financial leverage employed has a major effect on the value of the firm.
E)   M&M Proposition I states that financial leverage is irrelevant to the value of a firm.F) A) and C)
G) A) and E) E

Exam 16: Financial Leverage and Capital Structure Policy

Your firm has a debt-equity ratio of.60. Your cost of equity is 11% and your after-tax cost of debt is 7%. What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

Correct Answer
verified

It has been observed that, when firms get into financial trouble, they often find it difficult to attract and retain high-quality employees. The additional costs incurred in this situation would be considered direct bankruptcy costs.

Correct Answer
verified

A firm has a debt-equity ratio of.40, a WACC of 16%, and a yield-to-maturity on its debt of 13%. Ignoring taxes, what is the cost of equity?

Correct Answer
verified

When taxes are factored in, debt financing lowers a firm's weighted average cost of capital.

Correct Answer
verified

Using a graph of firm value against total debt, explain how M&M Proposition I with taxes differs from the static theory of capital structure.

Correct Answer
verified
Students should duplicate the graph in F...
View Answer

M&M Proposition II is the proposition that:

Correct Answer
verified

Which of the following is NOT true about bankruptcy and its costs?

Correct Answer
verified

M&M Proposition II with no tax states that a firm's cost of equity is dependent upon the required rate of return on the firm's assets.

Correct Answer
verified

According to M&M Proposition I with taxes, the interest tax shield:

Correct Answer
verified

Which of the following is the best definition of interest tax shield?

Correct Answer
verified

When a firm is operating with the optimal capital structure, the increased benefit from additional debt is equal to the increased bankruptcy costs of that debt.

Correct Answer
verified

Correct Answer
verified

In a world of corporate taxes only, show that the WACC can be written as WACC = RU * [1 - TC *(D/V)].

Correct Answer
verified
The student will need to use the M&M pro...
View Answer

Jensen Boat Works is an all equity firm that has 340,000 shares of stock outstanding. The company is in the process of borrowing $4 million at 8% interest to repurchase 80,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes?

Correct Answer
verified

Provide a definition of liquidation.

Correct Answer
verified
Termination of the firm as a going concern.

Calculate the company's cost of equity given the following information: return on assets 10.5%; return on debt 8.75%; total debt $995,000; total equity $1,520,000. Tax rate 40%.

Correct Answer
verified

The Brassy Co. has expected EBIT of $910, debt with a face and market value of $2,000 paying an 8.5% annual coupon, and an unlevered cost of capital of 12%. If the tax rate is 34%, what is the value of the Brassy's equity?

Correct Answer
verified
B

A Mississauga firm has debt of $18,000, equity of $42,000, a cost of debt of 7.5%, a cost of equity of 11.6%, and a tax rate of 34%. What is the firm's weighted average cost of capital?

Correct Answer
verified

Prescription Express has a debt-equity ratio of.70. The pre-tax cost of debt is 8.5% while the unlevered cost of capital is 15%. What is the cost of equity if the tax rate is 35%?

Correct Answer
verified

Which one of the following statements concerning financial leverage is correct in a world without taxes?

Correct Answer
verified
E

Exam 16: Financial Leverage and Capital Structure Policy

Your firm has a debt-equity ratio of.60. Your cost of equity is 11% and your after-tax cost of debt is 7%. What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

Correct AnswerverifiedShow Answer

It has been observed that, when firms get into financial trouble, they often find it difficult to attract and retain high-quality employees. The additional costs incurred in this situation would be considered direct bankruptcy costs.

Correct AnswerverifiedShow Answer

A firm has a debt-equity ratio of.40, a WACC of 16%, and a yield-to-maturity on its debt of 13%. Ignoring taxes, what is the cost of equity?

Correct AnswerverifiedShow Answer

When taxes are factored in, debt financing lowers a firm's weighted average cost of capital.

Correct AnswerverifiedShow Answer

Using a graph of firm value against total debt, explain how M&M Proposition I with taxes differs from the static theory of capital structure.

Correct AnswerverifiedStudents should duplicate the graph in F...View AnswerShow Answer

M&M Proposition II is the proposition that:

Correct AnswerverifiedShow Answer

Which of the following is NOT true about bankruptcy and its costs?

Correct AnswerverifiedShow Answer

M&M Proposition II with no tax states that a firm's cost of equity is dependent upon the required rate of return on the firm's assets.

Correct AnswerverifiedShow Answer

According to M&M Proposition I with taxes, the interest tax shield:

Correct AnswerverifiedShow Answer

Which of the following is the best definition of interest tax shield?

Correct AnswerverifiedShow Answer

When a firm is operating with the optimal capital structure, the increased benefit from additional debt is equal to the increased bankruptcy costs of that debt.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

In a world of corporate taxes only, show that the WACC can be written as WACC = RU * [1 - TC *(D/V)].

Correct AnswerverifiedThe student will need to use the M&M pro...View AnswerShow Answer

Jensen Boat Works is an all equity firm that has 340,000 shares of stock outstanding. The company is in the process of borrowing $4 million at 8% interest to repurchase 80,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes?

Correct AnswerverifiedShow Answer

Provide a definition of liquidation.

Correct AnswerverifiedTermination of the firm as a going concern.

Calculate the company's cost of equity given the following information: return on assets 10.5%; return on debt 8.75%; total debt $995,000; total equity $1,520,000. Tax rate 40%.

Correct AnswerverifiedShow Answer

The Brassy Co. has expected EBIT of $910, debt with a face and market value of $2,000 paying an 8.5% annual coupon, and an unlevered cost of capital of 12%. If the tax rate is 34%, what is the value of the Brassy's equity?

Correct AnswerverifiedB

A Mississauga firm has debt of $18,000, equity of $42,000, a cost of debt of 7.5%, a cost of equity of 11.6%, and a tax rate of 34%. What is the firm's weighted average cost of capital?

Correct AnswerverifiedShow Answer

Prescription Express has a debt-equity ratio of.70. The pre-tax cost of debt is 8.5% while the unlevered cost of capital is 15%. What is the cost of equity if the tax rate is 35%?

Correct AnswerverifiedShow Answer

Which one of the following statements concerning financial leverage is correct in a world without taxes?

Correct AnswerverifiedE

Correct Answer
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Students should duplicate the graph in F...
View Answer

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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The student will need to use the M&M pro...
View Answer

Correct Answer
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Correct Answer
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Termination of the firm as a going concern.

Correct Answer
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Correct Answer
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B

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Correct Answer
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Correct Answer
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E