Question 1

M&M Proposition I with taxes states that:

Accepted Answer

A) the optimal capital structure is the all-equity option. 
B) the levered value of a firm exceeds the firm's unlevered value. 
C) a firm's capital structure is irrelevant. 
D) the value of a firm is independent of taxes. 
E) WACC remains constant given any debt-equity ratio. 
A) the optimal capital structure is the all-equity option. 
B) the levered value of a firm exceeds the firm's unlevered value. 
C) a firm's capital structure is irrelevant. 
D) the value of a firm is independent of taxes. 
E) WACC remains constant given any debt-equity ratio. B

Question 2

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Accepted Answer

A) Strategic risk 
B) Financial risk 
C) Liquidity risk 
D) Industry risk 
E) Business risk 
A) Strategic risk 
B) Financial risk 
C) Liquidity risk 
D) Industry risk 
E) Business risk B

Question 3

Which one of the following states that a firm's cost of equity capital is a positive linear function of the firm's capital structure?

Accepted Answer

A) Static theory of capital structure 
B) M&M Proposition I without taxes 
C) M&M Proposition II without taxes 
D) Homemade leverage theory 
E) M&M Proposition I with taxes 
A) Static theory of capital structure 
B) M&M Proposition I without taxes 
C) M&M Proposition II without taxes 
D) Homemade leverage theory 
E) M&M Proposition I with taxes C

Question 4

Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt?

Accepted Answer

A) M&M Proposition I, with taxes 
B) M&M Proposition II, with taxes 
C) M&M Proposition I, without taxes 
D) Homemade leverage proposition 
E) Static theory of capital structure 
A) M&M Proposition I, with taxes 
B) M&M Proposition II, with taxes 
C) M&M Proposition I, without taxes 
D) Homemade leverage proposition 
E) Static theory of capital structure

Question 5

An all-equity firm has a return on assets of 17.5 percent.The firm is considering converting to a debt-equity ratio of .40.The pretax cost of debt is 7.5 percent.Ignoring taxes, what will the cost of equity be if the firm switches to the levered capital structure?

Accepted Answer

A) 21.95 percent 
B) 21.22 percent 
C) 22.54 percent 
D) 22.97 percent 
E) 21.50 percent 
A) 21.95 percent 
B) 21.22 percent 
C) 22.54 percent 
D) 22.97 percent 
E) 21.50 percent

Question 6

When is a firm insolvent from an accounting perspective?

Accepted Answer

A) When the firm is unable to meet its financial obligations in a timely manner 
B) When the firm's debt exceeds the value of the firm's equity 
C) When the firm has a negative net worth 
D) When the firm's revenues cease 
E) When the market value of the firm's equity equals zero 
A) When the firm is unable to meet its financial obligations in a timely manner 
B) When the firm's debt exceeds the value of the firm's equity 
C) When the firm has a negative net worth 
D) When the firm's revenues cease 
E) When the market value of the firm's equity equals zero

Question 7

Which one of the following best defines legal bankruptcy?

Accepted Answer

A) Negotiating new payment terms with a firm's creditors 
B) A temporary technical insolvency 
C) A legal proceeding for liquidating or reorganizing a business 
D) The internal process of revising the capital structure of a firm 
E) The failure of a firm to meet its financial obligations in a timely manner 
A) Negotiating new payment terms with a firm's creditors 
B) A temporary technical insolvency 
C) A legal proceeding for liquidating or reorganizing a business 
D) The internal process of revising the capital structure of a firm 
E) The failure of a firm to meet its financial obligations in a timely manner

Question 8

Triangle Enterprises has no debt but can borrow at 8 percent.The firm's WACC is currently 13.2 percent, and there is no corporate tax.If the firm converts to 30 percent debt, what will its cost of equity be?

Accepted Answer

A) 16.67 percent 
B) 12.95 percent 
C) 14.47 percent 
D) 16.39 percent 
E) 15.43 percent 
A) 16.67 percent 
B) 12.95 percent 
C) 14.47 percent 
D) 16.39 percent 
E) 15.43 percent

Question 9

Delta Mowers has a debt-equity ratio of .6.Its WACC is 11.8 percent, and its cost of debt is 7.7 percent.There is no corporate tax.What is the firm's cost of equity capital?

Accepted Answer

A) 12.60 percent 
B) 14.26 percent 
C) 13.83 percent 
D) 14.29 percent 
E) 14.80 percent 
A) 12.60 percent 
B) 14.26 percent 
C) 13.83 percent 
D) 14.29 percent 
E) 14.80 percent

Question 10

Peter's Tools recently defaulted on a bank loan.To avoid a bankruptcy proceeding, the bank agreed to a composition.This composition would do which one of the following?

Accepted Answer

A) Forgive the loan payment in its entirety 
B) Extend the due date on the missed loan payment 
C) Reduce the amount of the loan payments so Peter's can pay on time 
D) Transfer some of Peter's assets to the bank in lieu of the loan payment 
E) Transfer all the equity shares in Peter's to the lending bank 
A) Forgive the loan payment in its entirety 
B) Extend the due date on the missed loan payment 
C) Reduce the amount of the loan payments so Peter's can pay on time 
D) Transfer some of Peter's assets to the bank in lieu of the loan payment 
E) Transfer all the equity shares in Peter's to the lending bank

Question 11

A prepack:

Accepted Answer

A) guarantees full payment to all creditors but lengthens the time span of the debt. 
B) is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan. 
C) protects the interests of both the current creditors and the existing shareholders. 
D) applies only if a firm files under Chapter 7 of the bankruptcy code. 
E) extends the time that a firm is protected by the bankruptcy process. 
A) guarantees full payment to all creditors but lengthens the time span of the debt. 
B) is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan. 
C) protects the interests of both the current creditors and the existing shareholders. 
D) applies only if a firm files under Chapter 7 of the bankruptcy code. 
E) extends the time that a firm is protected by the bankruptcy process.

Question 12

Bruno's is considering changing from its current all-equity capital structure to 30 percent debt.There are currently 7,500 shares outstanding at a price per share of $39.EBIT is expected to remain constant at $23,000.The interest rate on new debt is 7.5 percent and there are no taxes.Tracie owns $12,675 worth of stock in the company.The firm has a 100 percent payout.What would Tracie's cash flow be under the new capital structure assuming that she keeps all of her shares?

Accepted Answer

A) $998 
B) $1,109 
C) $1,115 
D) $1,037 
E) $1,016 
A) $998 
B) $1,109 
C) $1,115 
D) $1,037 
E) $1,016

Question 13

Jones Inspection Services is an all-equity firm with a total market value of $1,245,000 and 25,000 shares of stock outstanding.Management is considering issuing $200,000 of debt at an interest rate of 6 percent and using the proceeds on a stock repurchase.As an all-equity firm, management believes its earnings before interest and taxes (EBIT) will be $210,000 if the economy is normal, $70,000 if it is in a recession, and $325,000 if the economy booms.Ignore taxes.What will the EPS be if the economy falls into a recession and the firm maintains its all-equity status?

Accepted Answer

A) $1.75 
B) $2.80 
C) $2.21 
D) $2.50 
E) $2.33 
A) $1.75 
B) $2.80 
C) $2.21 
D) $2.50 
E) $2.33

Question 14

Newborn Nursery has 12,000 bonds outstanding with a face value of $1,000 each.The coupon rate is 6.9 percent and the tax rate is 34 percent.What is the present value of the interest tax shield?

Accepted Answer

A) $4.14 million 
B) $4.86 million 
C) $3.87 million 
D) $3.92 million 
E) $4.08 million 
A) $4.14 million 
B) $4.86 million 
C) $3.87 million 
D) $3.92 million 
E) $4.08 million

Question 15

Which one of the following conditions exists at the point where a firm maximizes its value?

Accepted Answer

A) The tax benefit from an additional dollar of debt is zero. 
B) Financial distress costs are equal to zero. 
C) The debt-equity ratio is 1.0. 
D) WACC is minimized. 
E) The cost of equity is minimized. 
A) The tax benefit from an additional dollar of debt is zero. 
B) Financial distress costs are equal to zero. 
C) The debt-equity ratio is 1.0. 
D) WACC is minimized. 
E) The cost of equity is minimized.

Question 16

T.L.C.Enterprises just revised its capital structure from a debt-equity ratio of .37 to a debt-equity ratio of .48.The firm's shareholders who prefer the old capital structure should:

Accepted Answer

A) sell some shares and hold the sale proceeds in cash. 
B) sell all of their shares and loan out the entire sale proceeds. 
C) do nothing. 
D) sell some shares and loan out the sale proceeds. 
E) borrow funds and purchase more shares. 
A) sell some shares and hold the sale proceeds in cash. 
B) sell all of their shares and loan out the entire sale proceeds. 
C) do nothing. 
D) sell some shares and loan out the sale proceeds. 
E) borrow funds and purchase more shares.

Question 17

Petrol Service Stations has a tax rate of .percent.Its total interest payment for the year just ended was $41,000.What is the interest tax shield for the year?

Accepted Answer

A) $35,700 
B) $17,850 
C) $37,500 
D) $32,300 
E) $41,000 
A) $35,700 
B) $17,850 
C) $37,500 
D) $32,300 
E) $41,000

Question 18

Alderanian's is an all-equity firm that has 200,000 shares of stock outstanding.Neal, the financial vice president, is considering borrowing $300,000 at 8.5 percent interest to repurchase 50,000 shares.Ignoring taxes, what is the current value of the firm?

Accepted Answer

A) $700,000 
B) $1,240,000 
C) $925,000 
D) $960,000 
E) $1,200,000 
A) $700,000 
B) $1,240,000 
C) $925,000 
D) $960,000 
E) $1,200,000

Question 19

Ready To Go is an all-equity firm specializing in hot ready-to-eat meals.Management has estimated the firm's earnings before interest and taxes will be $68,000 annually forever.The present cost of equity is 14.1 percent.Currently, the firm has no debt but is considering borrowing $450,000 at 8 percent interest.The tax rate is 34 percent.What is the value of the unlevered firm?

Accepted Answer

A) $323,017 
B) $346,511 
C) $314,141 
D) $318,298 
E) $305,200 
A) $323,017 
B) $346,511 
C) $314,141 
D) $318,298 
E) $305,200

Question 20

Roller Coaster's has a WACC of 11.6 percent, ignoring taxes.It has a target capital structure of 60 percent equity and 40 percent debt and a cost of equity of 14.27 percent.What is the cost of debt?

Accepted Answer

A) 5.5 percent 
B) 7.6 percent 
C) 9.3 percent 
D) 9.4 percent 
E) 18.7 percent 
A) 5.5 percent 
B) 7.6 percent 
C) 9.3 percent 
D) 9.4 percent 
E) 18.7 percent

M&M Proposition I with taxes states that:

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Which one of the following states that a firm's cost of equity capital is a positive linear function of the firm's capital structure?

Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt?

An all-equity firm has a return on assets of 17.5 percent.The firm is considering converting to a debt-equity ratio of .40.The pretax cost of debt is 7.5 percent.Ignoring taxes, what will the cost of equity be if the firm switches to the levered capital structure?

When is a firm insolvent from an accounting perspective?

Which one of the following best defines legal bankruptcy?

Triangle Enterprises has no debt but can borrow at 8 percent.The firm's WACC is currently 13.2 percent, and there is no corporate tax.If the firm converts to 30 percent debt, what will its cost of equity be?

Delta Mowers has a debt-equity ratio of .6.Its WACC is 11.8 percent, and its cost of debt is 7.7 percent.There is no corporate tax.What is the firm's cost of equity capital?

Peter's Tools recently defaulted on a bank loan.To avoid a bankruptcy proceeding, the bank agreed to a composition.This composition would do which one of the following?

A prepack:

Newborn Nursery has 12,000 bonds outstanding with a face value of $1,000 each.The coupon rate is 6.9 percent and the tax rate is 34 percent.What is the present value of the interest tax shield?

Which one of the following conditions exists at the point where a firm maximizes its value?

T.L.C.Enterprises just revised its capital structure from a debt-equity ratio of .37 to a debt-equity ratio of .48.The firm's shareholders who prefer the old capital structure should:

Petrol Service Stations has a tax rate of .percent.Its total interest payment for the year just ended was $41,000.What is the interest tax shield for the year?

Alderanian's is an all-equity firm that has 200,000 shares of stock outstanding.Neal, the financial vice president, is considering borrowing $300,000 at 8.5 percent interest to repurchase 50,000 shares.Ignoring taxes, what is the current value of the firm?

Roller Coaster's has a WACC of 11.6 percent, ignoring taxes.It has a target capital structure of 60 percent equity and 40 percent debt and a cost of equity of 14.27 percent.What is the cost of debt?

Introduction to Financial Management

Financial Statements, Taxes, and Cash Flow

Working With Financial Statements

Introduction to Valuation: the Time Value of Money

Discounted Cash Flow Valuation

Interest Rates and Bond Valuation

Equity Markets and Stock Valuation

Net Present Value and Other Investment Criteria

Making Capital Investment Decisions

Some Lessons From Capital Market History

Risk and Return

Cost of Capital

Dividends and Dividend Policy

Raising Capital

Short-Term Financial Planning

Working Capital Management

International Aspects of Financial Management

Filters

Exam 13: Leverage and Capital Structure

M&M Proposition I with taxes states that:

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Which one of the following states that a firm's cost of equity capital is a positive linear function of the firm's capital structure?

Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt?

An all-equity firm has a return on assets of 17.5 percent.The firm is considering converting to a debt-equity ratio of .40.The pretax cost of debt is 7.5 percent.Ignoring taxes, what will the cost of equity be if the firm switches to the levered capital structure?

When is a firm insolvent from an accounting perspective?

Which one of the following best defines legal bankruptcy?

Triangle Enterprises has no debt but can borrow at 8 percent.The firm's WACC is currently 13.2 percent, and there is no corporate tax.If the firm converts to 30 percent debt, what will its cost of equity be?

Delta Mowers has a debt-equity ratio of .6.Its WACC is 11.8 percent, and its cost of debt is 7.7 percent.There is no corporate tax.What is the firm's cost of equity capital?

Peter's Tools recently defaulted on a bank loan.To avoid a bankruptcy proceeding, the bank agreed to a composition.This composition would do which one of the following?

A prepack:

Newborn Nursery has 12,000 bonds outstanding with a face value of $1,000 each.The coupon rate is 6.9 percent and the tax rate is 34 percent.What is the present value of the interest tax shield?

Which one of the following conditions exists at the point where a firm maximizes its value?

T.L.C.Enterprises just revised its capital structure from a debt-equity ratio of .37 to a debt-equity ratio of .48.The firm's shareholders who prefer the old capital structure should:

Petrol Service Stations has a tax rate of .percent.Its total interest payment for the year just ended was $41,000.What is the interest tax shield for the year?

Alderanian's is an all-equity firm that has 200,000 shares of stock outstanding.Neal, the financial vice president, is considering borrowing $300,000 at 8.5 percent interest to repurchase 50,000 shares.Ignoring taxes, what is the current value of the firm?

Roller Coaster's has a WACC of 11.6 percent, ignoring taxes.It has a target capital structure of 60 percent equity and 40 percent debt and a cost of equity of 14.27 percent.What is the cost of debt?

Introduction to Financial Management

Financial Statements, Taxes, and Cash Flow

Working With Financial Statements

Introduction to Valuation: the Time Value of Money

Discounted Cash Flow Valuation

Interest Rates and Bond Valuation

Equity Markets and Stock Valuation

Net Present Value and Other Investment Criteria

Making Capital Investment Decisions

Some Lessons From Capital Market History

Risk and Return

Cost of Capital

Dividends and Dividend Policy

Raising Capital

Short-Term Financial Planning

Working Capital Management

International Aspects of Financial Management

Filters