Exam 26: Analysis of Capital Structure Theory

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MM showed that in a world without taxes, a firm's value is not affected by its capital structure.

(True/False)
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Which of the following statements concerning the MM extension with growth is NOT CORRECT?

(Multiple Choice)
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(The following data apply to Problems 23 through 25. The problems MUST be kept together.) The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%. Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. -What is the value of the firm according to MM with corporate taxes?

(Multiple Choice)
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In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

(True/False)
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Firm L has debt with a market value of $200,000 and a yield of 9%. The firm's equity has a market value of $300,000, its earnings are growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what would Firm L's total value be if it had no debt?

(Multiple Choice)
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(The following data apply to Problems 23 through 25. The problems MUST be kept together.) The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%. Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. -Assume that the firm's gain from leverage according to the Miller model is $126,667. If the effective personal tax rate on stock income is TS = 20%, what is the implied personal tax rate on debt income?

(Multiple Choice)
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MM showed that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

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The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

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Your firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000. It is growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is the value of your firm's tax shield, i.e., how much value does the use of debt add?

(Multiple Choice)
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(The following data apply to Problems 26 through 28. The problems MUST be kept together.) Gomez computer systems has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Gomez must reinvest 20% of its EBIT in net operating assets. Gomez has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%. -According to the MM extension with growth, what is Gomez's value of equity?

(Multiple Choice)
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Which of the following statements concerning capital structure theory is NOT CORRECT?

(Multiple Choice)
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