Question 1

The basic lesson of MM theory is that the value of a ﬁrm is dependent upon the:

Accepted Answer

A) capital structure of the ﬁrm. 
B) total cash ﬂows of the ﬁrm. 
C) percentage of a ﬁrm to which the bondholders have a claim. 
D) tax claim placed on the ﬁrm by the government. 
E) size of the shareholders claims on the ﬁrm. 
A) capital structure of the ﬁrm. 
B) total cash ﬂows of the ﬁrm. 
C) percentage of a ﬁrm to which the bondholders have a claim. 
D) tax claim placed on the ﬁrm by the government. 
E) size of the shareholders claims on the ﬁrm.

Question 2

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from equities: 0%

Accepted Answer

A) £0.175 
B) £0.472 
C) £0.528 
D) £0.825 
E) None of the above. 
A) £0.175 
B) £0.472 
C) £0.528 
D) £0.825 
E) None of the above.

Question 3

Growth opportunities _______ the _____ of debt ﬁnancing.

Accepted Answer

A) increase; advantage 
B) decrease; advantage 
C) decrease; disadvantage 
D) Both A and C. 
E) None of the above. 
A) increase; advantage 
B) decrease; advantage 
C) decrease; disadvantage 
D) Both A and C. 
E) None of the above.

Question 4

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from shares: 30%

Accepted Answer

A) £-0.050 
B) £ 0.006 
C) £ 0.246 
D) £ 0.340 
E) £ 0.423 
A) £-0.050 
B) £ 0.006 
C) £ 0.246 
D) £ 0.340 
E) £ 0.423

Question 5

Issuing debt instead of new equity in a closely held ﬁrm more likely:

Accepted Answer

A) causes the owner-manager to work less hard and shirk their duties as they have less capital
At risk. 
B) causes the owner-manager to consume more perquisites because the cost is passed to the
Debtholders. 
C) causes both more shirking and perquisite consumption since the government provides a tax
Shield on debt. 
D) causes agency costs to fall as owner-managers do not need to worry about other
Shareholders. 
E) causes the owner-manager to reduce shirking and perquisite consumption as the excess
Cash ﬂow must be used to meet debt payments. 
A) causes the owner-manager to work less hard and shirk their duties as they have less capital
At risk. 
B) causes the owner-manager to consume more perquisites because the cost is passed to the
Debtholders. 
C) causes both more shirking and perquisite consumption since the government provides a tax
Shield on debt. 
D) causes agency costs to fall as owner-managers do not need to worry about other
Shareholders. 
E) causes the owner-manager to reduce shirking and perquisite consumption as the excess
Cash ﬂow must be used to meet debt payments.

Question 6

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

Question 7

Suppose a Miller equilibrium exists with corporate tax rate of 30% and personal tax rate on income from bonds of 35%.What is the personal tax rate on income from equities?

Accepted Answer

A) 0.0% 
B) 7.1% 
C) 10.05% 
D) 45.5% 
E) None of the above. 
A) 0.0% 
B) 7.1% 
C) 10.05% 
D) 45.5% 
E) None of the above.

Question 8

In Miller's model, when the quantity [(1-Tc)(1-Ts) = (1-Tb)], then:

Accepted Answer

A) the ﬁrm should hold no debt. 
B) the value of the levered ﬁrm is greater than the value of the unlevered ﬁrm. 
C) the tax shield on debt is exactly offset by higher personal taxes paid on interest income. 
D) the tax shield on debt is exactly offset by higher levels of dividends. 
E) the tax shield on debt is exactly offset by higher capital gains. 
A) the ﬁrm should hold no debt. 
B) the value of the levered ﬁrm is greater than the value of the unlevered ﬁrm. 
C) the tax shield on debt is exactly offset by higher personal taxes paid on interest income. 
D) the tax shield on debt is exactly offset by higher levels of dividends. 
E) the tax shield on debt is exactly offset by higher capital gains.

Question 9

In general, the capital structures used by ﬁrms:

Accepted Answer

A) tend to overweigh debt in relation to equity. 
B) are easily explained in terms of earnings volatility. 
C) are easily explained by analyzing the types of assets owned by the various ﬁrms. 
D) tend to be those which maximize the use of the ﬁrm's available tax shelters. 
E) vary signiﬁcantly across industries. 
A) tend to overweigh debt in relation to equity. 
B) are easily explained in terms of earnings volatility. 
C) are easily explained by analyzing the types of assets owned by the various ﬁrms. 
D) tend to be those which maximize the use of the ﬁrm's available tax shelters. 
E) vary signiﬁcantly across industries.

Question 10

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 50%
Personal tax rate on income from equities: 10%

Accepted Answer

A) £-0.050 
B) £-0.188 
C) £0.188 
D) £0.633 
E) None of the above. 
A) £-0.050 
B) £-0.188 
C) £0.188 
D) £0.633 
E) None of the above.

Question 11

The TrunkLine Company will earn £60 in one year if it does well.The debtholders are promised payments of £35 in one year if the ﬁrm does well.If the ﬁrm does poorly, expected earnings in one
Year will be £30 and the repayment will be £20 because of the dead weight cost of bankruptcy.The
Probability of the ﬁrm performing poorly or well is 50%.If bondholders are fully aware of these costs
What will they pay for the debt? The interest rate on the bonds is 10%.

Accepted Answer

A) £25.00 
B) £27.50 
C) £29.55 
D) £32.50 
E) £35.00 
A) £25.00 
B) £27.50 
C) £29.55 
D) £32.50 
E) £35.00

Question 12

Indirect costs of bankruptcy are born principally by:

Accepted Answer

A) bondholders. 
B) shareholders. 
C) managers. 
D) the federal government. 
E) the ﬁrm's suppliers. 
A) bondholders. 
B) shareholders. 
C) managers. 
D) the federal government. 
E) the ﬁrm's suppliers.

Question 13

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt?
Corporate tax rate: 40%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from shares: 30%

Accepted Answer

A) £-0.475 
B) £0.475 
C) £0.525 
D) £0.633 
E) None of the above. 
A) £-0.475 
B) £0.475 
C) £0.525 
D) £0.633 
E) None of the above.

Question 14

Covenants restricting the use of leasing and additional borrowings primarily protect:

Accepted Answer

A) the equityholders from added risk of default. 
B) the debtholders from added risk of dilution of their claims. 
C) the debtholders from the transfer of assets. 
D) the management from having to pay agency costs. 
E) None of the above. 
A) the equityholders from added risk of default. 
B) the debtholders from added risk of dilution of their claims. 
C) the debtholders from the transfer of assets. 
D) the management from having to pay agency costs. 
E) None of the above.

Question 15

The legal proceeding for liquidating or reorganizing a ﬁrm operating in default is called a:

Accepted Answer

A) tender offer. 
B) bankruptcy. 
C) merger. 
D) takeover. 
E) proxy ﬁght. 
A) tender offer. 
B) bankruptcy. 
C) merger. 
D) takeover. 
E) proxy ﬁght.

Question 16

An investment is available that pays a tax-free 6%.The corporate tax rate is 30%.Ignoring risk, what is the pre-tax return on taxable bonds?

Accepted Answer

A) 4.20% 
B) 6.00% 
C) 7.67% 
D) 8.57% 
E) None of the above. 
A) 4.20% 
B) 6.00% 
C) 7.67% 
D) 8.57% 
E) None of the above.

Question 17

Establishing a capital structure for a ﬁrm is not simple.Although ﬁnancial theory guides the process, there is no simple formula.List and explain four main items that one should consider in determining the capital structure.

Accepted Answer

Some points to consider are: Taxes--tax

Question 18

You own a big equity stake in QuickFix Inc, a do-it-yourself (DIY) store.Unfortunately, the DIY business is highly procyclical, and as the economy is going through a rough patch, the company is not doing too well.The company's management suggests investing in a new product line, and wants the existing equity holders to pay for it.You hesitate.Why?

Accepted Answer

Although the shareholders pay for the pr

Question 19

Corporations in Europe tend to:

Accepted Answer

A) minimize taxes. 
B) underutilize debt. 
C) rely less on equity ﬁnancing than they should. 
D) have extremely high debt-equity ratios. 
E) rely more heavily on bonds than stocks as the major source of ﬁnancing. 
A) minimize taxes. 
B) underutilize debt. 
C) rely less on equity ﬁnancing than they should. 
D) have extremely high debt-equity ratios. 
E) rely more heavily on bonds than stocks as the major source of ﬁnancing.

Question 20

Wigdor Manufacturing is currently all equity ﬁnanced, had EBIT of £2 million, and is in the 34% tax bracket.Louis, the company's founder, is the lone shareholder.If the ﬁrm were to convert £4 million of equity into debt at a cost of 10%, what would be the total cash ﬂow to Louis if he holds all the debt? Compare this to Louis' total cash ﬂow if the ﬁrm remains unlevered.

Accepted Answer

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Exam 16: Capital Structure: Limits to the Use of Debt

The basic lesson of MM theory is that the value of a ﬁrm is dependent upon the:

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 20% Personal tax rate on income from equities: 0%

Growth opportunities _______ the _____ of debt ﬁnancing.

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 20% Personal tax rate on income from shares: 30%

Issuing debt instead of new equity in a closely held ﬁrm more likely:

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?

Suppose a Miller equilibrium exists with corporate tax rate of 30% and personal tax rate on income from bonds of 35%.What is the personal tax rate on income from equities?

In Miller's model, when the quantity [(1-Tc)(1-Ts) = (1-Tb)], then:

In general, the capital structures used by ﬁrms:

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 50% Personal tax rate on income from equities: 10%

Indirect costs of bankruptcy are born principally by:

Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt? Corporate tax rate: 40% Personal tax rate on income from bonds: 20% Personal tax rate on income from shares: 30%

Covenants restricting the use of leasing and additional borrowings primarily protect:

The legal proceeding for liquidating or reorganizing a ﬁrm operating in default is called a:

An investment is available that pays a tax-free 6%.The corporate tax rate is 30%.Ignoring risk, what is the pre-tax return on taxable bonds?

Establishing a capital structure for a ﬁrm is not simple.Although ﬁnancial theory guides the process, there is no simple formula.List and explain four main items that one should consider in determining the capital structure.

Corporations in Europe tend to:

Introduction to Corporate Finance

Corporate Governance

Financial Statement Analysis

Discounted Cash Flow Valuation

Bond, Equity and Firm Valuation

Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, Real Options and Capital Budgeting

Risk and Return: Lessons From Market History

Risk and Return: the Capital Asset Pricing Model

Factor Models and the Arbitrage Pricing Theory

Risk, Cost of Capital and Capital Budgeting

Efficient Capital Markets and Behavioural Finance

Long-Term Financing: an Introduction

Capital Structure: Basic Concepts

Valuation and Capital Budgeting for the Levered Firm

Dividends and Other Payouts

Equity Financing

Debt Financing

Leasing

Options and Corporate Finance

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Financial Risk Management With Derivatives

Short-Term Finance and Planning

Short-Term Capital Management

Mergers and Acquisitions

Financial Distress

International Corporate Finance

Filters

Growth opportunities ___ the _ of debt ﬁnancing.