Exam 15: Capital Structure: Basic Concepts

A firm has a debt-to-equity ratio of .60.Its cost of debt is 8%.Its overall cost of capital is 12%.What is its cost of equity if there are no taxes or other imperfections?

The concept of homemade leverage is most associated with:

Wild Flowers Express has a debt-equity ratio of .60.The pre-tax cost of debt is 9% while the unlevered cost of capital is 14%.What is the cost of equity if the tax rate is 34%?

A firm has a debt-to-equity ratio of 1.75.If it had no debt, its cost of equity would be 14%.Its cost of debt is 10%.What is its cost of equity if the corporate tax rate is 30%?

Based on MM with taxes and without taxes, how much time should a financial manager spend analyzing the capital structure of his firm? What if the analysis is based on the static theory?

Consider two firms, U and L, both with €50,000 in assets.Firm U is unlevered, and firm L has €20,000 of debt that pays 8% interest.Firm U has 1,000 shares outstanding, while firm L has 600 shares outstanding.Mike owns 20% of firm L and believes that leverage works in his favor.Steve tells Mike that this is an illusion, and that with the possibility of borrowing on his own account at 8% interest, he can replicate Mike's payout from firm L.Given a level of operating income of €2,500, show the specific strategy that Mike has in mind.After seeing Steve's analysis, Mike tells Steve that while his analysis looks good on paper, Steve will never be able to borrow at 8%, but would have to pay a more realistic rate of 12%.Suppose the tax authorities allow firms to deduct their interest expense from operating income. Both firm U and firm L are in the 34% tax bracket.Show what happens to the market value of both firms if the debt held by firm L is permanent.Assume MM with taxes.

The increase in risk to equityholders when financial leverage is introduced is evidenced by:

MM Proposition I with corporate taxes states that:

The proposition that the cost of equity is a positive linear function of capital structure is called:

Your firm has a debt-equity ratio of .75.Your pre-tax cost of debt is 8.5% and your required return on assets is 15%. What is your cost of equity if you ignore taxes?

Bryan invested in Bryco NV shares when the firm was financed solely with equity.The firm is now utilizing debt in its capital structure.To unlever his position, Bryan needs to:

The capital structure chosen by a firm doesn't really matter because of:

A firm has debt of €5,000, equity of €16,000, a leveraged value of €8,900, a cost of debt of 8%, a cost of equity of 12%, and a tax rate of 34%.What is the firm's weighted average cost of capital?

Your firm has a €250,000 bond issue outstanding.These bonds have a 7% coupon, pay interest semiannually, and have a current market price equal to 103% of face value.What is the amount of the annual interest tax shield given a Tax rate of 35%?

MM Proposition I with taxes supports the theory that:

A firm has a debt-to-equity ratio of .5.Its cost of equity is 22%, and its cost of debt is 16%.If the corporate tax rate is 30%, what would its cost of equity be if the debt-to-equity ratio were 0?

In each of the theories of capital structure the cost of equity rises as the amount of debt increases.So why don't financial managers use as little debt as possible to keep the cost of equity down? After all, isn't the goal of the firm to maximize share value and minimize shareholder costs?

The change in firm value in the presence of corporate taxes only is:

A firm should select the capital structure which:

Consider two firms, U and L, both with €50,000 in assets.Firm U is unlevered, and firm L has €20,000 of debt that pays 8% interest.Firm U has 1,000 shares outstanding, while firm L has 600 shares outstanding.Mike owns 20% of firm L and believes that leverage works in his favor.Steve tells Mike that this is an illusion, and that with the possibility of borrowing on his own account at 8% interest, he can replicate Mike's payout from firm L.Given a level of operating income of €2,500, show the specific strategy that Mike has in mind.After seeing Steve's analysis, Mike tells Steve that while his analysis looks good on paper, Steve will never be able to borrow at 8%, but would have to pay a more realistic rate of 12%.If Mike is right, what will Steve's payout be?