Question 1

A levered ﬁrm is a company that has:

Accepted Answer

A) accounts payable as the only liability on the balance sheet. 
B) some debt in the capital structure. 
C) all equity in the capital structure. 
D) no long term liability. 
E) None of the above. 
A) accounts payable as the only liability on the balance sheet. 
B) some debt in the capital structure. 
C) all equity in the capital structure. 
D) no long term liability. 
E) None of the above.

Question 2

A ﬁrm has zero debt in its capital structure.Its overall cost of capital is 9%.The ﬁrm is considering a new capital structure with 40% debt.The interest rate on the debt would be 4%.Assuming that the corporate tax rate is 34%, what
Would its cost of equity capital with the new capital structure be?

Accepted Answer

A) 10.3% 
B) 11.0% 
C) 11.2% 
D) 13.9% 
E) None of the above. 
A) 10.3% 
B) 11.0% 
C) 11.2% 
D) 13.9% 
E) None of the above.

Question 3

In a world of no corporate taxes if the use of leverage does not change the value of the levered ﬁrm relative to the unlevered ﬁrm this is known as:

Accepted Answer

A) MM Proposition III that the cost of equity is less than the cost of debt. 
B) MM Proposition I that leverage is invariant to market value. 
C) MM Proposition II that the cost of equity is always constant. 
D) MM Proposition I that the market value of the ﬁrm is invariant to the capital structure. 
E) MM Proposition III that there is no risk associated with leverage in a no tax world. 
A) MM Proposition III that the cost of equity is less than the cost of debt. 
B) MM Proposition I that leverage is invariant to market value. 
C) MM Proposition II that the cost of equity is always constant. 
D) MM Proposition I that the market value of the ﬁrm is invariant to the capital structure. 
E) MM Proposition III that there is no risk associated with leverage in a no tax world.

Question 4

In an EPS-EBI graphical relationship, the slope of the debt ray is steeper than the equity ray.The debt ray has a lower intercept because:

Accepted Answer

A) more shares are outstanding for the same level of EBI. 
B) the break-even point is higher with debt. 
C) a ﬁxed interest charge must be paid even at low earnings. 
D) the amount of interest per share has only a positive effect on the intercept. 
E) the higher the interest rate the greater the slope. 
A) more shares are outstanding for the same level of EBI. 
B) the break-even point is higher with debt. 
C) a ﬁxed interest charge must be paid even at low earnings. 
D) the amount of interest per share has only a positive effect on the intercept. 
E) the higher the interest rate the greater the slope.

Question 5

MM Proposition I without taxes is used to illustrate:

Accepted Answer

A) the value of an unlevered ﬁrm equals that of a levered ﬁrm. 
B) that one capital structure is as good as another. 
C) leverage does not affect the value of the ﬁrm. 
D) capital structure changes have no effect stockholder's welfare. 
E) All of the above. 
A) the value of an unlevered ﬁrm equals that of a levered ﬁrm. 
B) that one capital structure is as good as another. 
C) leverage does not affect the value of the ﬁrm. 
D) capital structure changes have no effect stockholder's welfare. 
E) All of the above.

Question 6

The Modigliani-Miller Proposition I without taxes states:

Accepted Answer

A) a ﬁrm cannot change the total value of its outstanding securities by changing its capital structure
Proportions. 
B) when new projects are added to the ﬁrm the ﬁrm value is the sum of the old value plus the new. 
C) managers can make correct corporate decisions that will satisfy all shareholders if they select projects that
Maximize value. 
D) the determination of value must consider the timing and risk of the cash ﬂows. 
E) None of the above. 
A) a ﬁrm cannot change the total value of its outstanding securities by changing its capital structure
Proportions. 
B) when new projects are added to the ﬁrm the ﬁrm value is the sum of the old value plus the new. 
C) managers can make correct corporate decisions that will satisfy all shareholders if they select projects that
Maximize value. 
D) the determination of value must consider the timing and risk of the cash ﬂows. 
E) None of the above.

Question 7

What is its cost of equity for a ﬁrm if the corporate tax rate is 30%? The ﬁrm has a debt-to-equity ratio of 1.5.If it had no debt, its cost of equity would be 16%.Its current cost of debt is 12%.

Accepted Answer

A) 17.4% 
B) 18.4% 
C) 20.2% 
D) 21.4% 
E) None of the above. 
A) 17.4% 
B) 18.4% 
C) 20.2% 
D) 21.4% 
E) None of the above.

Question 8

Spartan Ltd has an unlevered cost of capital of 11%, a cost of debt of 8%, and a tax rate of 35%.What is the target debt- equity ratio if the targeted cost of equity is 12%?

Accepted Answer

A) .44 
B) .49 
C) .51 
D) .56 
E) .62 
A) .44 
B) .49 
C) .51 
D) .56 
E) .62

Question 9

MM Proposition II with taxes:

Accepted Answer

A) has the same general implications as MM Proposition II without taxes. 
B) reveals how the interest tax shield relates to the value of a ﬁrm. 
C) supports the argument that business risk is determined by the capital structure employed by a ﬁrm. 
D) supports the argument that the cost of equity decreases as the debt-equity ratio increases. 
E) reaches the ﬁnal conclusion that the capital structure decision is irrelevant to the value of a ﬁrm. 
A) has the same general implications as MM Proposition II without taxes. 
B) reveals how the interest tax shield relates to the value of a ﬁrm. 
C) supports the argument that business risk is determined by the capital structure employed by a ﬁrm. 
D) supports the argument that the cost of equity decreases as the debt-equity ratio increases. 
E) reaches the ﬁnal conclusion that the capital structure decision is irrelevant to the value of a ﬁrm.

Question 10

A key assumption of MM's Proposition I without taxes is:

Accepted Answer

A) that ﬁnancial leverage increases risk. 
B) that individuals can borrow on their own account at rates less than the ﬁrm. 
C) that individuals must be able to borrow on their own account at rates equal to the ﬁrm. 
D) managers are acting to maximize the value of the ﬁrm. 
E) All of the above. 
A) that ﬁnancial leverage increases risk. 
B) that individuals can borrow on their own account at rates less than the ﬁrm. 
C) that individuals must be able to borrow on their own account at rates equal to the ﬁrm. 
D) managers are acting to maximize the value of the ﬁrm. 
E) All of the above.

Question 11

MM Proposition II is the proposition that:

Accepted Answer

A) supports the argument that the capital structure of a ﬁrm is irrelevant to the value of the ﬁrm. 
B) the cost of equity depends on the return on debt, the debt-equity ratio and the tax rate. 
C) a ﬁrm's cost of equity capital is a positive linear function of the ﬁrm's capital structure. 
D) the cost of equity is equivalent to the required return on the total assets of a ﬁrm. 
E) supports the argument that the size of the pie does not depend on how the pie is sliced. 
A) supports the argument that the capital structure of a ﬁrm is irrelevant to the value of the ﬁrm. 
B) the cost of equity depends on the return on debt, the debt-equity ratio and the tax rate. 
C) a ﬁrm's cost of equity capital is a positive linear function of the ﬁrm's capital structure. 
D) the cost of equity is equivalent to the required return on the total assets of a ﬁrm. 
E) supports the argument that the size of the pie does not depend on how the pie is sliced.

Question 12

Walter's Distributors have a cost of equity of 13.84% and an unlevered cost of capital of 12%.The company has €5,000 in debt that is selling at par value.The levered value of the ﬁrm is €12,000 and the tax rate is 34%.What is the pre-tax
Cost of debt?

Accepted Answer

A) 7.92% 
B) 8.10% 
C) 8.16% 
D) 8.84% 
E) 9.00% 
A) 7.92% 
B) 8.10% 
C) 8.16% 
D) 8.84% 
E) 9.00%

Question 13

Backwoods Lumber AB has a debt-equity ratio of .80.The ﬁrm's required return on assets is 12% and its cost of equity is 15.68%.What is the pre-tax cost of debt based on MM Proposition II with no taxes?

Accepted Answer

A) 6.76% 
B) 7.00% 
C) 7.25% 
D) 7.40% 
E) 7.50% 
A) 6.76% 
B) 7.00% 
C) 7.25% 
D) 7.40% 
E) 7.50%

Question 14

MM Proposition I with taxes is based on the concept that:

Accepted Answer

A) the optimal capital structure is the one that is totally ﬁnanced with equity. 
B) the capital structure of the ﬁrm does not matter because investors can use homemade leverage. 
C) the ﬁrm is better off with debt based on the weighted average cost of capital. 
D) the value of the ﬁrm increases as total debt increases because of the interest tax shield. 
E) the cost of equity increases as the debt-equity ratio of a ﬁrm increases. 
A) the optimal capital structure is the one that is totally ﬁnanced with equity. 
B) the capital structure of the ﬁrm does not matter because investors can use homemade leverage. 
C) the ﬁrm is better off with debt based on the weighted average cost of capital. 
D) the value of the ﬁrm increases as total debt increases because of the interest tax shield. 
E) the cost of equity increases as the debt-equity ratio of a ﬁrm increases.

Question 15

A ﬁrm has a debt-to-equity ratio of 1.Its cost of equity is 16%, and its cost of debt is 8%.If there are no taxes or other imperfections, what would be its cost of equity if the debt-to-equity ratio were 0?

Accepted Answer

A) 8% 
B) 10% 
C) 12% 
D) 14% 
E) 16% 
A) 8% 
B) 10% 
C) 12% 
D) 14% 
E) 16%

Question 16

An unlevered ﬁrm has a cost of capital of 14% and earnings before interest and taxes of €150,000.A levered ﬁrm with the same operations and assets has both a book value and a face value of debt of €700,000 with a 7% annual
Coupon.The applicable tax rate is 35%.What is the value of the levered ﬁrm?

Accepted Answer

A) €696,429 
B) €907,679 
C) €941,429 
D) €1,184,929 
E) €1,396,429 
A) €696,429 
B) €907,679 
C) €941,429 
D) €1,184,929 
E) €1,396,429

Question 17

The use of personal borrowing to change the overall amount of ﬁnancial leverage to which an individual is exposed is called:

Accepted Answer

A) homemade leverage. 
B) dividend recapture. 
C) the weighted average cost of capital. 
D) private debt placement. 
E) personal offset. 
A) homemade leverage. 
B) dividend recapture. 
C) the weighted average cost of capital. 
D) private debt placement. 
E) personal offset.

Question 18

Bertha's Boutique has 2,000 bonds outstanding with a face value of €1,000 each and a coupon rate of 9%.The interest is paid semi-annually.What is the amount of the annual interest tax shield if the tax rate is 34%?

Accepted Answer

A) €58,500 
B) €60,100 
C) €60,750 
D) €61,200 
E) €62,250 
A) €58,500 
B) €60,100 
C) €60,750 
D) €61,200 
E) €62,250

Question 19

The interest tax shield is a key reason why:

Accepted Answer

A) the required rate of return on assets rises when debt is added to the capital structure. 
B) the value of an unlevered ﬁrm is equal to the value of a levered ﬁrm. 
C) the net cost of debt to a ﬁrm is generally less than the cost of equity. 
D) the cost of debt is equal to the cost of equity for a levered ﬁrm. 
E) ﬁrms prefer equity ﬁnancing over debt ﬁnancing. 
A) the required rate of return on assets rises when debt is added to the capital structure. 
B) the value of an unlevered ﬁrm is equal to the value of a levered ﬁrm. 
C) the net cost of debt to a ﬁrm is generally less than the cost of equity. 
D) the cost of debt is equal to the cost of equity for a levered ﬁrm. 
E) ﬁrms prefer equity ﬁnancing over debt ﬁnancing.

Question 20

A ﬁrm has zero debt in its capital structure.Its overall cost of capital is 10%.The ﬁrm is considering a new capital structure with 60% debt.The interest rate on the debt would be 8%.Assuming there are no taxes or other
Imperfections, its cost of equity capital with the new capital structure would be ______ .

Accepted Answer

A) 9% 
B) 10% 
C) 13% 
D) 14% 
E) None of the above. 
A) 9% 
B) 10% 
C) 13% 
D) 14% 
E) None of the above.

Exam 15: Capital Structure: Basic Concepts

A levered ﬁrm is a company that has:

In a world of no corporate taxes if the use of leverage does not change the value of the levered ﬁrm relative to the unlevered ﬁrm this is known as:

In an EPS-EBI graphical relationship, the slope of the debt ray is steeper than the equity ray.The debt ray has a lower intercept because:

MM Proposition I without taxes is used to illustrate:

The Modigliani-Miller Proposition I without taxes states:

What is its cost of equity for a ﬁrm if the corporate tax rate is 30%? The ﬁrm has a debt-to-equity ratio of 1.5.If it had no debt, its cost of equity would be 16%.Its current cost of debt is 12%.

Spartan Ltd has an unlevered cost of capital of 11%, a cost of debt of 8%, and a tax rate of 35%.What is the target debt- equity ratio if the targeted cost of equity is 12%?

MM Proposition II with taxes:

A key assumption of MM's Proposition I without taxes is:

MM Proposition II is the proposition that:

Walter's Distributors have a cost of equity of 13.84% and an unlevered cost of capital of 12%.The company has €5,000 in debt that is selling at par value.The levered value of the ﬁrm is €12,000 and the tax rate is 34%.What is the pre-tax Cost of debt?

Backwoods Lumber AB has a debt-equity ratio of .80.The ﬁrm's required return on assets is 12% and its cost of equity is 15.68%.What is the pre-tax cost of debt based on MM Proposition II with no taxes?

MM Proposition I with taxes is based on the concept that:

A ﬁrm has a debt-to-equity ratio of 1.Its cost of equity is 16%, and its cost of debt is 8%.If there are no taxes or other imperfections, what would be its cost of equity if the debt-to-equity ratio were 0?

The use of personal borrowing to change the overall amount of ﬁnancial leverage to which an individual is exposed is called:

Bertha's Boutique has 2,000 bonds outstanding with a face value of €1,000 each and a coupon rate of 9%.The interest is paid semi-annually.What is the amount of the annual interest tax shield if the tax rate is 34%?

The interest tax shield is a key reason why:

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: Limits to the Use of Debt

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