Exam 16: Capital Structure: Basic Concepts

If a firm is unlevered and has a cost of equity capital 12% what would the cost of equity be if the firms became levered at 2:1?The expected cost of debt would be 8%.

The firm's capital structure refers to:

MM Proposition I with taxes supports the theory that:

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?

Assume the corporate tax rate is 50%. A firm has perpetual expected EBIT of $100. The firm has no debt in its capital structure. Its cost of equity is 10%. What would be the value of the firm if it issued $400 in perpetual debt?

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

The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

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?

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%, its cost of equity capital with the new capital structure would be?

The difference between a market value balance sheet and a book value balance sheet is that a market value balance sheet:

The Montana Hills Co. has expected earnings before interest and taxes of $17,100, an unlevered cost of capital of 12.4 percent, and debt with both a book and face value of $25,000. The debt has an annual 6.2 percent coupon. If the tax rate is 34 percent, what is the value of the firm?

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:

The JumpStart Corporation is unlevered and valued at $500,000. JumpStart has 200,000 shares outstanding. The company announces that in the near future it will issue $200,000 of debt and buy back $200,000 of stock. If the firm is in the 34% tax bracket, how many shares of stock will be repurchased?

The Hifalutin Co. has perpetual EBIT of $3,000. It has no debt in its capital structure, and its cost of equity is 15%. The corporate tax rate is 40%. There are 300 shares outstanding. Hifalutin has announced that it will borrow $3,750 in perpetual debt at 8% and use the proceeds to buy up stock. What will the stock price now be after the recapitalization?

The unlevered cost of capital is:

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.40, what would its cost of equity be if the debt-to-equity ratio were 0?

MM Proposition I with no tax supports the argument that:

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

The weighted average cost of capital is invariant to the use of leverage under MM conditions of no taxes. Graph the relationship of the weighted average cost of capital and leverage; be sure to include the cost of equity and debt. Explain why this relationship holds.

The Nantucket Nugget is unlevered and is valued at $640,000. Nantucket is currently deciding whether including debt in their capital structure would increase their value. Under consideration is issuing $300,000 in new debt with an 8% interest rate. Nantucket would repurchase $300,000 of stock with the proceeds of the debt issue. There are currently 32,000 shares outstanding and their effective marginal tax bracket is zero. What is the change in value and how many shares of stock will be repurchased?