Exam 16: Capital Structure: Basic Concepts

The Montana Hills Co. has expected earnings before interest and taxes of $8,100,an unlevered cost of capital of 11%,and debt with both a book and face value of $12,000. The debt has an annual 8% coupon. The tax rate is 34%. What is the value of the firm?

Which of the following statements are correct in relation to MM Proposition II with no taxes? I. The required return on assets is equal to the weighted average cost of capital. II. Financial risk is determined by the debt-equity ratio. III. Financial risk determines the return on assets. IV. The cost of equity declines when the amount of leverage used by a firm rises.

According the MM with taxes,the value of the firm is maximized by taking on as much debt as possible. Show graphically how adding debt can increase value through the overall cost of capital. Explain how and under what conditions this impacts the cost of capital and translates into firm value.

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

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%?

Your firm has a pre-tax cost of debt of 7% and an unlevered cost of capital of 13%. Your tax rate is 35% and your cost of equity is 15.26%. What is your debt-equity ratio?

Financial leverage impacts the performance of the firm by:

MM Proposition II is the proposition that:

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

A firm has a debt-to-equity ratio of 1.75. If it had no debt,its cost of equity would be 9%. Its cost of debt is 7%. What is its cost of equity if the corporate tax rate is 50%?

The Backwoods Lumber Co. 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?

A firm has a debt-to-equity ratio of 1.20. If it had no debt,its cost of equity would be 15%. Its cost of debt is 10%. What is its cost of equity if there are no taxes or other imperfections?

In an EPS-EBI graphical relationship,the debt ray and equity ray cross. At this point the equity and debt are:

The interest tax shield has no value for a firm when: I. the tax rate is equal to zero. II. the debt-equity ratio is exactly equal to 1. III. the firm is unlevered. IV. a firm elects 100% equity as its capital structure.

Explain homemade leverage and why it matters.

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

The Nantucket Nugget is unlevered and is valued at $640,000. Nantucket is currently deciding whether including debt in its capital structure would increase its value. The current of cost of equity is 12%. 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 its effective marginal tax bracket is 34%. What will Nantucket's new WACC be?

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?

Discuss Modigliani and Miller's Propositions I and II in a world with taxes. List the basic assumptions,results,and intuition of the model.

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