Question 1

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 on stockholders' welfare. 
E)  All of 
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 on stockholders' welfare. 
E)  All of

Question 2

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

Question 3

The Spartan Co. 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 4

The effect of financial leverage depends on the operating earnings of the company. Which of the following is not true?

Accepted Answer

A)  Below the indifference or break-even point in EBIT the non-levered structure is superior. 
B)  Financial leverage increases the slope of the EPS line. 
C)  Above the indifference or break-even point the increase in EPS for all equity structures is less than debt-equity structures. 
D)  Above the indifference or break-even point the increase in EPS for all equity structures is greater than debt-equity structures. 
E)  The rate of return on operating assets is unaffected by leveragE. 
A)  Below the indifference or break-even point in EBIT the non-levered structure is superior. 
B)  Financial leverage increases the slope of the EPS line. 
C)  Above the indifference or break-even point the increase in EPS for all equity structures is less than debt-equity structures. 
D)  Above the indifference or break-even point the increase in EPS for all equity structures is greater than debt-equity structures. 
E)  The rate of return on operating assets is unaffected by leveragE.

Question 5

A firm has debt of $90,000,equity of $140,000,a leveraged value of $100,000,a cost of debt of 6%,a cost of equity of 12%,and a tax rate of 40%. What is the firm's weighted average cost of capital?

Accepted Answer

A)  8.15% 
B)  8.40% 
C)  8.70% 
D)  9.30% 
E)  None of these. 
A)  8.15% 
B)  8.40% 
C)  8.70% 
D)  9.30% 
E)  None of these.

Question 6

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

Accepted Answer

A)  levered firms pay less taxes compared with identical unlevered firms. 
B)  bondholders require higher rates of return compared with stockholders. 
C)  earnings per share are no longer relevant with taxes. 
D)  dividends are no longer relevant with taxes. 
E)  All of 
A)  levered firms pay less taxes compared with identical unlevered firms. 
B)  bondholders require higher rates of return compared with stockholders. 
C)  earnings per share are no longer relevant with taxes. 
D)  dividends are no longer relevant with taxes. 
E)  All of

Question 7

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 8

Boutelle Homes has 4,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 7%. The interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 40%?

Accepted Answer

A)  $58,000 
B)  $60,000 
C)  $72,000 
D)  $98,000 
E)  $112,000 
A)  $58,000 
B)  $60,000 
C)  $72,000 
D)  $98,000 
E)  $112,000

Question 9

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 
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

Question 10

The unlevered cost of capital is:

Accepted Answer

A)  the cost of capital for a firm with no equity in its capital structure. 
B)  the cost of capital for a firm with no debt in its capital structure. 
C)  the interest tax shield times pretax net income. 
D)  the cost of preferred stock for a firm with equal parts debt and common stock in its capital structure. 
E)  equal to the profit margin for a firm with some debt in its capital structurE. 
A)  the cost of capital for a firm with no equity in its capital structure. 
B)  the cost of capital for a firm with no debt in its capital structure. 
C)  the interest tax shield times pretax net income. 
D)  the cost of preferred stock for a firm with equal parts debt and common stock in its capital structure. 
E)  equal to the profit margin for a firm with some debt in its capital structurE.

Question 11

Joe's Leisure Time Sports is an unlevered firm with an after-tax net income of $86,000. The unlevered cost of capital is 10% and the tax rate is 34%. What is the value of this firm?

Accepted Answer

A)  $567,600 
B)  $781,818 
C)  $860,000 
D)  $946,000 
E)  $1,152,400 
A)  $567,600 
B)  $781,818 
C)  $860,000 
D)  $946,000 
E)  $1,152,400

Question 12

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?

Accepted Answer

A)  11.25% 
B)  12.21% 
C)  16.67% 
D)  19.88% 
E)  21.38% 
A)  11.25% 
B)  12.21% 
C)  16.67% 
D)  19.88% 
E)  21.38%

Question 13

You own 25% of Unique Vacations,Inc. You have decided to retire and want to sell your shares in this closely held,all equity firm. The other shareholders have agreed to have the firm borrow $1.5 million to purchase your 1,000 shares of stock. What is the total value of this firm today if you ignore taxes?

Accepted Answer

A)  $4.8 million 
B)  $5.1 million 
C)  $5.4 million 
D)  $5.7 million 
E)  $6.0 million 
A)  $4.8 million 
B)  $5.1 million 
C)  $5.4 million 
D)  $5.7 million 
E)  $6.0 million

Question 14

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 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 effective marginal tax bracket is zero. What will Nantucket's new WACC be?

Accepted Answer

New Firm Value: $640,000 + (.0) ($300,00

Question 15

Gail's Dance Studio is currently an all equity firm that has 80,000 shares of stock outstanding with a market price of $42 a share. The current cost of equity is 12% and the tax rate is 34%. Gail is considering adding $1 million of debt with a coupon rate of 8% to her capital structure. The debt will be sold at par value. What is the levered value of the equity?

Accepted Answer

A)  $2.4 million 
B)  $2.7 million 
C)  $3.3 million 
D)  $3.7 million 
E)  $3.9 million 
A)  $2.4 million 
B)  $2.7 million 
C)  $3.3 million 
D)  $3.7 million 
E)  $3.9 million

Question 16

The firm's capital structure refers to:

Accepted Answer

A)  the way a firm invests its assets. 
B)  the amount of capital in the firm. 
C)  the amount of dividends a firm pays. 
D)  the mix of debt and equity used to finance the firm's assets. 
E)  how much cash the firm holds. 
A)  the way a firm invests its assets. 
B)  the amount of capital in the firm. 
C)  the amount of dividends a firm pays. 
D)  the mix of debt and equity used to finance the firm's assets. 
E)  how much cash the firm holds.

Question 17

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.
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.

Accepted Answer

The answer of Consider two firms,U and L,both with $50,000...

Question 18

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 is known as:

Accepted Answer

A)  MM Proposition III that the cost of stock 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 stock 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 19

A firm should select the capital structure which:

Accepted Answer

A)  produces the highest cost of capital. 
B)  maximizes the value of the firm. 
C)  minimizes taxes. 
D)  is fully unlevered. 
E)  has no debt. 
A)  produces the highest cost of capital. 
B)  maximizes the value of the firm. 
C)  minimizes taxes. 
D)  is fully unlevered. 
E)  has no debt.

Question 20

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)  All of these. 
E)  None of these. 
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)  All of these. 
E)  None of these.

Exam 16: Capital Structure: Basic Concepts

MM Proposition I without taxes is used to illustrate:

The Spartan Co. 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%?

The effect of financial leverage depends on the operating earnings of the company. Which of the following is not true?

A firm has debt of $90,000,equity of $140,000,a leveraged value of $100,000,a cost of debt of 6%,a cost of equity of 12%,and a tax rate of 40%. What is the firm's weighted average cost of capital?

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

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?

Boutelle Homes has 4,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 7%. The interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 40%?

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

The unlevered cost of capital is:

Joe's Leisure Time Sports is an unlevered firm with an after-tax net income of $86,000. The unlevered cost of capital is 10% and the tax rate is 34%. What is the value of this firm?

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?

The firm's capital structure refers to:

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 is known as:

A firm should select the capital structure which:

A levered firm is a company that has:

Introduction to Corporate Finance

Financial Statements and Cash Flow

Financial Statements Analysis and Financial Models

Discounted Cash Flow Valuation

Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, Real Options, and Capital Budgeting

Interest Rates and Bond Valuation

Stock Valuation

Risk and Return: Lessons From Market History

Return and Risk: the Capital Asset Pricing Model Capm

An Alternative View of Risk and Return: The Arbitrage Pricing Theory

Risk, Cost of Capital, and Valuation

Efficient Capital Markets and Behavioral Challenges

Long-Term Financing

Capital Structure: Limits to the Use of Debt

Valuation and Capital Budgeting for the Levered Firm

Dividends and Other Payouts

Raising Capital

Leasing

Options and Corporate Finance

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Derivatives and Hedging Risk

Short-Term Finance and Planning

Cash Management

Credit and Inventory Management

Mergers, Acquisitions, and Divestitures

Financial Distress

International Corporate Finance

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