Question 1

A manager should attempt to maximize the value of the firm by:

Accepted Answer

A)  changing the capital structure if and only if the value of the firm increases. 
B)  changing the capital structure if and only if the value of the firm increases to the benefit of inside management. 
C)  changing the capital structure if and only if the value of the firm increases only to the benefits of the debtholders. 
D)  changing the capital structure if and only if the value of the firm increases although it decreases the stockholders' value. 
E)  changing the capital structure if and only if the value of the firm increases and stockholder wealth is constant. 
A)  changing the capital structure if and only if the value of the firm increases. 
B)  changing the capital structure if and only if the value of the firm increases to the benefit of inside management. 
C)  changing the capital structure if and only if the value of the firm increases only to the benefits of the debtholders. 
D)  changing the capital structure if and only if the value of the firm increases although it decreases the stockholders' value. 
E)  changing the capital structure if and only if the value of the firm increases and stockholder wealth is constant.

Question 2

MM Proposition I with corporate taxes states that:

Accepted Answer

A)  capital structure can affect firm value. 
B)  by raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value. 
C)  firm value is maximized at an all debt capital structure. 
D)  All of these. 
E)  None of these. 
A)  capital structure can affect firm value. 
B)  by raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value. 
C)  firm value is maximized at an all debt capital structure. 
D)  All of these. 
E)  None of these.

Question 3

The tax savings of the firm derived from the deductibility of interest expense is called the:

Accepted Answer

A)  interest tax shield. 
B)  depreciable basis. 
C)  financing umbrella. 
D)  current yield. 
E)  tax-loss carry forward savings. 
A)  interest tax shield. 
B)  depreciable basis. 
C)  financing umbrella. 
D)  current yield. 
E)  tax-loss carry forward savings.

Question 4

When comparing levered vs. unlevered capital structures,leverage works to increase EPS for high levels of EBIT because:

Accepted Answer

A)  interest payments on the debt vary with EBIT levels. 
B)  interest payments on the debt stay fixed, leaving less income to be distributed over less shares. 
C)  interest payments on the debt stay fixed, leaving more income to be distributed over less shares. 
D)  interest payments on the debt stay fixed, leaving less income to be distributed over more shares. 
E)  interest payments on the debt stay fixed, leaving more income to be distributed over more shares. 
A)  interest payments on the debt vary with EBIT levels. 
B)  interest payments on the debt stay fixed, leaving less income to be distributed over less shares. 
C)  interest payments on the debt stay fixed, leaving more income to be distributed over less shares. 
D)  interest payments on the debt stay fixed, leaving less income to be distributed over more shares. 
E)  interest payments on the debt stay fixed, leaving more income to be distributed over more shares.

Question 5

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?

Accepted Answer

Under either MM scenario,the financial m

Question 6

Jasmine'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 7

Uptown Interior Designs is an all equity firm that has 40,000 shares of stock outstanding. The company has decided to borrow $1 million to buy out the shares of a deceased stockholder who holds 2,500 shares. What is the total value of this firm if you ignore taxes?

Accepted Answer

A)  $15.5 million 
B)  $15.6 million 
C)  $16.0 million 
D)  $16.8 million 
E)  $17.2 million 
A)  $15.5 million 
B)  $15.6 million 
C)  $16.0 million 
D)  $16.8 million 
E)  $17.2 million

Question 8

Salmon Inc. has debt with both a face and a market value of $3,000. This debt has a coupon rate of 7% and pays interest annually. The expected earnings before interest and taxes is $1,200,the tax rate is 34%,and the unlevered cost of capital is 12%. What is the firm's cost of equity?

Accepted Answer

A)  13.25% 
B)  13.89% 
C)  13.92% 
D)  14.14% 
E)  14.25% 
A)  13.25% 
B)  13.89% 
C)  13.92% 
D)  14.14% 
E)  14.25%

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

Alexandria's Dance Studio is currently an all equity firm that has 60,000 shares of stock outstanding with a market price of $24 a share. The current cost of equity is 11% and the tax rate is 40%. Alexandria is considering adding $2 million of debt with a coupon rate of 7% to her capital structure. The debt will be sold at par value. What is the levered value of the equity?

Accepted Answer

A)  $.12 million 
B)  $.24 million 
C)  $1.12 million 
D)  $2.24 million 
E)  $2.84 million 
A)  $.12 million 
B)  $.24 million 
C)  $1.12 million 
D)  $2.24 million 
E)  $2.84 million

Question 11

The cost of capital for a firm,R-WACC,in a zero tax environment is:

Accepted Answer

A)  equal to the expected earnings divided by market value of the unlevered firm. 
B)  equal to the rate of return for that business risk class. 
C)  equal to the overall rate of return required on the levered firm. 
D)  is constant regardless of the amount of leverage. 
E)  All of 
A)  equal to the expected earnings divided by market value of the unlevered firm. 
B)  equal to the rate of return for that business risk class. 
C)  equal to the overall rate of return required on the levered firm. 
D)  is constant regardless of the amount of leverage. 
E)  All of

Exam 16: Capital Structure: Basic Concepts

A manager should attempt to maximize the value of the firm by:

MM Proposition I with corporate taxes states that:

The tax savings of the firm derived from the deductibility of interest expense is called the:

When comparing levered vs. unlevered capital structures,leverage works to increase EPS for high levels of EBIT because:

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?

Jasmine'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%?

Uptown Interior Designs is an all equity firm that has 40,000 shares of stock outstanding. The company has decided to borrow $1 million to buy out the shares of a deceased stockholder who holds 2,500 shares. What is the total value of this firm if you ignore taxes?

Salmon Inc. has debt with both a face and a market value of $3,000. This debt has a coupon rate of 7% and pays interest annually. The expected earnings before interest and taxes is $1,200,the tax rate is 34%,and the unlevered cost of capital is 12%. What is the firm's cost of equity?

MM Proposition II with taxes:

The cost of capital for a firm,R-WACC,in a zero tax environment is:

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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