Question 1

MM Proposition II,with taxes

Accepted Answer

A) reaches the final conclusion that the capital structure decision is irrelevant to the value of a firm. 
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) has the same general implications as MM Proposition II,without taxes. 
E) supports the argument that the cost of equity decreases as the debt-equity ratio increases. 
A) reaches the final conclusion that the capital structure decision is irrelevant to the value of a firm. 
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) has the same general implications as MM Proposition II,without taxes. 
E) supports the argument that the cost of equity decreases as the debt-equity ratio increases.

Question 2

Durbin,Inc.,is an unlevered firm with a total market value of $460,000 and 40,000 shares of stock outstanding.The firm has expected EBIT of $48,000 if the economy is normal and $56,000 if the economy booms.The firm is considering a bond issue of $57,500 with an attached interest rate of 6.8 percent.The bond proceeds will be used to repurchase shares.Ignore taxes.What will be the earnings per share after the repurchase if the economy booms?

Accepted Answer

A) $1.49 
B) $1.63 
C) $1.45 
D) $1.54 
E) $1.68 
A) $1.49 
B) $1.63 
C) $1.45 
D) $1.54 
E) $1.68

Question 3

If R0 exceeds RB then

Accepted Answer

A) RS increases with leverage. 
B) RWACC increases with leverage. 
C) RS decreases with leverage. 
D) RS remains constant as leverage changes. 
E) RS = RB. 
A) RS increases with leverage. 
B) RWACC increases with leverage. 
C) RS decreases with leverage. 
D) RS remains constant as leverage changes. 
E) RS = RB.

Question 4

Dakota Co.has expected earnings before interest and taxes of $37,800,an unlevered cost of capital of 12.2 percent,debt with a coupon rate of 5.6 percent,and both a book and face value of $24,000.The tax rate is 35 percent.What is the value of the firm?

Accepted Answer

A) $210,408.15 
B) $209,106.11 
C) $209,793.44 
D) $218,406.11 
E) $201,393.44 
A) $210,408.15 
B) $209,106.11 
C) $209,793.44 
D) $218,406.11 
E) $201,393.44

Question 5

A firm has zero debt and an overall cost of capital of 11.7 percent.The firm is considering a new capital structure with 45 percent debt at an interest rate of 6.8 percent.Assume there are no taxes or other imperfections.What will be the levered cost of equity?

Accepted Answer

A) 16.47% 
B) 14.67% 
C) 15.80% 
D) 15.71% 
E) 16.16% 
A) 16.47% 
B) 14.67% 
C) 15.80% 
D) 15.71% 
E) 16.16%

Question 6

A general rule for managers to follow is to establish a firm's capital structure such that the firm's

Accepted Answer

A) cost of equity is minimized. 
B) bondholders are fully secured. 
C) current market value is maximized. 
D) dividend payout is maximized. 
E) assets are minimized. 
A) cost of equity is minimized. 
B) bondholders are fully secured. 
C) current market value is maximized. 
D) dividend payout is maximized. 
E) assets are minimized.

Question 7

Which one of these represents the difference between the value of a levered and an unlevered firm?

Accepted Answer

A) R0 - RS 
B) RS × tcB 
C) VU + R × tcB 
D) (B / S)(1 - tc)( R0 - RS) 
E) tcB 
A) R0 - RS 
B) RS × tcB 
C) VU + R × tcB 
D) (B / S)(1 - tc)( R0 - RS) 
E) tcB

Question 8

An unlevered firm has expected earnings of $37,584 and a market value of equity of $324,000.The firm is planning to issue $65,000 of debt at 6.6 percent interest and use the proceeds to repurchase shares at their current market value.Ignore taxes.What will be the cost of equity after the repurchase?

Accepted Answer

A) 12.85% 
B) 13.58% 
C) 13.40% 
D) 12.04% 
E) 12.48% 
A) 12.85% 
B) 13.58% 
C) 13.40% 
D) 12.04% 
E) 12.48%

Question 9

In the absence of taxes,MM argues that

Accepted Answer

A) no one capital structure for a firm is superior to any other capital structure for that firm. 
B) the cost of equity for a levered firm is equal to the firm's unlevered WACC. 
C) homemade leverage is insufficient to offset a firm's use of leverage. 
D) the value of a levered firm exceeds the value of the unlevered firm. 
E) the cost of equity decreases as the debt-equity ratio increases. 
A) no one capital structure for a firm is superior to any other capital structure for that firm. 
B) the cost of equity for a levered firm is equal to the firm's unlevered WACC. 
C) homemade leverage is insufficient to offset a firm's use of leverage. 
D) the value of a levered firm exceeds the value of the unlevered firm. 
E) the cost of equity decreases as the debt-equity ratio increases.

Question 10

Which one of these events might cause the biggest challenge to the MM propositions?

Accepted Answer

A) An increase in the corporate tax rates 
B) A decrease in the cost of debt 
C) An increase in a firm's unlevered WACC 
D) A new law requiring equal lending rates for all borrowers 
E) A change in tax laws to treat interest and dividends equally 
A) An increase in the corporate tax rates 
B) A decrease in the cost of debt 
C) An increase in a firm's unlevered WACC 
D) A new law requiring equal lending rates for all borrowers 
E) A change in tax laws to treat interest and dividends equally

Question 11

Which one of these symbols is correctly matched with its definition?

Accepted Answer

A) tc: Taxable corporate income 
B) VU: Present value of unlevered firm 
C) R0: Levered cost of equity 
D) RWACC: Levered cost of equity 
E) RB: Weight of debt in the capital structure 
A) tc: Taxable corporate income 
B) VU: Present value of unlevered firm 
C) R0: Levered cost of equity 
D) RWACC: Levered cost of equity 
E) RB: Weight of debt in the capital structure

Question 12

An unlevered firm has a cost of capital of 13.8 percent and earnings before interest and taxes of $214,560.Assume the firm borrows $430,000 at an interest rate of 5.85 percent.The applicable tax rate is 35 percent.What is the value of the levered firm?

Accepted Answer

A) $1,209,518.70 
B) $1,007,018.11 
C) $1,161,108.70 
D) $1,246,082.19 
E) $1,105,018.11 
A) $1,209,518.70 
B) $1,007,018.11 
C) $1,161,108.70 
D) $1,246,082.19 
E) $1,105,018.11

Question 13

What does the present value of the tax shield from debt formula assume?

Accepted Answer

A) The interest rate on the debt is less than cost of equity. 
B) The debt will not be replaced when paid. 
C) Interest on the debt is paid only when the debt matures. 
D) The interest is paid semiannually. 
E) The debt is perpetual. 
A) The interest rate on the debt is less than cost of equity. 
B) The debt will not be replaced when paid. 
C) Interest on the debt is paid only when the debt matures. 
D) The interest is paid semiannually. 
E) The debt is perpetual.

Question 14

Bryan invested in Bryco stock when the firm was financed solely with equity.The firm is now utilizing debt in its capital structure.To unlever his position,Bryan needs to

Accepted Answer

A) borrow some money and purchase additional shares of Bryco stock. 
B) sell some shares of Bryco stock and loan out the sale proceeds. 
C) sell some shares of Bryco stock and hold the proceeds in cash. 
D) maintain his current position because the firm's use of leverage did not affect him. 
E) sell some of his shares and also borrow money to increase his cash reserves. 
A) borrow some money and purchase additional shares of Bryco stock. 
B) sell some shares of Bryco stock and loan out the sale proceeds. 
C) sell some shares of Bryco stock and hold the proceeds in cash. 
D) maintain his current position because the firm's use of leverage did not affect him. 
E) sell some of his shares and also borrow money to increase his cash reserves.

Question 15

Which one of these statements is correct?

Accepted Answer

A) There is no condition known to date whereby a corporation can increase firm value through the use of leverage. 
B) Corporations generally pay a lower cost on debt than do individuals due to their vast pool of liquid assets. 
C) If individuals pay a higher cost to borrow than corporations do,then corporations can increase firm value by borrowing. 
D) Margin accounts tend to be high interest rate sources of funds for individuals. 
E) Corporations can increase firm value by borrowing provided their interest rate on debt exceeds that paid by individuals. 
A) There is no condition known to date whereby a corporation can increase firm value through the use of leverage. 
B) Corporations generally pay a lower cost on debt than do individuals due to their vast pool of liquid assets. 
C) If individuals pay a higher cost to borrow than corporations do,then corporations can increase firm value by borrowing. 
D) Margin accounts tend to be high interest rate sources of funds for individuals. 
E) Corporations can increase firm value by borrowing provided their interest rate on debt exceeds that paid by individuals.

Question 16

Brown's is an unlevered firm with a total market value of $368,000 and 18,400 shares of stock outstanding.The firm has expected EBIT of $17,500 if the economy is normal and $19,000 if the economy booms.The firm is considering a bond issue of $120,000 with an attached interest rate of 5.9 percent.The bond proceeds will be used to repurchase shares.The tax rate is 34 percent.What will be the earnings per share after the repurchase if the economy booms?

Accepted Answer

A) $0.92 
B) $0.84 
C) $0.75 
D) $0.59 
E) $0.63 
A) $0.92 
B) $0.84 
C) $0.75 
D) $0.59 
E) $0.63

Question 17

In an EPS-EBI graphical relationship,the debt line and the no debt line intersect.Which one of these is true at the intersection point?

Accepted Answer

A) The advantages of debt outweigh the disadvantages of debt. 
B) The aftertax earnings of both capital structures are equal. 
C) The earnings per share for both capital structures equal zero. 
D) There is no advantage or disadvantage to debt. 
E) The EPS is maximized for both the levered and the unlevered firm. 
A) The advantages of debt outweigh the disadvantages of debt. 
B) The aftertax earnings of both capital structures are equal. 
C) The earnings per share for both capital structures equal zero. 
D) There is no advantage or disadvantage to debt. 
E) The EPS is maximized for both the levered and the unlevered firm.

Question 18

Delta Mills and Franklin Mill are identical firms except for their capital structures.Delta is an unlevered firm with $680,000 of equity.Franklin is a levered firm with $425,000 of equity and $255,000 of debt at an interest rate of 6.2 percent.Both Delta and Franklin have an expected EBIT of $84,000.Ignore taxes.Delta has a WACC of ________ percent and Franklin's WACC is ________ percent.

Accepted Answer

A) 12.35; 11.05 
B) 12.35; 14.10 
C) 12.35; 12.35 
D) 14.10; 14.10 
E) 16.10; 14.10 
A) 12.35; 11.05 
B) 12.35; 14.10 
C) 12.35; 12.35 
D) 14.10; 14.10 
E) 16.10; 14.10

Question 19

The fact that interest payments on debt are tax deductible is a key factor in which of these propositions?

Accepted Answer

A) Both MM Proposition I and II,with taxes 
B) MM Proposition I,without tax 
C) MM Proposition II,without tax 
D) MM Proposition I,with tax 
E) MM Proposition II,with tax 
A) Both MM Proposition I and II,with taxes 
B) MM Proposition I,without tax 
C) MM Proposition II,without tax 
D) MM Proposition I,with tax 
E) MM Proposition II,with tax

Question 20

Consider the pie models of corporate structure.What is the difference between the all-equity pie and the levered pie for a firm in the presence of taxes?

Accepted Answer

A) The size of the levered pie is smaller than the all-equity pie. 
B) Taxes eat a slice of the levered pie but pass by the all-equity pie. 
C) Both pies are the same size and are sliced identically. 
D) Taxes eat a slice of both pies but take a larger slice of the all-equity pie. 
E) The all-equity pie is smaller in size than the levered pie. 
A) The size of the levered pie is smaller than the all-equity pie. 
B) Taxes eat a slice of the levered pie but pass by the all-equity pie. 
C) Both pies are the same size and are sliced identically. 
D) Taxes eat a slice of both pies but take a larger slice of the all-equity pie. 
E) The all-equity pie is smaller in size than the levered pie.

MM Proposition II,with taxes

If R₀ exceeds R_B then

Dakota Co.has expected earnings before interest and taxes of $37,800,an unlevered cost of capital of 12.2 percent,debt with a coupon rate of 5.6 percent,and both a book and face value of $24,000.The tax rate is 35 percent.What is the value of the firm?

A firm has zero debt and an overall cost of capital of 11.7 percent.The firm is considering a new capital structure with 45 percent debt at an interest rate of 6.8 percent.Assume there are no taxes or other imperfections.What will be the levered cost of equity?

A general rule for managers to follow is to establish a firm's capital structure such that the firm's

Which one of these represents the difference between the value of a levered and an unlevered firm?

An unlevered firm has expected earnings of $37,584 and a market value of equity of $324,000.The firm is planning to issue $65,000 of debt at 6.6 percent interest and use the proceeds to repurchase shares at their current market value.Ignore taxes.What will be the cost of equity after the repurchase?

In the absence of taxes,MM argues that

Which one of these events might cause the biggest challenge to the MM propositions?

Which one of these symbols is correctly matched with its definition?

An unlevered firm has a cost of capital of 13.8 percent and earnings before interest and taxes of $214,560.Assume the firm borrows $430,000 at an interest rate of 5.85 percent.The applicable tax rate is 35 percent.What is the value of the levered firm?

What does the present value of the tax shield from debt formula assume?

Bryan invested in Bryco stock when the firm was financed solely with equity.The firm is now utilizing debt in its capital structure.To unlever his position,Bryan needs to

Which one of these statements is correct?

In an EPS-EBI graphical relationship,the debt line and the no debt line intersect.Which one of these is true at the intersection point?

The fact that interest payments on debt are tax deductible is a key factor in which of these propositions?

Consider the pie models of corporate structure.What is the difference between the all-equity pie and the levered pie for a firm in the presence of taxes?

Introduction to Corporate Finance

Financial Statements and Cash Flow

Financial Statements Analysis and Financial Models

Discounted Cash Flow Valuation

Interest Rates and Bond Valuation

Stock 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

Return and Risk: The Capital Asset Pricing Model Capm

Risk, Cost of Capital, and Valuation

Efficient Capital Markets and Behavioral Challenges

Capital Structure: Limits to the Use of Debt

Dividends and Other Payouts

Options and Corporate Finance

Short-Term Finance and Planning

Raising Capital

International Corporate Finance

Mergers and Acquisitions Web Only

Filters

Exam 14: Capital Structure: Basic Concepts

MM Proposition II,with taxes

If R0 exceeds RB then

Dakota Co.has expected earnings before interest and taxes of $37,800,an unlevered cost of capital of 12.2 percent,debt with a coupon rate of 5.6 percent,and both a book and face value of $24,000.The tax rate is 35 percent.What is the value of the firm?

A firm has zero debt and an overall cost of capital of 11.7 percent.The firm is considering a new capital structure with 45 percent debt at an interest rate of 6.8 percent.Assume there are no taxes or other imperfections.What will be the levered cost of equity?

A general rule for managers to follow is to establish a firm's capital structure such that the firm's

Which one of these represents the difference between the value of a levered and an unlevered firm?

In the absence of taxes,MM argues that

Which one of these events might cause the biggest challenge to the MM propositions?

Which one of these symbols is correctly matched with its definition?

An unlevered firm has a cost of capital of 13.8 percent and earnings before interest and taxes of $214,560.Assume the firm borrows $430,000 at an interest rate of 5.85 percent.The applicable tax rate is 35 percent.What is the value of the levered firm?

What does the present value of the tax shield from debt formula assume?

Bryan invested in Bryco stock when the firm was financed solely with equity.The firm is now utilizing debt in its capital structure.To unlever his position,Bryan needs to

Which one of these statements is correct?

In an EPS-EBI graphical relationship,the debt line and the no debt line intersect.Which one of these is true at the intersection point?

The fact that interest payments on debt are tax deductible is a key factor in which of these propositions?

Consider the pie models of corporate structure.What is the difference between the all-equity pie and the levered pie for a firm in the presence of taxes?

Introduction to Corporate Finance

Financial Statements and Cash Flow

Financial Statements Analysis and Financial Models

Discounted Cash Flow Valuation

Interest Rates and Bond Valuation

Stock 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

Return and Risk: The Capital Asset Pricing Model Capm

Risk, Cost of Capital, and Valuation

Efficient Capital Markets and Behavioral Challenges

Capital Structure: Limits to the Use of Debt

Dividends and Other Payouts

Options and Corporate Finance

Short-Term Finance and Planning

Raising Capital

International Corporate Finance

Mergers and Acquisitions Web Only

Filters

If R₀ exceeds R_B then