Question 1

Financial leverage impacts the performance of the firm by:

Accepted Answer

A) increasing the volatility of the firm's EBIT. 
B) decreasing the volatility of the firm's EBIT. 
C) decreasing the volatility of the firm's net income. 
D) increasing the volatility of the firm's net income 
E) None of the above. 
A) increasing the volatility of the firm's EBIT. 
B) decreasing the volatility of the firm's EBIT. 
C) decreasing the volatility of the firm's net income. 
D) increasing the volatility of the firm's net income 
E) None of the above.

Question 2

MM Proposition I with no tax supports the argument that:

Accepted Answer

A) business risk determines the return on assets. 
B) the cost of equity rises as leverage rises. 
C) it is completely irrelevant how a firm arranges its finances. 
D) a firm should borrow money to the point where the tax benefit from debt is equal to the cost of the increased probability of financial distress. 
E) financial risk is determined by the debt-equity ratio. 
A) business risk determines the return on assets. 
B) the cost of equity rises as leverage rises. 
C) it is completely irrelevant how a firm arranges its finances. 
D) a firm should borrow money to the point where the tax benefit from debt is equal to the cost of the increased probability of financial distress. 
E) financial risk is determined by the debt-equity ratio.

Question 3

Which of the following statements are correct in relation to MM Proposition II with no taxes?
I.The 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.

Accepted Answer

A) I and III only 
B) II and IV only 
C) I and II only 
D) III and IV only 
E) I and IV only 
A) I and III only 
B) II and IV only 
C) I and II only 
D) III and IV only 
E) I and IV only

Question 4

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 Suppose the tax authorities allow firms to...

Question 5

Scott's Leisure Time Sports is an unlevered firm with an after-tax net income of $94,600.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 6

Anderson's Furniture Outlet has an unlevered cost of capital of 10%,a tax rate of 34%,and expected earnings before interest and taxes of $1,600.The company has $3,000 in bonds outstanding that have an 8% coupon and pay interest annually.The bonds are selling at par value.What is the cost of equity?

Accepted Answer

A) 8.67% 
B) 9.34% 
C) 9.72% 
D) 9.99% 
E) 10.46% 
A) 8.67% 
B) 9.34% 
C) 9.72% 
D) 9.99% 
E) 10.46%

Question 7

MM Proposition I with taxes supports the theory that:

Accepted Answer

A) the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield. 
B) the value of a firm is inversely related to the amount of leverage used by the firm. 
C) there is a positive linear relationship between the amount of debt in a levered firm and its value. 
D) a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm. 
E) a firm's weighted average cost of capital increases as the debt-equity ratio of the firm rises. 
A) the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield. 
B) the value of a firm is inversely related to the amount of leverage used by the firm. 
C) there is a positive linear relationship between the amount of debt in a levered firm and its value. 
D) a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm. 
E) a firm's weighted average cost of capital increases as the debt-equity ratio of the firm rises.

Question 8

Juanita's Steak House has $14,000 of debt outstanding that is selling at par and has a coupon rate of 8%.The tax rate is 34%.What is the present value of the tax shield?

Accepted Answer

A) $2,823 
B) $2,887 
C) $4,080 
D) $4,500 
E) $4,760 
A) $2,823 
B) $2,887 
C) $4,080 
D) $4,500 
E) $4,760

Question 9

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

Question 10

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?

Accepted Answer

A) $696,429 
B) $907,679 
C) $941,429 
D) $1,184,929 
E) $1,396,429 
A) $696,429 
B) $907,679 
C) $941,429 
D) $1,184,929 
E) $1,396,429

Question 11

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

Accepted Answer

A) that individuals must be able to borrow on their own account at rates equal to the firm. 
B) managers are acting to maximize the value of the firm. 
C) that financial leverage increases risk. 
D) that individuals can borrow on their own account at rates less than the firm. 
E) All of the above. 
A) that individuals must be able to borrow on their own account at rates equal to the firm. 
B) managers are acting to maximize the value of the firm. 
C) that financial leverage increases risk. 
D) that individuals can borrow on their own account at rates less than the firm. 
E) All of the above.

Question 12

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 the above. 
E) None of the above. 
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 the above. 
E) None of the above.

Question 13

The unlevered cost of capital is:

Accepted Answer

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

Question 14

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

Accepted Answer

A) 10.0% 
B) 13.5% 
C) 14.4% 
D) 18.0% 
E) None of the above. 
A) 10.0% 
B) 13.5% 
C) 14.4% 
D) 18.0% 
E) None of the above.

Question 15

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) supports the argument that the cost of equity decreases as the debt-equity ratio increases. 
E) has the same general implications as MM Proposition II without taxes. 
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) supports the argument that the cost of equity decreases as the debt-equity ratio increases. 
E) has the same general implications as MM Proposition II without taxes.

Question 16

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

Accepted Answer

A) 10.3% 
B) 11.0% 
C) 11.2% 
D) 13.9% 
E) None of the above. 
A) 10.3% 
B) 11.0% 
C) 11.2% 
D) 13.9% 
E) None of the above.

Question 17

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

Accepted Answer

A) equivalent with respect to EPS but above and below this point equity is always superior. 
B) at breakeven and MM Proposition II states that debt is the better choice. 
C) equal but away from breakeven equity is better as fewer shares are outstanding. 
D) at breakeven in EPS but above this point debt increases EPS via leverage and decreases EPS below this point. 
E) at breakeven and debt is the better choice below breakeven because small payments can be made. 
A) equivalent with respect to EPS but above and below this point equity is always superior. 
B) at breakeven and MM Proposition II states that debt is the better choice. 
C) equal but away from breakeven equity is better as fewer shares are outstanding. 
D) at breakeven in EPS but above this point debt increases EPS via leverage and decreases EPS below this point. 
E) at breakeven and debt is the better choice below breakeven because small payments can be made.

Question 18

The cost of capital for a firm,rWACC,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 the above. 
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 the above.

Question 19

Explain homemade leverage and why it matters.

Accepted Answer

Homemade leverage is the ability of inve

Question 20

Bigelow,Inc.has a cost of equity of 13.00% and a pre-tax cost of debt of 7%.The required return on the assets is 11%.What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

Accepted Answer

A) .50 
B) .64 
C) .72 
D) .75 
E) .80 
A) .50 
B) .64 
C) .72 
D) .75 
E) .80

Financial leverage impacts the performance of the firm by:

MM Proposition I with no tax supports the argument that:

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.

Scott's Leisure Time Sports is an unlevered firm with an after-tax net income of $94,600.The unlevered cost of capital is 10% and the tax rate is 34%.What is the value of this firm?

Anderson's Furniture Outlet has an unlevered cost of capital of 10%,a tax rate of 34%,and expected earnings before interest and taxes of $1,600.The company has $3,000 in bonds outstanding that have an 8% coupon and pay interest annually.The bonds are selling at par value.What is the cost of equity?

MM Proposition I with taxes supports the theory that:

Juanita's Steak House has $14,000 of debt outstanding that is selling at par and has a coupon rate of 8%.The tax rate is 34%.What is the present value of the tax shield?

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

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

MM Proposition I with corporate taxes states that:

The unlevered cost of capital is:

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

MM Proposition II with taxes:

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

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

The cost of capital for a firm,r_WACC,in a zero tax environment is:

Explain homemade leverage and why it matters.

Bigelow,Inc.has a cost of equity of 13.00% and a pre-tax cost of debt of 7%.The required return on the assets is 11%.What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

Introduction to Corporate Finance

Financial Statements Cash Flow

Financial Statements Analysis and Long-Term Planning

Discounted Cash Flow Valuation

Interest Rate 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 Capital Budgeting

Efficient Capital Markets and Behavioral Challenges

Capital Structure: Limits to the Use of Debt

Dividend and Other Payouts

Options and Corporate Finance

Short-Term Finance and Planning

Raising Capital

International Corporate Finance

Filters

Exam 14: Capital Structure: Basic Concepts

Financial leverage impacts the performance of the firm by:

MM Proposition I with no tax supports the argument that:

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.

Scott's Leisure Time Sports is an unlevered firm with an after-tax net income of $94,600.The unlevered cost of capital is 10% and the tax rate is 34%.What is the value of this firm?

Anderson's Furniture Outlet has an unlevered cost of capital of 10%,a tax rate of 34%,and expected earnings before interest and taxes of $1,600.The company has $3,000 in bonds outstanding that have an 8% coupon and pay interest annually.The bonds are selling at par value.What is the cost of equity?

MM Proposition I with taxes supports the theory that:

Juanita's Steak House has $14,000 of debt outstanding that is selling at par and has a coupon rate of 8%.The tax rate is 34%.What is the present value of the tax shield?

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

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

MM Proposition I with corporate taxes states that:

The unlevered cost of capital is:

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

MM Proposition II with taxes:

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

The cost of capital for a firm,rWACC,in a zero tax environment is:

Explain homemade leverage and why it matters.

Bigelow,Inc.has a cost of equity of 13.00% and a pre-tax cost of debt of 7%.The required return on the assets is 11%.What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

Introduction to Corporate Finance

Financial Statements Cash Flow

Financial Statements Analysis and Long-Term Planning

Discounted Cash Flow Valuation

Interest Rate 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 Capital Budgeting

Efficient Capital Markets and Behavioral Challenges

Capital Structure: Limits to the Use of Debt

Dividend and Other Payouts

Options and Corporate Finance

Short-Term Finance and Planning

Raising Capital

International Corporate Finance

Filters

The cost of capital for a firm,r_WACC,in a zero tax environment is: