Exam 16: Financial Leverage and Capital Structure Policy

Georga's Restaurants has 5,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 8.25 percent.The interest is paid semi-annually.What is the amount of the annual interest tax shield if the tax rate is 37 percent?

Winter's Toyland has a debt-equity ratio of 0.65.The pre-tax cost of debt is 8.7 percent and the required return on assets is 16.1 percent.What is the cost of equity if you ignore taxes?

W.V.Trees,Inc.has a debt-equity ratio of 1.4.Its WACC is 10 percent,and its cost of debt is 9 percent.The corporate tax rate is 33 percent.What is the firm's unlevered cost of equity capital?

The Green Paddle has a cost of equity of 12.1 percent and a pre-tax cost of debt of 7.6 percent.The debt-equity ratio is 0.65 and the tax rate is 32 percent.What is Green Paddle's unlevered cost of capital?

Kelso Electric is debating between a leveraged and an unleveraged capital structure.The all equity capital structure would consist of 40,000 shares of stock.The debt and equity option would consist of 25,000 shares of stock plus $280,000 of debt with an interest rate of 7 percent.What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes.

Which of the following are correct according to pecking-order theory? I.Firms stockpile internally-generated cash. II.There is an inverse relationship between a firm's profit level and its debt level. III.Firms avoid external debt at all costs. IV.A firm's capital structure is dictated by its need for external financing.

Pewter & Glass is an all equity firm that has 80,000 shares of stock outstanding.The company is in the process of borrowing $600,000 at 9 percent interest to repurchase 12,000 shares of the outstanding stock.What is the value of this firm if you ignore taxes?

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs.

Which form of financing do firms prefer to use first according to the pecking-order theory?

Which one of the following is the legal proceeding under which an insolvent firm can be reorganized?

Bankruptcy:

AA Tours is comparing two capital structures to determine how to best finance its operations.The first option consists of all equity financing.The second option is based on a debt-equity ratio of 0.45.What should AA Tours do if its expected earnings before interest and taxes (EBIT)are less than the break-even level? Assume there are no taxes.

In general,the capital structures used by U.S.firms:

Draw the following two graphs,one above the other: In the top graph,plot firm value on the vertical axis and total debt on the horizontal axis.Use this graph to illustrate the value of a firm under M & M without taxes,M & M with taxes,and the static theory of capital structure.On the lower graph,plot the WACC on the vertical axis and the debt-equity ratio on the horizontal axis.Use this second graph to illustrate the value of the firm's WACC under M & M without taxes,M & M with taxes,and the static theory.Briefly explain what the two graphs reveal about firm value and its cost of capital under the three different theories.

The June Bug has a $270,000 bond issue outstanding.These bonds have a 7.5 percent coupon,pay interest semiannually,and have a current market price equal to 98.6 percent of face value.The tax rate is 39 percent.What is the amount of the annual interest tax shield?

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

Pete is the CFO of Dexter International.He would like to increase the debt-equity ratio of the firm but is concerned that the firm's shareholders may not be willing to accept additional financial leverage.Pete has come to you for advice.What is your recommendation?

Which one of the following states that a firm's cost of equity capital is directly and proportionally related to the firm's capital structure?