Question 1

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Accepted Answer

A) Strategic risk 
B) Financial risk 
C) Liquidity risk 
D) Industry risk 
E) Business risk 
A) Strategic risk 
B) Financial risk 
C) Liquidity risk 
D) Industry risk 
E) Business risk B

Question 2

Chick 'N Fish is considering two different capital structures.The first option is an all-equity firm with22,500 shares of stock.The second option consists of 18,750 shares of stock plus $120,000 of debt at an interest rate of 7.8 percent.Ignore taxes.What is the break-even level of earnings before interest and taxes (EBIT)between these two options?

Accepted Answer

A) $62,813 
B) $54,204 
C) $60,410 
D) $56,150 
E) $61,290 
A) $62,813 
B) $54,204 
C) $60,410 
D) $56,150 
E) $61,290 D

Question 3

Sand Mountain Resort has a tax rate of 32 percent.Its total interest payment for the year just ended was $41,000.What is the interest tax shield for the year?

Accepted Answer

A) $27,590 
B) $13,120 
C) $13,410 
D) 427,880 
E) $41,000 
A) $27,590 
B) $13,120 
C) $13,410 
D) 427,880 
E) $41,000 B

Question 4

Ernst Electrical has 7,500 shares of stock outstanding and no debt.The new CFO is considering issuing $50,000 of debt and using the proceeds to retire 600 shares of stock.The coupon rate on the debt is 8.5 percent.What is the break-even level of earnings before interest and taxes between these two capital structure options?

Accepted Answer

A) $48,360 
B) $50,020 
C) $49,740 
D) $52,500 
E) $53,125 
A) $48,360 
B) $50,020 
C) $49,740 
D) $52,500 
E) $53,125

Question 5

Green Tea House has a tax rate of 35 percent and an interest tax shield valued at $8,046 for the year.How much did the firm pay in annual interest?

Accepted Answer

A) $2,816.10 
B) $2,304.11 
C) $23,468.09 
D) $21,107.99 
E) $22,988.57 
A) $2,816.10 
B) $2,304.11 
C) $23,468.09 
D) $21,107.99 
E) $22,988.57

Question 6

Stevenson's Bakery is an all-equity company that has projected perpetual earnings before interest and taxes of $43,700 a year.The cost of equity is 15.2 percent and the tax rate is 34 percent.The company can borrow money at 7.15 percent.If the company borrows $50,000,what will be its levered value?

Accepted Answer

A) $187,613 
B) $189,919 
C) $206,750 
D) $229,507 
E) $203,682 
A) $187,613 
B) $189,919 
C) $206,750 
D) $229,507 
E) $203,682

Question 7

Forbidden Fruit Extracts expects its earnings before interest and taxes to be $287,600 a year forever.Currently,the firm has no debt.The cost of equity is 15.4 percent and the tax rate is 34 percent.The company is in the process of issuing $3 million of bonds at par that carry an annual coupon rate of 7.6 percent.What is the unlevered value of the firm?

Accepted Answer

A) $1,371,429 
B) $1,331,971 
C) $1,107,405 
D) $969,325 
E) $1,232,571 
A) $1,371,429 
B) $1,331,971 
C) $1,107,405 
D) $969,325 
E) $1,232,571

Question 8

Marcos & Sons has no debt.Its current total value is $13 million.What will the company's value be if it sells $5 million in debt and has a tax rate of 35 percent? Assume all debt proceeds are used to repurchase equity.

Accepted Answer

A) $16.25 million 
B) $18.00 million 
C) $11.25 million 
D) $13.00 million 
E) $14.75 million 
A) $16.25 million 
B) $18.00 million 
C) $11.25 million 
D) $13.00 million 
E) $14.75 million

Question 9

Delta Mowers has a debt-equity ratio of .6.Its WACC is 11.8 percent,and its cost of debt is 7.7 percent.There is no corporate tax.What is the firm's cost of equity capital?

Accepted Answer

A) 12.60 percent 
B) 14.26 percent 
C) 13.83 percent 
D) 14.29 percent 
E) 14.80 percent 
A) 12.60 percent 
B) 14.26 percent 
C) 13.83 percent 
D) 14.29 percent 
E) 14.80 percent

Question 10

M& M Proposition II,without taxes,states that the:

Accepted Answer

A) capital structure of a firm is highly relevant. 
B) weighted average cost of capital decreases as the debt-equity ratio decreases. 
C) cost of equity increases as a firm increases its debt-equity ratio. 
D) return on equity is equal to the return on assets multiplied by the debt-equity ratio. 
E) return on equity remains constant as the debt-equity ratio increases. 
A) capital structure of a firm is highly relevant. 
B) weighted average cost of capital decreases as the debt-equity ratio decreases. 
C) cost of equity increases as a firm increases its debt-equity ratio. 
D) return on equity is equal to the return on assets multiplied by the debt-equity ratio. 
E) return on equity remains constant as the debt-equity ratio increases.

Question 11

A firm is considering two different capital structures.The first option is an all-equity firm with 40,000 shares of stock.The second option is 28,000 shares of stock plus some debt.Ignoring taxes,the break-even level of earnings before interest and taxes between these two options is $52,000.How much money is the firm considering borrowing if the interest rate is 9 percent?

Accepted Answer

A) $175,000 
B) $173,333 
C) $208,333 
D) $216,667 
E) $225,000 
A) $175,000 
B) $173,333 
C) $208,333 
D) $216,667 
E) $225,000

Question 12

You are comparing two possible capital structures for a firm.The first option is an all-equity firm.The second option involves the use of $3.8 million of debt.The break-even point between these two financing options occurs when the earnings before interest and taxes (EBIT)are $428,000.Given this,you know that leverage is beneficial to the firm:

Accepted Answer

A) whenever EBIT is less than $428,000. 
B) only when EBIT is $428,000. 
C) whenever EBIT exceeds $428,000. 
D) only if the debt is decreased by $428,000. 
E) only if the debt is increased by $428,000 
A) whenever EBIT is less than $428,000. 
B) only when EBIT is $428,000. 
C) whenever EBIT exceeds $428,000. 
D) only if the debt is decreased by $428,000. 
E) only if the debt is increased by $428,000

Question 13

The Park Place has a return on assets of 12.9 percent,a cost of equity of 16.2 percent,and a pretax cost of debt of 7.7 percent.What is the debt-equity ratio? Ignore taxes.

Accepted Answer

A) .44 
B) .47 
C) .67 
D) .91 
E) .63 
A) .44 
B) .47 
C) .67 
D) .91 
E) .63

Question 14

Northern Wood Products is an all-equity firm with 14,000 shares of stock outstanding and a total market value of $585,480.Based on its current capital structure,the firm is expected to have earnings before interest and taxes of $46,800 if the economy is normal,$21,200 if the economy is in a recession,and $56,000 if the economy booms.Ignore taxes.Management is considering issuing $150,000 of debt at a coupon rate of 7 percent.If the firm issues the debt,the proceeds will be used to repurchase stock.What will the earnings per share be if the debt is issued and the economy is in a recession? (Round the number of shares repurchased down to the nearest whole share.)

Accepted Answer

A) $.97 
B) $1.03 
C) $1.36 
D) $.88 
E) $.68 
A) $.97 
B) $1.03 
C) $1.36 
D) $.88 
E) $.68

Question 15

Granny's Home Remedy has a $27 million bond issue outstanding with a coupon rate of 8.75 percent and a current yield of 8.13 percent.What is the present value of the tax shield if the tax rate is 35 percent?

Accepted Answer

A) $768,285 
B) $826,875 
C) $839,002 
D) $8,160,000 
E) $9,450,000 
A) $768,285 
B) $826,875 
C) $839,002 
D) $8,160,000 
E) $9,450,000

Question 16

The Bethlehem Inn is an all-equity firm with 9,000 shares outstanding at a value per share of $26.80.The firm is issuing $39,932 of debt and using the proceeds to reduce the number of outstanding shares.How many shares of stock will be outstanding once the debt is issued? Ignore taxes.

Accepted Answer

A) 7,970 shares 
B) 7,510 shares 
C) 7,846 shares 
D) 8,030 shares 
E) 7,561 shares 
A) 7,970 shares 
B) 7,510 shares 
C) 7,846 shares 
D) 8,030 shares 
E) 7,561 shares

Question 17

Shoe Box Stores is currently an all-equity firm with 25,000 shares of stock outstanding.Management is considering changing the capital structure to 35 percent debt.The interest rate on the debt would be 8 percent.Ignore taxes.Jamie owns 600 shares of Shoe Box Stores stock that is priced at $22 a share.What should Jamie do if she prefers the all-equity structure but Shoe Box Stores adopts the new capital structure?

Accepted Answer

A) Borrow money and buy an additional 180 shares 
B) Borrow money and buy an additional 210 shares 
C) Keep her shares but loan out all of the dividend income at 8 percent 
D) Sell 210 shares and loan out the proceeds at 8 percent 
E) Sell 180 shares and loan out the proceeds at 8 percent 
A) Borrow money and buy an additional 180 shares 
B) Borrow money and buy an additional 210 shares 
C) Keep her shares but loan out all of the dividend income at 8 percent 
D) Sell 210 shares and loan out the proceeds at 8 percent 
E) Sell 180 shares and loan out the proceeds at 8 percent

Question 18

Which one of the following will generally receive the highest priority in a bankruptcy liquidation,assuming the absolute priority rule is followed?

Accepted Answer

A) Claims by unsecured creditors 
B) Employee wages 
C) Government tax claims 
D) Contributions to employee retirement plans 
E) Bankruptcy administrative expenses 
A) Claims by unsecured creditors 
B) Employee wages 
C) Government tax claims 
D) Contributions to employee retirement plans 
E) Bankruptcy administrative expenses

Question 19

Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases?

Accepted Answer

A) M&M Proposition I without taxes 
B) M&M Proposition II without taxes 
C) M& MProposition I with taxes 
D) Static theory of capital structure 
E) No theory suggests this 
A) M&M Proposition I without taxes 
B) M&M Proposition II without taxes 
C) M& MProposition I with taxes 
D) Static theory of capital structure 
E) No theory suggests this

Question 20

Bruno's is considering changing from its current all-equity capital structure to 30 percent debt.There are currently 7,500 shares outstanding at a price per share of $39.EBIT is expected to remain constant at $23,000.The interest rate on new debt is 7.5 percent and there are no taxes.Tracie owns $12,675 worth of stock in the company.The firm has a 100 percent payout.What would Tracie's cash flow be under the new capital structure assuming that she keeps all of her shares?

Accepted Answer

A) $998 
B) $1,109 
C) $1,115 
D) $1,037 
E) $1,016 
A) $998 
B) $1,109 
C) $1,115 
D) $1,037 
E) $1,016

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Sand Mountain Resort has a tax rate of 32 percent.Its total interest payment for the year just ended was $41,000.What is the interest tax shield for the year?

Green Tea House has a tax rate of 35 percent and an interest tax shield valued at $8,046 for the year.How much did the firm pay in annual interest?

Stevenson's Bakery is an all-equity company that has projected perpetual earnings before interest and taxes of $43,700 a year.The cost of equity is 15.2 percent and the tax rate is 34 percent.The company can borrow money at 7.15 percent.If the company borrows $50,000,what will be its levered value?

Marcos & Sons has no debt.Its current total value is $13 million.What will the company's value be if it sells $5 million in debt and has a tax rate of 35 percent? Assume all debt proceeds are used to repurchase equity.

Delta Mowers has a debt-equity ratio of .6.Its WACC is 11.8 percent,and its cost of debt is 7.7 percent.There is no corporate tax.What is the firm's cost of equity capital?

M& M Proposition II,without taxes,states that the:

The Park Place has a return on assets of 12.9 percent,a cost of equity of 16.2 percent,and a pretax cost of debt of 7.7 percent.What is the debt-equity ratio? Ignore taxes.

Granny's Home Remedy has a $27 million bond issue outstanding with a coupon rate of 8.75 percent and a current yield of 8.13 percent.What is the present value of the tax shield if the tax rate is 35 percent?

The Bethlehem Inn is an all-equity firm with 9,000 shares outstanding at a value per share of $26.80.The firm is issuing $39,932 of debt and using the proceeds to reduce the number of outstanding shares.How many shares of stock will be outstanding once the debt is issued? Ignore taxes.

Which one of the following will generally receive the highest priority in a bankruptcy liquidation,assuming the absolute priority rule is followed?

Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases?

Introduction to Financial Management

Financial Statements,Taxes,and Cash Flow

Working With Financial Statements

Introduction to Valuation: The Time Value of Money

Discounted Cash Flow Valuation

Interest Rates and Bond Valuation

Equity Markets and Stock Valuation

Net Present Value and Other Investment Criteria

Making Capital Investment Decisions

Some Lessons From Capital Market History

Risk and Return

Cost of Capital

Dividends and Dividend Policy

Raising Capital

Short-Term Financial Planning

Working Capital Management

International Aspects of Financial Management

Filters

Exam 13: Leverage and Capital Structure

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Sand Mountain Resort has a tax rate of 32 percent.Its total interest payment for the year just ended was $41,000.What is the interest tax shield for the year?

Green Tea House has a tax rate of 35 percent and an interest tax shield valued at $8,046 for the year.How much did the firm pay in annual interest?

Stevenson's Bakery is an all-equity company that has projected perpetual earnings before interest and taxes of $43,700 a year.The cost of equity is 15.2 percent and the tax rate is 34 percent.The company can borrow money at 7.15 percent.If the company borrows $50,000,what will be its levered value?

Marcos & Sons has no debt.Its current total value is $13 million.What will the company's value be if it sells $5 million in debt and has a tax rate of 35 percent? Assume all debt proceeds are used to repurchase equity.

Delta Mowers has a debt-equity ratio of .6.Its WACC is 11.8 percent,and its cost of debt is 7.7 percent.There is no corporate tax.What is the firm's cost of equity capital?

M& M Proposition II,without taxes,states that the:

The Park Place has a return on assets of 12.9 percent,a cost of equity of 16.2 percent,and a pretax cost of debt of 7.7 percent.What is the debt-equity ratio? Ignore taxes.

Granny's Home Remedy has a $27 million bond issue outstanding with a coupon rate of 8.75 percent and a current yield of 8.13 percent.What is the present value of the tax shield if the tax rate is 35 percent?

The Bethlehem Inn is an all-equity firm with 9,000 shares outstanding at a value per share of $26.80.The firm is issuing $39,932 of debt and using the proceeds to reduce the number of outstanding shares.How many shares of stock will be outstanding once the debt is issued? Ignore taxes.

Which one of the following will generally receive the highest priority in a bankruptcy liquidation,assuming the absolute priority rule is followed?

Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases?

Introduction to Financial Management

Financial Statements,Taxes,and Cash Flow

Working With Financial Statements

Introduction to Valuation: The Time Value of Money

Discounted Cash Flow Valuation

Interest Rates and Bond Valuation

Equity Markets and Stock Valuation

Net Present Value and Other Investment Criteria

Making Capital Investment Decisions

Some Lessons From Capital Market History

Risk and Return

Cost of Capital

Dividends and Dividend Policy

Raising Capital

Short-Term Financial Planning

Working Capital Management

International Aspects of Financial Management

Filters