Question 1

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 2

Explain homemade leverage and why it matters.

Accepted Answer

Homemade leverage is the ability of inve

Question 3

Thompson & Thomson is an all equity firm that has 500,000 shares outstanding.The company is in the process of borrowing €8 million at 9% interest to repurchase 200,000 shares of the outstanding equity.What is the value of this firm if you ignore taxes?

Accepted Answer

A) €20.0 million 
B) €20.8 million 
C) €21.0 million 
D) €21.2 million 
E) €21.3 million 
A) €20.0 million 
B) €20.8 million 
C) €21.0 million 
D) €21.2 million 
E) €21.3 million

Question 4

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

Question 5

Bertha'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 6

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 7

Wild Flowers Express has a debt-equity ratio of .60.The pre-tax cost of debt is 9% while the unlevered cost of capital is 14%.What is the cost of equity if the tax rate is 34%?

Accepted Answer

A) 7.52% 
B) 8.78% 
C) 15.98% 
D) 16.83% 
E) 17.30% 
A) 7.52% 
B) 8.78% 
C) 15.98% 
D) 16.83% 
E) 17.30%

Question 8

A firm has a debt-to-equity ratio of 1.Its cost of equity is 16%,and its cost of debt is 8%.If there are no taxes or other imperfections,what would be its cost of equity if the debt-to-equity ratio were 0?

Accepted Answer

A) 8% 
B) 10% 
C) 12% 
D) 14% 
E) 16% 
A) 8% 
B) 10% 
C) 12% 
D) 14% 
E) 16%

Question 9

Consider two firms,U and L,both with €50,000 in assets.Firm U is unlevered,and firm L has €20,000 of debt that pays 8% interest.Firm U has 1,000 shares outstanding,while firm L has 600 shares outstanding.Mike owns 20% of firm L and believes that leverage works in his favor.Steve tells Mike that this is an illusion,and that with the possibility of borrowing on his own account at 8% interest,he can replicate Mike's payout from firm L.Given a level of operating income of €2,500,show the specific strategy that Mike has in mind.After seeing Steve's analysis,Mike tells Steve that while his analysis looks good on paper,Steve will never be able to borrow at 8%,but would have to pay a more realistic rate of 12%.If Mike is right,what will Steve's payout be?

Accepted Answer

Mike is entitled to .2 (€2,500 - €1,600)

Question 10

A firm has a debt-to-equity ratio of .5.Its cost of equity is 22%,and its cost of debt is 16%.If the corporate tax rate is .40,what would its cost of equity be if the debt-to-equity ratio were 0?

Accepted Answer

A) 14.00% 
B) 20.61% 
C) 21.07% 
D) 22.00% 
E) None of the above. 
A) 14.00% 
B) 20.61% 
C) 21.07% 
D) 22.00% 
E) None of the above.

Question 11

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 12

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 13

The Modigliani-Miller Proposition I without taxes states:

Accepted Answer

A) a firm cannot change the total value of its outstanding securities by changing its capital structure proportions. 
B) when new projects are added to the firm the firm value is the sum of the old value plus the new. 
C) managers can make correct corporate decisions that will satisfy all shareholders if they select projects that maximize value. 
D) the determination of value must consider the timing and risk of the cash flows. 
E) None of the above. 
A) a firm cannot change the total value of its outstanding securities by changing its capital structure proportions. 
B) when new projects are added to the firm the firm value is the sum of the old value plus the new. 
C) managers can make correct corporate decisions that will satisfy all shareholders if they select projects that maximize value. 
D) the determination of value must consider the timing and risk of the cash flows. 
E) None of the above.

Question 14

Spartan Ltd has an unlevered cost of capital of 11%,a cost of debt of 8%, and a tax rate of 35%.What is the target debt-equity ratio if the targeted cost
Of equity is 12%?

Accepted Answer

A) .44 
B) .49 
C) .51 
D) .56 
E) .62 
A) .44 
B) .49 
C) .51 
D) .56 
E) .62

Question 15

A firm should select the capital structure which:

Accepted Answer

A) produces the highest cost of capital. 
B) maximizes the value of the firm. 
C) minimizes taxes. 
D) is fully unlevered. 
E) has no debt. 
A) produces the highest cost of capital. 
B) maximizes the value of the firm. 
C) minimizes taxes. 
D) is fully unlevered. 
E) has no debt.

Question 16

The Nantucket Nugget is unlevered and is valued at €640,000.Nantucket is currently deciding whether including debt in its capital structure would increase its value.The current of cost of equity is 12%.Under consideration is issuing €300,000 in new debt with an 8% interest rate.Nantucket would repurchase €300,000 of equity with the proceeds of the debt issue.There are currently 32,000 shares outstanding and its effective marginal tax bracket is 34%.What will Nantucket's new WACC be?

Accepted Answer

New Firm Value: €640,000 + (.34)(€300,00

Question 17

Scott's Leisure Time Sports is an unlevered firm with an after-tax net income of €86,000.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 18

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 19

In each of the theories of capital structure the cost of equity rises as the amount of debt increases.So why don't financial managers use as little debt as possible to keep the cost of equity down?
 After all,isn't the goal of the firm to maximize share value and minimize shareholder costs?

Accepted Answer

This question requires students to diffe

Question 20

Your firm has a debt-equity ratio of .75.Your pre-tax cost of debt is 8.5% and your required return on assets is 15%.What is your cost of equity if you ignore taxes?

Accepted Answer

A) 11.25% 
B) 12.21% 
C) 16.67% 
D) 19.88% 
E) 21.38% 
A) 11.25% 
B) 12.21% 
C) 16.67% 
D) 19.88% 
E) 21.38%

Exam 15: Capital Structure: Basic Concepts

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

Explain homemade leverage and why it matters.

Thompson & Thomson is an all equity firm that has 500,000 shares outstanding.The company is in the process of borrowing €8 million at 9% interest to repurchase 200,000 shares of the outstanding equity.What is the value of this firm if you ignore taxes?

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

Bertha'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%?

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?

Wild Flowers Express has a debt-equity ratio of .60.The pre-tax cost of debt is 9% while the unlevered cost of capital is 14%.What is the cost of equity if the tax rate is 34%?

A firm has a debt-to-equity ratio of 1.Its cost of equity is 16%,and its cost of debt is 8%.If there are no taxes or other imperfections,what would be its cost of equity if the debt-to-equity ratio were 0?

A firm has a debt-to-equity ratio of .5.Its cost of equity is 22%,and its cost of debt is 16%.If the corporate tax rate is .40,what would its cost of equity be if the debt-to-equity ratio were 0?

MM Proposition I with no tax supports the argument that:

The Modigliani-Miller Proposition I without taxes states:

Spartan Ltd has an unlevered cost of capital of 11%,a cost of debt of 8%, and a tax rate of 35%.What is the target debt-equity ratio if the targeted cost Of equity is 12%?

A firm should select the capital structure which:

Scott's Leisure Time Sports is an unlevered firm with an after-tax net income of €86,000.The unlevered cost of capital is 10% and the tax rate is 34%.What is the value of this firm?

In each of the theories of capital structure the cost of equity rises as the amount of debt increases.So why don't financial managers use as little debt as possible to keep the cost of equity down? After all,isn't the goal of the firm to maximize share value and minimize shareholder costs?

Your firm has a debt-equity ratio of .75.Your pre-tax cost of debt is 8.5% and your required return on assets is 15%.What is your cost of equity if you ignore taxes?

Introduction to Corporate Finance

Corporate Governance

Financial Statement Analysis and Long-Term Planning

Discounted Cash Flow Valuation

How to Value Bonds and Shares

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

Factor Models and the Arbitrage Pricing Theory

Risk, cost of Capital, and Capital Budgeting

Corporate Financing Decisions and Efficient Capital Markets

Long-Term Financing: An Introduction

Capital Structure: Limits to the Use of Debt

Valuation and Capital Budgeting for the Levered Firm

Dividend and Other Payouts

Equity Financing

Debt Financing

Leasing and Off-Balance-Sheet Financing

Options and Corporate Finance

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Financial Risk Management With Derivatives

Short-Term Finance and Planning

Cash Management

Credit Management

Mergers and Acquisitions

Financial Distress

International Corporate Finance

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