Question 1

A levered firm is a company that has:

Accepted Answer

A) accounts payable as its only liability. 
B) some debt in its capital structure. 
C) an all-equity capital structure. 
D) a tax loss carry forward. 
E) taxable income. 
A) accounts payable as its only liability. 
B) some debt in its capital structure. 
C) an all-equity capital structure. 
D) a tax loss carry forward. 
E) taxable income. B

Question 2

The proposition that the value of the firm is independent of its capital structure is called:

Accepted Answer

A) the capital asset pricing model. 
B) MM Proposition I (no taxes). 
C) MM Proposition II (no taxes). 
D) the law of one price. 
E) the efficient markets hypothesis. 
A) the capital asset pricing model. 
B) MM Proposition I (no taxes). 
C) MM Proposition II (no taxes). 
D) the law of one price. 
E) the efficient markets hypothesis. B

Question 3

Juanita's Steak House has $12,000 of debt outstanding that is selling at 101.2 percent of par and has a coupon rate of 8 percent and a current yield of 7.91 percent.The tax rate is 21 percent.What is the present value of the tax shield on debt?

Accepted Answer

A) $3,188 
B) $3,887 
C) $2,520 
D) $2,500 
E) $2,550 
A) $3,188 
B) $3,887 
C) $2,520 
D) $2,500 
E) $2,550 C

Question 4

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

Accepted Answer

A) homemade leverage. 
B) dividend recapture. 
C) the weighted average cost of capital. 
D) private debt placement. 
E) personal offset. 
A) homemade leverage. 
B) dividend recapture. 
C) the weighted average cost of capital. 
D) private debt placement. 
E) personal offset.

Question 5

A firm has a debt-equity ratio of 1,a cost of equity of 16 percent,and a cost of debt of 8 percent.If there are no taxes or other imperfections,what is its unlevered cost of equity?

Accepted Answer

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

Question 6

Bigelow has a levered cost of equity of 14.29 percent and a pretax cost of debt of 7.23 percent.The required return on the assets is 11 percent.What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

Accepted Answer

A) .67 
B) .87 
C) .72 
D) .75 
E) .81 
A) .67 
B) .87 
C) .72 
D) .75 
E) .81

Question 7

MM Proposition II is the proposition that:

Accepted Answer

A) supports the argument that the capital structure of a firm is irrelevant to the value of the firm. 
B) the cost of levered equity depends solely on the return on debt,the debt-equity ratio,and the tax rate. 
C) a firm's cost of equity capital is a positive linear function of the firm's capital structure. 
D) the cost of equity is equivalent to the required return on the total assets of a levered firm. 
E) the cost of debt is inversely related to a firm's debt-equity ratio. 
A) supports the argument that the capital structure of a firm is irrelevant to the value of the firm. 
B) the cost of levered equity depends solely on the return on debt,the debt-equity ratio,and the tax rate. 
C) a firm's cost of equity capital is a positive linear function of the firm's capital structure. 
D) the cost of equity is equivalent to the required return on the total assets of a levered firm. 
E) the cost of debt is inversely related to a firm's debt-equity ratio.

Question 8

The tax shield on debt has no value for a firm when:

Accepted Answer

A) the firm's debt-equity ratio is exactly equal to 1. 
B) the firm's debt-equity ratio is exactly .5. 
C) the firm is unlevered. 
D) shareholders fully utilize homemade leverage. 
E) RS is less than R0. 
A) the firm's debt-equity ratio is exactly equal to 1. 
B) the firm's debt-equity ratio is exactly .5. 
C) the firm is unlevered. 
D) shareholders fully utilize homemade leverage. 
E) RS is less than R0.

Question 9

The reason that MM Proposition I without taxes does not hold in the presence of corporate taxation is because:

Accepted Answer

A) levered firms pay less taxes compared with identical unlevered firms. 
B) bondholders require higher rates of return than stockholders do. 
C) earnings per share are no longer relevant with taxes. 
D) dividends become a tax shield. 
E) debt is more expensive than equity. 
A) levered firms pay less taxes compared with identical unlevered firms. 
B) bondholders require higher rates of return than stockholders do. 
C) earnings per share are no longer relevant with taxes. 
D) dividends become a tax shield. 
E) debt is more expensive than equity.

Question 10

A firm has zero debt and an overall cost of capital of 13.8 percent.The firm is considering a new capital structure with 40 percent debt.The interest rate on the debt would be 7.2 percent and the corporate tax rate is 21 percent.What would be the cost of equity with the new capital structure?

Accepted Answer

A) 16.90 percent 
B) 16.11 percent 
C) 17.28 percent 
D) 17.34 percent 
E) 17.59 percent 
A) 16.90 percent 
B) 16.11 percent 
C) 17.28 percent 
D) 17.34 percent 
E) 17.59 percent

Question 11

The Montana Hills Co.has expected earnings before interest and taxes of $17,100,an unlevered cost of capital of 12.4 percent,and debt with both a book and face value of $25,000.The debt has an annual 6.2 percent coupon.If the tax rate is 21 percent,what is the value of the firm?

Accepted Answer

A) $91,016 
B) $137,903 
C) $114,194 
D) $106,667 
E) $146,403 
A) $91,016 
B) $137,903 
C) $114,194 
D) $106,667 
E) $146,403

Question 12

Based on MM Propositions,with and without taxes,how much time should a financial manager spend analyzing the capital structure of his firm?

Accepted Answer

Under either MM scenario,the financial m

Question 13

Discuss MM Propositions I and II in a world without taxes.List the basic assumptions,results,and intuition of the model.

Accepted Answer

MM I and II without taxes: Assumptions:

Question 14

Explain homemade leverage and why it matters.

Accepted Answer

Homemade leverage is the ability of inve

Question 15

MM Proposition I with taxes states that:

Accepted Answer

A) capital structure does not affect firm value. 
B) increasing the debt-equity ratio increases firm value. 
C) firm value is maximized when the firm is all-equity financed. 
D) the cost of equity rises as the debt-equity ratio increases. 
E) the unlevered cost of equity is equal to RWacc. 
A) capital structure does not affect firm value. 
B) increasing the debt-equity ratio increases firm value. 
C) firm value is maximized when the firm is all-equity financed. 
D) the cost of equity rises as the debt-equity ratio increases. 
E) the unlevered cost of equity is equal to RWacc.

Question 16

A firm has debt of $7,000,equity of $12,000,a cost of debt of 7 percent,a cost of equity of 14 percent,and a tax rate of 21 percent.What is the firm's weighted average cost of capital?

Accepted Answer

A) 8.45 percent 
B) 9.90 percent 
C) 10.88 percent 
D) 12.50 percent 
E) 11.27 percent 
A) 8.45 percent 
B) 9.90 percent 
C) 10.88 percent 
D) 12.50 percent 
E) 11.27 percent

Question 17

In an EPS-EBI graphical relationship,the slope of the debt ray is steeper than the equity ray.The debt ray has a lower intercept because:

Accepted Answer

A) more shares are outstanding for the same level of EBI. 
B) the break-even point is higher with debt. 
C) a fixed interest charge must be paid even at low earnings. 
D) the amount of interest per share has only a positive effect on the intercept. 
E) the break-even point is lower with debt. 
A) more shares are outstanding for the same level of EBI. 
B) the break-even point is higher with debt. 
C) a fixed interest charge must be paid even at low earnings. 
D) the amount of interest per share has only a positive effect on the intercept. 
E) the break-even point is lower with debt.

Question 18

Discuss MM Propositions I and II in a world with taxes.List the basic assumptions,results,and intuition of the model.

Accepted Answer

MM Proposition I and II with taxes: Assu

Question 19

Explain why the weighted average cost of capital is invariant to the firm's debt-equity ratio in the absence of corporate taxes.

Accepted Answer

In a world without taxes,the cost of equ

Question 20

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

Accepted Answer

A) size is maximized. 
B) value is maximized. 
C) bondholders are secured. 
D) suppliers of raw materials are satisfied. 
E) dividend payout is maximized. 
A) size is maximized. 
B) value is maximized. 
C) bondholders are secured. 
D) suppliers of raw materials are satisfied. 
E) dividend payout is maximized.

Exam 16: Capital Structure: Basic Concepts

A levered firm is a company that has:

The proposition that the value of the firm is independent of its capital structure is called:

Juanita's Steak House has $12,000 of debt outstanding that is selling at 101.2 percent of par and has a coupon rate of 8 percent and a current yield of 7.91 percent.The tax rate is 21 percent.What is the present value of the tax shield on debt?

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

A firm has a debt-equity ratio of 1,a cost of equity of 16 percent,and a cost of debt of 8 percent.If there are no taxes or other imperfections,what is its unlevered cost of equity?

Bigelow has a levered cost of equity of 14.29 percent and a pretax cost of debt of 7.23 percent.The required return on the assets is 11 percent.What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

MM Proposition II is the proposition that:

The tax shield on debt has no value for a firm when:

The reason that MM Proposition I without taxes does not hold in the presence of corporate taxation is because:

A firm has zero debt and an overall cost of capital of 13.8 percent.The firm is considering a new capital structure with 40 percent debt.The interest rate on the debt would be 7.2 percent and the corporate tax rate is 21 percent.What would be the cost of equity with the new capital structure?

The Montana Hills Co.has expected earnings before interest and taxes of $17,100,an unlevered cost of capital of 12.4 percent,and debt with both a book and face value of $25,000.The debt has an annual 6.2 percent coupon.If the tax rate is 21 percent,what is the value of the firm?

Based on MM Propositions,with and without taxes,how much time should a financial manager spend analyzing the capital structure of his firm?

Discuss MM Propositions I and II in a world without taxes.List the basic assumptions,results,and intuition of the model.

Explain homemade leverage and why it matters.

MM Proposition I with taxes states that:

A firm has debt of $7,000,equity of $12,000,a cost of debt of 7 percent,a cost of equity of 14 percent,and a tax rate of 21 percent.What is the firm's weighted average cost of capital?

In an EPS-EBI graphical relationship,the slope of the debt ray is steeper than the equity ray.The debt ray has a lower intercept because:

Discuss MM Propositions I and II in a world with taxes.List the basic assumptions,results,and intuition of the model.

Explain why the weighted average cost of capital is invariant to the firm's debt-equity ratio in the absence of corporate taxes.

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

Introduction to Corporate Finance

Financial Statements and Cash Flow

Financial Statements and Cash Flow

Discounted Cash Flow Valuation

Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, real Options, and Capital Budgeting

Interest Rates and Bond Valuation

Stock Valuation

Lessons From Market History

Return, risk, and the Capital Asset Pricing Model Capm

An Alternative View of Risk and Return: the Arbitrage Pricing Theory

Risk, cost of Capital, and Valuation

Efficient Capital Markets and Behavioral Challenges

Long-Term Financing

Capital Structure: Limits to the Use of Debt

Valuation and Capital Budgeting for the Levered Firm

Dividends and Other Payouts

Raising Capital

Leasing

Options and Corporate Finance

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Derivatives and Hedging Risk

Short-Term Finance and Planning

Cash Management

Credit and Inventory Management

Mergers,acquisitions,and Divestitures

Financial Distress

International Corporate Finance

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