Exam 16: Capital Structure: Basic Concepts

Lyme Home has 5,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 7.65 percent.Interest is paid semiannually.What is the amount of the annual tax shield on debt if the tax rate is 23 percent?

Aspen's Distributors has a levered cost of equity of 13.84 percent and an unlevered cost of capital of 12.5 percent.The company has $5,000 in debt that is selling at par.The levered value of the firm is $14,600 and the tax rate is 25 percent.What is the pretax cost of debt?

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 doesn't a lower discount rate applied to the firm's cash flows increase the present value of those cash flows?

A firm has debt of $5,000,equity of $16,000,a cost of debt of 8 percent,a cost of equity of 12 percent,and a tax rate of 21 percent.What is the firm's weighted average cost of capital?

The increase in risk to shareholders when financial leverage is introduced is best evidenced by:

The tax shield on debt is one reason why:

The Dance Studio is currently an all-equity firm that has 22,000 shares of stock outstanding with a market price of $27 a share.The current cost of equity is 12 percent and the tax rate is 23 percent.The firm is considering adding $225,000 of debt with a coupon rate of 6.25 percent to its capital structure.The debt will sell at par.What will be the levered value of the equity?

A key underlying assumption of MM Proposition I without taxes is that:

MM Proposition I with no tax supports the argument that:

An unlevered firm has a cost of capital of 13.6 percent and earnings before interest and taxes of $138,000.A levered firm with the same operations and assets has both a book value and a face value of debt of $520,000 with an annual coupon of 7 percent.The applicable tax rate is 21 percent.What is the value of the levered firm?

Boutelle Homes has an all-equity value of $648,200,a cost of equity of 11.7 percent,and a tax rate of 35 percent.Assume the firm's capital structure changes to 30 percent debt followed by a lowering of the tax rate to 21 percent.What will be the change in the levered value of the firm due to the reduction in the tax rate?

A firm has zero debt in its capital structure and has an overall cost of capital of 10 percent.The firm is considering a new capital structure with 60 percent debt at an interest rate of 8 percent.Assuming there are no taxes or other imperfections,what would be the cost of equity with the new capital structure?

Uptown Interior Designs is an all-equity firm that has 40,000 shares of stock outstanding.The company has decided to borrow $74,000 to buy out the 2,100 shares of a deceased stockholder.What is the total value of this firm if you ignore taxes?

Alexandria's Dance Studio is currently an all-equity firm with earnings before interest and taxes of $338,000 and a cost of equity of 14.2 percent.Assume the tax rate is 22 percent.The firm is considering adding $400,000 of debt with a coupon rate of 7 percent to its capital structure.The debt will be sold at par value.What is the levered value of the equity?

Wild Flowers Express has a debt-equity ratio of .60.The pretax cost of debt is 9 percent while the unlevered cost of capital is 14 percent.What is the cost of equity if the tax rate is 23 percent?

When comparing levered versus unlevered capital structures,leverage works to increase EPS for high levels of EBIT because interest payments on the debt:

A manager should attempt to maximize the value of the firm by changing the capital structure if and only if the value of the firm increases:

The concept of homemade leverage is most associated with:

MM Proposition I with taxes supports the theory that:

The Backwoods Lumber Co.has a debt-equity ratio of .68.The firm's required return on assets is 11.7 percent and its levered cost of equity is 15.54 percent.What is the pretax cost of debt based on MM Proposition II with no taxes?