Exam 16: Capital Structure: Basic Concepts

MM Proposition II is the proposition that:

The interest tax shield is a key reason why:

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

What is the cost of equity for a firm if the corporate tax rate is 40%? The firm has a debt-to-equity ratio of 1.5.If it had no debt, its cost of equity would be 16%.Its current cost of debt is 10%.

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?

Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of 8%.The tax rate is 34%.What is the present value of the tax shield?

The change in firm value in the presence of corporate taxes only is:

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%?

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:

Gail's Dance Studio is currently an all equity firm that has 80,000 shares of stock outstanding with a market price of $42 a share.The current cost of equity is 12% and the tax rate is 34%.Gail is considering adding $1 million of debt with a coupon rate of 8% to her capital structure.The debt will be sold at par value.What is the levered value of the equity?

The proposition that the cost of equity is a positive linear function of capital structure is called:

MM Proposition I with taxes supports the theory that:

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

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?

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. -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?

If a firm is unlevered and has a cost of equity capital of 12%, what would its cost of equity be if its debt-equity ratio became 2? The expected cost of debt is 8%.

Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure? I.a reduction in tax rates II.a large tax loss carryforward III.a large depreciation tax deduction IV.a sizeable increase in taxable income

MM Proposition I with no tax supports the argument that:

A key assumption of MM's Proposition I without taxes is:

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?