Exam 16: Capital Structure: Basic Concepts

Suppose the tax authorities allow firms to deduct their interest expense from operating income.Both firm U and firm L are in the 34% tax bracket.Show what happens to the market value of both firms if the debt held by firm L is permanent.

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?

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

A manager should attempt to maximize the value of the firm by:

What will the stock price now be after the recapitalization?

A firm has zero debt in its capital structure.Its overall cost of capital is 9%.The firm is considering a new capital structure with 40% debt.The interest rate on the debt would be 4%.Assuming that the corporate tax rate is 34%,its cost of equity capital with the new capital structure would be?

Bryan invested in Bryco,Inc.stock when the firm was financed solely with equity.The firm is now utilizing debt in its capital structure.To unlever his position,Bryan needs to:

The Boston Firm is unlevered with assets of $30 million and EBIT of $6 million.If the firm's tax rate is 34%,calculate both its after-tax cash flow and its value given a risk adjusted discount rate of 12%.

The interest tax shield is a key reason why:

A firm has a debt-to-equity ratio of 1.75.If it had no debt,its cost of equity would be 9%.Its cost of debt is 7%.What is its cost of equity if the corporate tax rate is 50%?

The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

The change in firm value due to infusion of debt in the presence of corporate taxes is:

A levered firm is a company that:

Assume the corporate tax rate is 50%.A firm has perpetual expected EBIT of $100.The firm has no debt in its capital structure.Its cost of equity is 10%.What would be the value of the firm if it issued $400 in perpetual debt?

How many shares will be purchased?

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

The firm's capital structure refers to:

The Nantucket Nugget is unlevered and is valued at $640,000.Nantucket is currently deciding whether including debt in their capital structure would increase their value.Under consideration is issuing $300,000 in new debt with an 8% interest rate.Nantucket would repurchase $300,000 of stock with the proceeds of the debt issue.There are currently 32,000 shares outstanding and their effective marginal tax bracket is zero.What is the change in value and how many shares of stock will be repurchased?

The weighted average cost of capital is invariant to the use of leverage under MM conditions of no taxes.Graph the relationship of the weighted average cost of capital and leverage; be sure to include the cost of equity and debt.Explain why this relationship holds.

What is its cost of equity if there are no taxes or other imperfections? The firm has a debt-to-equity ratio of .60.Its cost of debt is 8%.Its overall cost of capital is 12%.