Exam 16: Capital Structure: Basic Concepts

A firm has zero debt in its capital structure.Its overall cost of capital is 10%.The firm is considering a new capital structure with 60% debt.The interest rate on the debt would be 8%.Assuming there are no taxes or other imperfections,its cost of equity capital with the new capital structure would be:

A firm has debt of $5,000,equity of $16,000,a leveraged value of $8,900,a cost of debt of 8%,a cost of equity of 12%,and a tax rate of 34%.What is the firm's weighted average cost of capital?

Eigner Engineering is currently unlevered with 2,000 shares outstanding and assets valued at $50,000.The company expects operating income in the current period to be $6,000.Suppose that the company can exchange 400 shares of stock for $10,000 in debt paying 10% interest.From the standpoint of EPS,would the exchange be wise? Assume no taxes.

A firm has a debt-to-equity ratio of 1.20.If it had no debt,its cost of equity would be 15%.Its cost of debt is 10%.What is its cost of equity if there are no taxes or other imperfections?

You own 25% of Unique Vacations,Inc.You have decided to retire and want to sell your shares in this closely held,all equity firm.The other shareholders have agreed to have the firm borrow $1.5 million to purchase your 1,000 shares of stock.What is the total value of this firm today if you ignore taxes?

The capital structure chosen by a firm doesn't really matter because of:

The value of the firm is maximized by taking on as much debt as possible.Show graphically how adding debt can increase value through the overall cost of capital.Explain under what conditions how this impacts the cost of capital and translates into firm value.

A general rule for managers to follow is to set the firms capital structure such that:

The effect of financial leverage depends on the operating earnings of the company.Which if the following is not true?

MM Proposition I with taxes is based on the concept that:

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?

In an EPS-EBIT graphical relationship,the debt ray and equity cross.At this point the equity and debt are:

The Winter Wear Company has expected earnings before interest and taxes of $2,100,an unlevered cost of capital of 14% and a tax rate of 34%.The company also has $2,800 of debt that carries a 7% coupon.The debt is selling at par value.What is the value of this firm?

MM Proposition I with taxes supports the theory that:

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

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