Exam 14: Capital Structure: Basic Concepts

An unlevered firm has a cost of capital of 14.6 percent and earnings before interest and taxes of $223,000.Assume the firm borrows $700,000 at a 7 percent rate of interest.The applicable tax rate is 34 percent.What is the value of the levered firm?

Alto and Tenor have 15,000 shares of stock outstanding at a market price of $21 per share.The firm also has $140,000 of 6 percent bonds outstanding that are selling at par.The firm does not expect to pay taxes for the foreseeable future.The cost of equity is 14.7 percent.What is the value of R_WACC?

Which of these statements apply MM Proposition II without taxes? I.The expected return on equity is positively related to leverage. II.The value of a firm cannot be changed by changing its capital structure. III.Risk to equity holders increases with leverage. IV.The expected return on equity is affected by the firm's debt-to-equity ratio.

Travel Express has a debt-to-equity ratio of .65.The pretax cost of debt is 8 percent while the unlevered cost of capital is 14 percent.What is the cost of equity if the tax rate is 34 percent?

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

Delta Mills and Franklin Mill are identical firms except for their capital structures.Delta is an unlevered firm with $750,000 in stock.Franklin is a levered firm with $375,000 of stock and an interest rate on debt of 8 percent.Both Delta and Franklin have an expected EBIT of $90,000.Ignore taxes.Delta has a WACC of _____ percent and Franklin's WACC is _____ percent.

An unlevered firm has expected earnings of $2,401 and a market value of equity of $19,600.The firm is planning to issue $4,000 of debt at 6 percent interest and use the proceeds to repurchase shares at their current market value.Ignore taxes.What will be the cost of equity after the repurchase?

The Grist Mill has no debt.The firm has a total market value of $245,000 with 10,000 shares of stock outstanding.The firm has expected EBIT of $14,000 if the economy is normal and $17,000 if the economy booms.The firm is considering a bond issue of $49,000 with an attached interest rate of 8 percent.The bond proceeds will be used to repurchase shares.The tax rate is 34 percent.Compute the EPS after the repurchase for both a normal and a boom economy.What is the percentage increase in EPS if the economy booms rather than being normal?

In an EPS-EBI graphical relationship,the debt line and the no debt line intersect.Which of these are true at the intersection point? I.The advantages of debt outweigh the disadvantages of debt. II.The aftertax earnings of both capital structures are equal. III.The earnings per share for both capital structures are equal. IV.There is no advantage or disadvantage to debt.

A levered firm has a pretax cost of debt of 8.5 percent and an unlevered cost of capital of 14 percent.The tax rate is 35 percent and the cost of equity is 15.89 percent.What is the debt-to-equity ratio?

Which one of these symbols is correctly matched with its definition?

Dexter's is an unlevered firm with a total market value of $348,000 with 20,000 shares of stock outstanding.The firm has expected EBIT of $27,500 if the economy is normal and $32,000 if the economy booms.The firm is considering a bond issue of $69,600 with an attached interest rate of 6 percent.The bond proceeds will be used to repurchase shares.The tax rate is 35 percent.Compute the EPS after the repurchase for both a normal and a boom economy.What is the percentage increase in EPS if the economy booms rather than being normal?

Identify and explain the Modigliani-Miller proposition that supports the concept that adding debt to a firm's capital structure increases the value of that firm.

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

The interest tax shield has no value for a firm when the: I.the tax rate is equal to zero. II.the debt-equity ratio is exactly equal to 1. III.the firm is unlevered. IV.a firm elects an all-equity capital structure.

The Border Cafe has a cost of equity of 13.2 percent and a pretax cost of debt of 7.5 percent.The debt-equity ratio is .6 and the tax rate is 35 percent.What is the unlevered cost of capital?

The MM propositions would suggest that firms should prefer which one of these debt-to-equity ratios?

In the absence of taxes,MM argues that:

The interest tax shield is a key reason why:

An unlevered firm has expected earnings of $33,062.50 and a market value of equity of $287,500.The firm is planning to issue $50,000 of debt at 7 percent interest and use the proceeds to repurchase shares at their current market value.Ignore taxes.What will be the cost of equity after the repurchase?