Exam 14: Capital Structure: Basic Concepts

A firm has zero debt and an overall cost of capital of 12.5 percent.The firm is considering a new capital structure with 55 percent debt at an interest rate of 6.5 percent.Assume there are no taxes or other imperfections.What will be the cost of equity capital of the levered firm?

Bryan invested in Bryco 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 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 percent and the tax rate is 34 percent.The firm is considering adding $1.25 million of debt with a coupon rate of 8 percent to its capital structure.The debt will be sold at par value.What is the levered value of the equity?

Which of these proposes that the value of a levered firm exceeds the value of an unlevered firm by the present value of the tax shield?

Marley's is an unlevered firm with a total market value of $180,000 with 4,000 shares of stock outstanding.The firm has expected EBIT of $6,500 if the economy is normal and $8,000 if the economy booms.The firm is considering a $67,500 bond issue with an attached interest rate of 6.5 percent.The bond proceeds will be used to repurchase shares.Ignore taxes.What will the earnings per share be after the repurchase if the economy booms?

MM Proposition II without taxes implies that the required return on equity is:

Which one of these events might cause the biggest challenge to the MM propositions?

Financial analysts value items in terms of their:

How is the value of equity determined for a market value balance sheet?

Why does MM Proposition I not hold in the presence of corporate taxation?

A firm has a debt-to-equity ratio of 1.Its cost of equity is 16 percent and its pretax cost of debt is 8 percent.If there are no taxes or other imperfections,what would be its cost of equity if the debt-to-equity ratio were zero?

You have seen that the cost of equity increases as the amount of debt increases.So why shouldn't financial managers of tax-paying firms use as little debt as possible to keep the cost of equity down? After all,the goal of financial management is to maximize the value of the firm to its shareholders.

Sun Sports has an unlevered cost of capital of 11 percent,a cost of debt of 7 percent,and a tax rate of 34 percent.What is the target debt-equity ratio if the targeted levered cost of equity is 12.27 percent?

Consider the pie models of corporate structure.What is the difference between the all-equity pie and the levered pie for a firm in the presence of taxes?

An unlevered firm has a cost of capital of 11.3 percent and a tax rate of 34 percent.The firm is considering a new capital structure with 60 percent debt.The interest rate on the debt would be 7.25 percent.What would be the firm's levered cost of capital if it adopts the new capital structure?

An all equity firm has a cost of capital of 15 percent.The firm is considering switching to a debt-equity ratio of .65 with a pretax cost of debt of 7.5 percent.What will the firm's cost of equity be if the firm makes the switch? Ignore taxes.

Which one of these presents the idea that the cost of equity is a positive linear function of capital structure?

Which one of these best supports the argument that leverage increases shareholder risk?

Given a world without taxes,R_WACC of an unlevered firm will equal:

Durbin,Inc. ,is an unlevered firm with a total market value of $380,000 with 20,000 shares of stock outstanding.The firm has expected EBIT of $23,000 if the economy is normal and $30,000 if the economy booms.The firm is considering a bond issue of $85,500 with an attached interest rate of 5.5 percent.The bond proceeds will be used to repurchase shares.The tax rate is 34 percent.What will be the earnings per share after the repurchase if the economy booms?