Exam 16: Capital Structure

Allied Investment Fund lends $200,000 for each new idea.The Fund's history is that it selects high-risk projects or ideas that hit 20% of the time.What rate of return must each successful project pay the Fund for it to break even?

Longmont Inc.is in the property management business and has a required return on its assets of 10%.It can borrow in the debt market at 5%.If there are no taxes and M&M's proposition II holds,what is the cost of equity if there is 10% equity financing and 90% debt financing?

Investors Bill and Maggie lend $60,000 to each new idea.Bill picks low-risk projects that are successful 60% of the time.Maggie takes on high-risk projects that that are successful 20% of the time.What rate of return must each successful project pay Bill and Maggie for them to break even?

Why is financial leverage attractive?

In the Modigliani & Miller model of capital structure,with no corporate taxes,as a firm increases the D/V ratio,the cost of equity also increases.

Which of the formulations below expresses the weighted average cost of capital (WACC)formula?

The municipal bond market is open only to ________.

Using debt financing to replace equity financing always leads to greater EPS for the firm.

The return to the investor is the cost to the seller.

________ financial world is one without taxes,bankruptcy,and other imperfections.

Corporate financing problems are ________ personal financing ones.

Consider the Modigliani and Miller world of corporate taxes.An unlevered (all-equity)firm value is $500 million.By adding debt,the annual interest expense is $100 million,the corporate tax rate is 30%,and the discount rate on the tax shield is 8%.What is the value of the firm after adding debt?

Transitions Inc.is an import-export company specializing in products from Asia and the West Coast.It can borrow in the debt market at 8%.Its cost of equity with 40% D/V ratio is 12%.Its corporate tax rate is 30%.If the M&M world of taxes holds true,what is the WACC for Transitions Inc.with a 40% D/V financing?

To say that the investing decision and financing decision of a firm are separable is to say ________.

IBM Inc.has a project that costs $90,000.It has a 50% chance of paying off $200,000 and a 50% chance of paying off $0.What is the expected payoff and the expected profit or loss from the new project?

M&M's Proposition II suggests that in a world of no taxes and no bankruptcy,________.

Consider the M&M world of corporate taxes.The interest expense is $10 million,the corporate tax rate is 20%,and the discount rate on the tax shield is 10%.What is the gain to leverage or the value added from issuing debt?

Describe the Static Theory of Capital Structure.

Garson Corp.is looking at two possible capital structures.Currently,the firm is an all-equity firm with $1.2 million dollars in assets and 200,000 shares outstanding.The market value of each share of stock is $6.00.The CEO of Garson is thinking of leveraging the firm by selling $600,000 of debt financing and retiring 100,000 shares,leaving 100,000 outstanding.The cost of debt is 10% annually,and the current corporate tax rate for Garson is 30%.If the CEO believes that Garson will earn $100,000 per year before interest and taxes,should she leverage the firm? Explain.

Firewall Corp.is a small company looking at two possible capital structures.Currently,the firm is an all-equity firm with $900,000 in assets and 100,000 shares outstanding.The market value of each share is $9.00.The CEO of Firewall is thinking of leveraging the firm by selling $270,000 of debt financing and retiring 30,000 shares,leaving 70,000 shares outstanding.The cost of debt is 6% annually,and the current corporate tax rate for Firewall is 30%.The CEO believes that Firewall will earn $100,000 per year before interest and taxes.Which of the statements below is TRUE?