Deck 16: Assessing Long-Term Debt, Equity, and Capital Structure

Question 1

Which of the following is NOT a factor for determining whether to use the active or passive approach to capital structure changes?

A)How much the firm faces in flotation costs under the active management approach
B)How much the firm faces in debt costs under the active management approach
C)How quickly the firm is growing
D)How strongly and how quickly they wish to change the capital structure

Answer 1

How much the firm faces in debt costs under the active management approach

Question 2

If a firm changes their capital structure by waiting until the firm requires additional capital to cover capital budgeting needs and then selling more of the type of claims they wish to increase, they are using which type of capital structure change?

A)Active
B)Passive
C)Separation
D)Supportive

Answer 2

Passive

Question 3

Which of the following is a true statement regarding Proposition I?

A)Vu in a world with taxes is going to be more than Vu in a world without taxes.
B)Vu in a world with taxes is going to be less than Vu in a world without taxes.
C)Vu in a world with taxes is going to be equal to Vu in a world without taxes.
D)Vu in a world with taxes cannot be compared to Vu in a world without taxes.

Answer 3

Vu in a world with taxes is going to be less than Vu in a world without taxes.

Question 4

Which of the following allows for two types of bankruptcy for which most businesses can file?

A)Securities Exchange Commission
B)Generally Accepted Accounting Principles
C)The Internal Revenue Service
D)The United States Bankruptcy Code

Question 5

The mix of debt and equity that a firm uses to finance its operations is known as:

A)capital structure.
B)capital management.
C)separation structure.
D)break even.

Question 6

If a firm changes their capital structure by immediately selling additional claims of one type of capital and using the proceeds to retire another kind of claim, they are using which type of capital structure change?

A)Active
B)Passive
C)Separation
D)Supportive

Question 7

Which of the following is NOT a feature of the "perfect world" in M&M's theorem for optimal capital structure?

A)No taxes
B)No chance of bankruptcy
C)Perfectly efficient markets
D)Asymmetric information sets for all participants

Question 8

Which type of bankruptcy involves an attempt to allow the firm to reorganize the business under court supervision?

A)Chapter 7
B)Chapter 11
C)Chapter 13
D)Chapter 9

Question 9

Which of the following is one of the most extreme examples of firm re-leveraging that occurs when someone uses a firm's debt capacity to buy out the majority of the firm's equity holders?

A)Debt buyout
B)Equity buyout
C)Leveraged buyout
D)Separation buyout

Question 10

How can an investor leverage itself more than the firm?

A)By borrowing money and investing it in stock along with the money with which they started
B)By buying the firm's bonds
C)By buying the firm's preferred stock
D)Investors cannot leverage themselves more than the firm.

Question 11

Which of the following is a feature of the "perfect world" in M&M's theorem for optimal capital structure?

A)Income taxes
B)The chance of bankruptcy
C)Perfectly efficient markets
D)Asymmetric information sets for all participants

Question 12

Which type of bankruptcy involves a business liquidating their assets?

A)Chapter 7
B)Chapter 11
C)Chapter 13
D)Chapter 9

Question 13

The level of EBIT at which EPS will be equal for two different capital structures is known as:

A)break-even EBIT.
B)break-even EPS.
C)break-even capital structures.
D)break-even financial structures.

Question 14

Another name for debt in the capital structure is:

A)active.
B)leverage.
C)passive.
D)long position.

Question 15

In M&M's perfect world, their theorem's two main propositions are referred to as which of the following?

A)Active capital structure management
B)Passive capital structure management
C)Capital structure irrelevance assertion
D)Capital structure relevance assertion

Question 16

What causes the change in optimal strategy when taxes are added back to the M&M theorem?

A)The fact that we have added taxation differentially
B)The fact that both dividends and interest are taxable to the receiver
C)The fact that it changes the effect that an increase in leverage has on the stockholders' expected returns
D)The fact that it changes the volatility of stockholders' expected returns

Question 17

Which of these is the rule under which claimants are paid in a Chapter 7 bankruptcy?

A)First come, first served
B)Absolute priority
C)Term structure priority
D)Date due priority

Question 18

Which of the following makes this a true statement? In this slightly more realistic world with corporate taxes, managers can:

A)minimize the firm's value by taking on as much debt as possible.
B)maximize the firm's value by taking on as much debt as possible.
C)maximize the firm's value by taking on as much equity as possible.
D)maximize the firm's value by financing only with debt.

Question 19

Which of these is the assumption that decisions about which projects to fund are separate from the decisions about how to fund them?

A)Break-even principle
B)Capital structure principle
C)Separation principle
D)Long position principle

Question 20

Which of the following is a true statement?

A)A firm's cost of debt increases with the use of equity in the capital structure.
B)A firm's cost of equity increases with the use of equity in the capital structure.
C)A firm's cost of equity increases with the use of debt in the capital structure.
D)A firm's cost of equity decreases with the use of debt in the capital structure.

Question 21

Your company doesn't face any taxes and has $750 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.15 0.65 0.20
Expected EBIT in state $ 100 million $ 175 million $ 235million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)3.76
B)9.15
C)14.17
D)83.79

Question 22

Your company doesn't face any taxes and has $750 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.55 0.45
Expected EBIT in state $ 20million $ 70million
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the break-even level of EBIT?

A)$20 million
B)$23.75 million
C)$42.5 million
D)$75 million

Question 23

Suppose that a company's equity is currently selling for $22 per share and that there are 4 million shares outstanding and 30 thousand bonds outstanding, which are selling at 101 percent of par ($1,000). If the firm was considering an active change to their capital structure so that the firm would have a D/E of 0.9, which type of security (stocks or bonds) would they need to sell to accomplish this, and how much would they have to sell?

A)$25,736,842 in new debt
B)$10,434,060 in new debt
C)$10,434,060 in new equity
D)$25,742,080 in new equity

Question 24

Which of the following is the condition in which a firm is near bankruptcy?

A)Passive capital structure
B)Active capital structure
C)Financial distress
D)Call position

Question 25

Your company doesn't face any taxes and has $800 million in assets, currently financed entirely with equity. Equity is worth $60 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.15 0.60 0.25
Expected EBIT in state $ 20million $ 50million $ 100million
The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)2.47
B)5.36
C)6.12
D)28.76

Question 26

Your company doesn't face any taxes and has $200 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.20 0.70 0.10
Expected EBIT in state $10 million $20 million $35 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 7 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)1.05
B)1.56
C)2.67
D)7.15

Question 27

Your company doesn't face any taxes and has $200 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below: State Pessimistic Optimistic
Probability of state 0.25 0.75
Expected EBIT in state $ 5million $ 25million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$0.75
B)$1.1325
C)$1.1925
D)$1.55

Question 28

Suppose that a company's equity is currently selling for $20 per share and that there are 2 million shares outstanding. If the firm also has 8 thousand bonds outstanding, which are selling at 99 percent of par ($1,000), what are the firm's current capital structure weights for equity and debt respectively?

A)50 percent, 50 percent
B)16.81 percent, 83.19 percent
C)83.47 percent, 16.53 percent
D)83.33 percent, 16.67 percent

Question 29

Suppose that a company's equity is currently selling for $30 per share and that there are 5 million shares outstanding. If the firm also has 20 thousand bonds outstanding, which are selling at 98 percent of par ($1,000), what are the firm's current capital structure weights for equity and debt respectively?

A)50 percent, 50 percent
B)88.44 percent, 11.56 percent
C)99.60 percent, 0.40 percent
D)88.23 percent, 11.77 percent

Question 30

Your company doesn't face any taxes and has $300 million in assets, currently financed entirely with equity. Equity is worth $15 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.40 0.60
Expected EBIT in state $ 12million $ 40million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$1.21
B)$1.41
C)$1.55
D)$2.21

Question 31

Your company doesn't face any taxes and has $300 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.4 0.6
Expected EBIT in state $ 8million $ 30million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the break-even EBIT?

A)$19,000,000
B)$21,200,000
C)$27,000,000
D)$30,000,000

Question 32

Your company doesn't face any taxes and has $750 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.55 0.45
Expected EBIT in state $ 20million $ 70million
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$1.06
B)$1.17
C)$2.27
D)$2.28

Question 33

Suppose that a company's equity is currently selling for $55 per share and that there are 1 million shares outstanding. If the firm also has 50 thousand bonds outstanding, which are selling at 95 percent of par ($1,000), what are the firm's current capital structure weights for equity and debt respectively?

A)50 percent, 50 percent
B)53.66 percent, 46.34 percent
C)52.38 percent, 47.62 percent
D)36.67 percent, 63.33 percent

Question 34

Which of the following is a true statement?

A)Sectors of the U.S. economy that tend to have quite variable income streams also carry the highest D/E ratios.
B)Sectors of the U.S. economy that tend to have quite variable income streams also carry the lowest D/E ratios.
C)Conglomerates tend to have high, unstable income streams.
D)Utilities have variable income streams and carry low D/E ratios.

Question 35

Suppose that a company's equity is currently selling for $19 per share and that there are 3 million shares outstanding and 10 thousand bonds outstanding, which are selling at 100 percent of par ($1,000). If the firm was considering an active change to their capital structure so that the firm would have a D/E of 0.5, which type of security (stocks or bonds) would they need to sell to accomplish this, and how much would they have to sell?

A)$12,333,333 in new debt
B)$1,755,400 in new debt
C)$12,328,000 in new equity
D)$1,755,400 in new equity

Question 36

A situation that arises when a firm's equity is close to worthless, and equity holders will prefer to invest in overly risky projects with a small chance of success rather than simply paying debt holders their regularly scheduled payments is known as a(n):

A)leverage problem.
B)overinvestment problem.
C)underinvestment problem.
D)long position.

Question 37

Which of these is a situation that arises when a firm's equity is close to worthless, and equity holders will prefer to not invest in safe projects?

A)Leverage problem
B)Overinvestment problem
C)Underinvestment problem
D)Long position

Question 38

Your company doesn't face any taxes and has $500 million in assets, currently financed entirely with equity. Equity is worth $40 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown as follows: State Recession Average Boom
Probability of state 0.30 0.45 0.25
Expected EBIT in state $ 50million $ 100million $ 170million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)5.07
B)9.78
C)25.73
D)95.68

Question 39

Suppose that a company's equity is currently selling for $45 per share and that there are 1 million shares outstanding. If the firm also has 7 thousand bonds outstanding, which are selling at 97 percent of par ($1,000), what are the firm's current capital structure weights for equity and debt respectively?

A)50 percent, 50 percent
B)86.89 percent, 13.11 percent
C)12.50 percent, 87.50 percent
D)31.69 percent, 68.31 percent

Question 40

Your company doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $8 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.25 0.75
Expected EBIT in state $ 10million $ 50million
The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$1.02
B)$1.42
C)$1.82
D)$2.00

Question 41

Your company has a 40 percent tax rate and has $750 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.15 0.65 0.20
Expected EBIT in state $ 100million $ 175million $ 235million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)2.26
B)5.10
C)10.05
D)30.16

Question 42

Suppose that Papa Bell Inc.'s equity is currently selling for $95 per share, with 4 million shares outstanding. If the firm also has 80 thousand bonds outstanding, which are selling at 91.5 percent of par ($1,000), what are the firm's current capital structure weights?

A)Weight of Equity = 83.85 percent; Weight of Debt = 16.15 percent
B)Weight of Equity = 81.29 percent; Weight of Debt = 18.71 percent
C)Weight of Equity = 77.80 percent; Weight of Debt = 12.20 percent
D)Weight of Equity = 65.19 percent; Weight of Debt = 34.81 percent

Question 43

Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $13 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.05 0.25 0.70
Expected EBIT in state $ 5 million $ 10 million $ 17 million
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$0.59
B)$0.41
C)$0.27
D)$0.19

Question 44

Suppose that Lil John Industries' equity is currently selling for $64 per share and that there are 1 million shares outstanding. If the firm also has 20 thousand bonds outstanding, which are selling at 108 percent of par ($1,000), what are the firm's current capital structure weights?

A)Weight of Equity = 25.23 percent; Weight of Debt = 74.77 percent
B)Weight of Equity = 84.77 percent; Weight of Debt = 15.23 percent
C)Weight of Equity = 74.77 percent; Weight of Debt = 25.23 percent
D)Weight of Equity = 32.23 percent; Weight of Debt = 67.77 percent

Question 45

Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $20 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.20 0.60 0.20
Expected EBIT in state $ 5 million $ 10 million $ 15 million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$0.33
B)$0.21
C)$0.37
D)$0.29

Question 46

Your company has a 40 percent tax rate and has $750 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.15 0.65 0.20
Expected EBIT in state $ 100million $ 175million $ 235million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$8.56
B)$8.84
C)$8.88
D)$25.67

Question 47

Your company has a 38 percent tax rate and has $800 million in assets, currently financed entirely with equity. Equity is worth $60 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.15 0.60 0.25
Expected EBIT in state $ 20million $ 50million $ 100million
The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$1.98
B)$2.29
C)$2.36
D)$2.44

Question 48

Your company doesn't face any taxes and has $150 million in assets, currently financed entirely with equity. Equity is worth $8 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.3 0.7
Expected EBIT in state $ 15million $ 40million
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 12 percent yield on perpetual debt in either event. What will be the break-even EBIT?

A)$18 million
B)$27.5 million
C)$32.5 million
D)$40 million

Question 49

Suppose that Papa Bell Inc.'s equity is currently selling for $30 per share, with 4 million shares outstanding. If the firm also has 70 thousand bonds outstanding, which are selling at 95 percent of par ($1,000), what are the firm's current capital structure weights?

A)Weight of Equity = 74.11 percent; Weight of Debt = 25.89 percent
B)Weight of Equity = 64.34 percent; Weight of Debt = 35.66 percent
C)Weight of Equity = 67.80 percent; Weight of Debt = 32.20 percent
D)Weight of Equity = 65.19 percent; Weight of Debt = 34.81 percent

Question 50

Your company has a 25 percent tax rate and has $600 million in assets, currently financed entirely with equity. Equity is worth $20 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.05 0.70 0.25
Expected EBIT in state $ 5million $ 20million $ 50million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)0.46
B)0.49
C)0.88
D)1.16

Question 51

Your company has a 38 percent tax rate and has $800 million in assets, currently financed entirely with equity. Equity is worth $60 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.15 0.60 0.25
Expected EBIT in state $ 20million $ 50million $ 100million
The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the break-even level of EBIT?

A)$26.67 million
B)$50 million
C)$56.67 million
D)$80.1 million

Question 52

Your company has a 25 percent tax rate and has $600 million in assets, currently financed entirely with equity. Equity is worth $20 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.05 0.70 0.25
Expected EBIT in state $ 5million $ 20million $ 50million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$0.32
B)$0.36
C)$0.38
D)$0.95

Question 53

Your company has a 25 percent tax rate and has $600 million in assets, currently financed entirely with equity. Equity is worth $20 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.05 0.70 0.25
Expected EBIT in state $ 5million $ 20million $ 50million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the break-even level of EBIT?

A)$16,758,621
B)$20,000,000
C)$25,000,000
D)$54,000,000

Question 54

Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $13 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below: State Recession Average Boom
Probability of state 0.25 0.55 0.20
Expected EBIT in state $ 5 million $ 10 million $ 17 million
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)$0.28
B)$0.33
C)$0.41
D)$0.11

Question 55

Your company faces a 30 percent tax rate and has $300 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.4 0.6
Expected EBIT in state $ 8million $ 30million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$0.30
B)$0.365
C)$0.44
D)$0.73

Question 56

Your company faces a 34 percent tax rate and has $200 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.25 0.75
Expected EBIT in state $ 5 million $ 25 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$0.748
B)$0.7965
C)$0.946
D)$1.023

Question 57

Your company has a 38% tax rate and has $800 million in assets, currently financed entirely with equity. Equity is worth $60 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.15 0.60 0.25
Expected EBIT in state $ 20million $ 50million $ 100million
The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)1.53
B)2.35
C)3.32
D)11.04

Question 58

Your company faces a 34 percent tax rate and has $150 million in assets, currently financed entirely with equity. Equity is worth $8 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.3 0.7
Expected EBIT in state $ 15 million $ 40 million
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 12 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$0.49
B)$1.08
C)$1.31
D)$1.67

Question 59

Your company faces a 25 percent tax rate and has $750 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.55 0.45
Expected EBIT in state $ 20 million $ 70 million
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)0.6886
B)0.8298
C)1.1857
D)1.4059

Question 60

Your company doesn't face any taxes and has $200 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.25 0.75
Expected EBIT in state $ 5million $ 25million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt in either event. What will be the break-even EBIT?

A)$13.6 million
B)$15 million
C)$16 million
D)$20 million

Question 61

A situation that arises when a firm's equity is close to worthless, and equity holders will prefer to invest in overly risky projects with a small chance of success rather than simply paying debt holders their regularly scheduled payments is referred to as:

A)separation principle.
B)underinvestment problem.
C)overinvestment problem.
D)passive capital structure management.

Question 62

HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.33 0.67
Expected EBIT in state $ 8 million $ 15 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)$7.91
B)$7.54
C)$6.59
D)$6.13

Question 63

Ultras Inc. has a 20 percent tax rate and has $100 million in assets, currently financed entirely with equity. Equity is worth $80 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.25 0.55 0.20
Expected EBIT in state $ 6 million $ 10 million $ 17 million
The firm is considering switching to a 10 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$6.27
B)$6.83
C)$7.17
D)$7.60

Question 64

Ultras Inc. has a 20 percent tax rate and has $350 million in assets, currently financed entirely with equity. Equity is worth $80 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.25 0.55 0.20
Expected EBIT in state $ 5 million $ 10 million $ 17 million
The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 7 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$1.20
B)$1.04
C)$0.93
D)$1.29

Question 65

When a stockholder's stake is worthless the firm runs the risk of:

A)underinvestment because there isn't much capital for investment.
B)overinvestment because there isn't much wealth at risk.
C)having bondholders invoke the separation principle to obtain first rights on the firm's assets.
D)none of the options.

Question 66

The policy of changing the capital structure gradually over time by funding new capital projects disproportionately with the type of capital you want to increase in the capital structure is referred as:

A)separation principle.
B)overinvestment problem.
C)passive capital structure management.
D)active captive structure management.

Question 67

Which of the following is incorrect with respect to leverage buyouts (LBOs)?

A)They originated in the 1960s and were originally known as bootstrap transactions that reflected the general consensus that the firm was, more or less, paying for its own acquisition.
B)The typical LBO uses a ratio of 70 percent debt to 30 percent equity but levels of debt can reach much higher.
C)LBOs are an extreme example of re-leveraging because debt is used to buy out the majority of the equity holders to gain control of the firm.
D)None of the statements are incorrect.

Question 68

HiLo, Inc., faces a 38 percent tax rate and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below: State Pessimistic Optimistic
Probability of state 0.65 0.35
Expected EBIT in state $ 5 million $ 15 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$2.33
B)$3.68
C)$4.17
D)$4.91

Question 69

GTB, Inc., has a 34 percent tax rate and has $100 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.45 0.55
Expected EBIT in state $ 10 million $ 20 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 5 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)$1.03
B)$0.42
C)$0.62
D)$0.55

Question 70

Ultras Inc. has a 20 percent tax rate and has $350 million in assets, currently financed entirely with equity. Equity is worth $80 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.25 0.55 0.20
Expected EBIT in state $ 5 million $ 10 million $ 17 million
The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 7 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if the firm switches to the proposed capital structure?

A)$1.17
B)$0.92
C)$0.81
D)$1.06

Question 71

HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.42 0.58
Expected EBIT in state $ 5 million $ 15 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$3.19
B)$3.94
C)$4.41
D)$5.67

Question 72

Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $20 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.20 0.60 0.20
Expected EBIT in state $ 5 million $ 10 million $ 15 million
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switched to the proposed capital structure?

A)$0.37
B)$0.21
C)$0.36
D)$0.29

Question 73

HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.42 0.58
Expected EBIT in state $ 5 million $ 15 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)$4.12
B)$14.57
C)$15.82
D)$15.09

Question 74

HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.62 0.38
Expected EBIT in state $ 5 million $ 15 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$3.19
B)$4.00
C)$4.72
D)$5.97

Question 75

All else the same, firms facing relatively high tax rates should:

A)use more debt.
B)use less debt.
C)have lower E/E ratios.
D)none of the options.

Question 76

All else the same, firms with stable, predictable income streams will be able to:

A)use less debt.
B)use more debt.
C)have lower D/E ratios.
D)none of the options.

Question 77

HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.33 0.67
Expected EBIT in state $ 8 million $ 15 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the break-even level of EBIT?

A)$7.25 million
B)$7 million
C)$10 million
D)$11.2 million

Question 78

HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.65 0.35
Expected EBIT in state $ 5 million $ 19 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 15 percent yield on perpetual debt. What will be the break-even level of EBIT?

A)$11.2 million
B)$9.5 million
C)$13.0 million
D)$15.0 million

Question 79

HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Pessimistic Optimistic
Probability of state 0.33 0.67
Expected EBIT in state $ 8 million $ 15 million
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

A)$7.24
B)$6.94
C)$5.59
D)$5.67

Question 80

Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $13 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows: State Recession Average Boom
Probability of state 0.05 0.25 0.70
Expected EBIT in state $ 5 million $ 10 million $ 17 million
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switch to the proposed capital structure?

A)$0.33
B)$0.26
C)$0.21
D)$0.16