Deck 15: Debt and Taxes

Question 1

Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and interest expense of $3 million. FBNA's marginal corporate tax rate is 40%.
FBNA's EBIT is closest to:

A) $43 million
B) $40 Million
C) $45 million
D) $60 million

Answer 1

$43 million

Question 2

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ Millions):

The interest rate tax shield for Kroger in 2006 is closest to:

A) $187 million
B) $332 million
C) $534 million
D) $179 million

Answer 2

$179 million

Question 3

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ Millions):

The interest rate tax shield for Kroger in 2004 is closest to:

A) $268 million
B) $393 million
C) $211 million
D) $94 million

Answer 3

$211 million

Question 4

Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
If Rosewood had no interest expense, its net income would be closest to:

A) $405 million
B) $160 million
C) $450 million
D) $290 million

Question 5

Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and interest expense of $3 million. FBNA's marginal corporate tax rate is 40%.
IF FBNA increases leverage so that its interest expense rises by $1 million, then the amount its unlevered EBIT will change is closest to:

A) $0
B) -$400,000
C) $600,000
D) $400,000

Question 6

The income that would be available to equity holders in 2006 if Kroger was not levered is closest to:

A) $1,525 million
B) $2,035 million
C) $1,500 million
D) $1,325 million

Question 7

Use the following information to answer the question(s) below.
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the foreseeable future.
Wyatt's annual interest tax shield is closest to:

A) $2.8 million
B) $4.2 million
C) $7.0 million
D) $40 million

Question 8

Which of the following statements is FALSE?

A) In general, the gain to investors from the tax deductibility of interest payments is referred to as the interest tax shield.
B) The interest tax shield is the additional amount that a firm would have paid in taxes if it did not have leverage.
C) Because Corporations pay taxes on their profits after interest payments are deducted, interest expenses reduce the amount of corporate tax firms must pay.
D) As Modigliani and Miller made clear in their original work, capital structure matters in perfect capital markets. Thus, if capital structure does not matter, then it must stem from a market imperfection.

Question 9

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ Millions):

Calculate the interest tax shield, the total amount available to payout to all the investors, and the income that would be available to equity holders if Kroger was not levered all for the year 2004.

Question 10

Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
Rosewood's net income is closest to:

A) $450 million
B) $180 million
C) $290 million
D) $95 million

Question 11

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ Millions):

The total amount available to payout to all the investors in Kroger in 2006 is closest to:

A) $990 million
B) $1,525 million
C) $1,500 million
D) $2,035 million

Question 12

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ Millions):

The total amount available to payout to all the investors in Kroger in 2005 is closest to:

A) $190 million
B) $847 million
C) $745 million
D) $290 million

Question 13

The income that would be available to equity holders in 2005 if Kroger was not levered is closest to:

A) $290 million
B) $745 million
C) $847 million
D) $550 million

Question 14

Use the following information to answer the question(s) below.
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the foreseeable future.
The present value of Wyatt's annual interest tax shield is closest to:

A) $4.2 million
B) $7.0 million
C) $40 million
D) $60 million

Question 15

Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
The amount of Rosewood's interest tax shield is closest to:

A) $115 million
B) $290 million
C) $175 million
D) $60 million

Question 16

Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and interest expense of $3 million. FBNA's marginal corporate tax rate is 40%.
IF FBNA increases leverage so that its interest expense rises by $1 million, then the amount its net income will change is closest to:

A) -$400,000
B) -$600,000
C) $400,000
D) $600,000

Question 17

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ Millions):

Assume that investors hold Google stock in retirement accounts that are free from personal taxes. Also assume that Google's current pre-tax WACC is 14%. If Google were to issue sufficient debt at a pre-tax cost of 7% to give them a debt to value ratio of 0.5, then the Google's after-tax WACC would be closest to:

A) 10.4%
B) 12.8%
C) 13.0%
D) 15.0%
E) 16.0%

Question 18

Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
The total of Rosewood's net income and interest payments is closest to:

A) $270 million
B) $355 million
C) $290 million
D) $450 million

Question 19

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ Millions):

The interest rate tax shield for Kroger in 2005 is closest to:

A) $362 million
B) $36 million
C) $102 million
D) $195 million

Question 20

Use the following information to answer the question(s) below.
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the foreseeable future.
Assume that five years have passed since Wyatt issued this debt. While tax rates have remained at 40%, interest rates have dropped so that Wyatt's current cost of debt capital is now only 4%. Wyatt's annual interest tax shield is now closest to:

A) $2.8 million
B) $4.2 million
C) $40.0 million
D) $60.0 million

Question 21

Use the following information to answer the question(s) below.
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the foreseeable future.
Taggart Transcontinental currently has no debt and an equity cost of capital of 16%. Suppose that Taggart decides to increase its leverage and maintain a market debt-to-value ratio of 1/3. Suppose Taggart's debt cost of capital is 9% and its corporate tax rate is 35%. Assuming that Taggart's pre-tax WACC remains constant, then with the addition of leverage its effective after-tax WACC will be closest to:

A) 12.9%
B) 13.0%
C) 15.0%
D) 16.0%

Question 22

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff's interest tax shield is closest to:

A) $11 million
B) $18 million
C) $10 million
D) $24 million

Question 23

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff as an all equity firm would be closest to:

A) $80 million
B) $100 million
C) $73 million
D) $115 million

Question 24

Which of the following statements is FALSE?

A) To determine the benefit of leverage for the value of the firm, we must compute the present value of the stream of future interest tax shields the firm will receive.
B) Because the cash flows of the levered firm are equal to the sum of the cash flows from the unlevered firm plus the interest tax shield, by the Law of One Price the same must be true for the present values of these cash flows.
C) By increasing the amount paid to debt holders through interest payments, the amount of the pre-tax cash flows that must be paid as taxes increases.
D) When a firm uses debt, the interest tax shield provides a corporate tax benefit each year.

Question 25

Which of the following statements is FALSE?

A) Given a forecast of future interest payments, we can determine the interest tax shield and compute its present value by discounting it at a rate that corresponds to its risk.
B) The total value of the unlevered firm exceeds the value of the firm with leverage due to the present value of the tax savings from debt.
C) To compute the increase in the firm's total value associated with the interest tax shield, we need to forecast how a firm's debt-and therefore its interest payments.
D) There is an important tax advantage to the use of debt financing.

Question 26

Use the following information to answer the question(s) below.
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the foreseeable future.
Rearden Metal has no debt, and maintains a policy of holding $50 million in excess cash reserves, invested in risk free treasury securities currently yielding 4%. If Rearden is in the 40% marginal tax bracket, the cost of permanently maintaining this $50 million reserve is closest to:

A) $0.8 million
B) $1.2 million
C) $20.0 million
D) $30.0 million

Question 27

Which of the following statements is FALSE?

A) The higher the firm's leverage, the more the firm exploits the tax advantage of debt, and the lower its WACC.
B) Corporate taxes lower the effective cost of debt financing, which translates into a reduction in the weighted average cost of capital.
C) Because the firm's free cash flow is computed without considering the firm's leverage, we account for the benefit of the interest tax shield by calculating the WACC using the before tax cost of debt.
D) The reduction in the WACC increases with the amount of debt financing.

Question 28

Consider the following formula: r_wacc = r_E + r_D - r_Dτ_c
The term r_Dτ_c represents:

A) the reduction due to the interest tax shield.
B) the present value of the interest tax shield.
C) the preset value of the future interest payments.
D) the interest tax shield each year.

Question 29

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff as a levered firm is closest to:

A) $114 million
B) $100 million
C) $111 million
D) $140 million

Question 30

Use the following information to answer the question(s) below.
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the foreseeable future.
Nielson Motors has no debt, and maintains a policy of holding $80 million in excess cash reserves, invested in risk free treasury securities currently yielding 3%. If Nielson is in the 35% marginal tax bracket, the cost of permanently maintaining this $80 million reserve is closest to:

A) $0.85 million
B) $1.6 million
C) $24.0 million
D) $28.0 million

Question 31

Use the following information to answer the question(s) below.
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the foreseeable future.
Assume that five years have passed since Wyatt issued this debt. While tax rates have remained at 40%, interest rates have dropped so that Wyatt's current cost of debt capital is now only 4%. The present value of Wyatt's annual interest tax shield is now closest to:

A) $2.8 million
B) $40.0 million
C) $60.0 million
D) $70.0 million

Question 32

Which of the following statements is FALSE?

A) The tax deductibility of interest lowers the effective cost of debt financing for the firm.
B) When a firm uses debt financing, the cost of the interest it must pay is offset to some extent by the tax savings from the interest tax shield.
C) With tax-deductible interest, the effective after-tax borrowing rate is r(τ_C).
D) The WACC represents the cost of capital for the free cash flow generated by the firm's assets.

Question 33

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff currently maintains a .5 debt to equity ratio, then Flagstaff's after-tax WACC is closest to:

A) 10.00%
B) 10.25%
C) 9.50%
D) 8.75%

Question 34

Use the following information to answer the question(s) below.
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the foreseeable future.
Rearden Metal currently has no debt and an equity cost of capital of 14%. Suppose that Rearden decides to increase its leverage and maintain a market debt-to-value ratio of 1/2. Suppose Rearden's debt cost of capital is 8% and its corporate tax rate is 40%. Assuming that Rearden's pre-tax WACC remains constant, then with the addition of leverage its effective after-tax WACC will be closest to:

A) 10.8%
B) 12.4%
C) 12.8%
D) 13.4%

Question 35

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff maintains a .5 debt to equity ratio, then Flagstaff's pre-tax WACC is closest to:

A) 10.5%
B) 11.0%
C) 9.0%
D) 10.0%

Question 36

Consider the following formula: V_L = V_U + The term represents:

A) the value of firm with leverage.
B) the present value of the interest tax shield.
C) the preset value of the future interest payments.
D) the interest tax shield each year.

Question 37

Consider the following formula: r_wacc = r_E + r_D - r_Dτ_c
The terms r_E + r_D represent:

A) the after tax wacc.
B) the reduction due to equity financing.
C) the before tax wacc.
D) the reduction due to the interest tax shield.

Question 38

Which of the following equations is INCORRECT?

A) V_L = V_U +
B) V_L = V_U + τ_cD
C) r_wacc = r_E +
r_D -
r_Dτ_c
D) r_wacc = r_E +
r_D(1 + τ_c)

Question 39

Which of the following statements is FALSE?

A) Given a 35% corporate tax rate, for every $1 in new permanent debt that the firm issues, the value of the firm increases by $0.65.
B) The firm's marginal tax rate may fluctuate due to changes in the tax code and changes in the firm's income bracket.
C) Many large firms have a policy of maintaining a certain amount of debt on their balance sheets.
D) Typically, the level of future interest payments varies due to changes the firm makes in the amount of debt outstanding, changes in the interest rate on that debt, and the risk that the firm may default and fail to make an interest payment.

Question 40

Consider the following formula: V_L = V_U + τ_cD
The term τ_cD represents:

A) the present value of the interest tax shield.
B) the value of firm with leverage.
C) the preset value of the future interest payments.
D) the interest tax shield each year.

Question 41

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
Which of the following statements is FALSE?

A) Once investors know the recap will occur, the share price will rise immediately to a level that reflects the value of the interest tax shield that the firm will receive from its recapitalization.
B) When securities are fairly priced, the original shareholders of a firm capture the full benefit of the interest tax shield from an increase in leverage.
C) In the presence of corporate taxes, we do not include the interest tax shield as one of the firm's assets on its market value balance sheet.
D) We can analyze the recapitalization using the market value balance sheet; it states that the total market value of a firm's securities must equal the total market value of the firm's assets.

Question 42

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff currently maintains a debt to equity ratio of 1, then the value of Flagstaff as an all equity firm would be closest to:

A) $73 million
B) $80 million
C) $115 million
D) $100 million

Question 43

Use the information for the question(s) below.
KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt. KD has had consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
After the recapitalization, the value of KD's levered equity is closest to:

A) $670 million
B) $400 million
C) $330 million
D) $470 million

Question 44

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
Which of the following statements regarding recapitalizations is FALSE?

A) With a recapitalization, even though leverage reduces the total value of equity, shareholders capture the benefits of the interest tax shield up front.
B) The share price always rises after the completion of the recapitalization.
C) Leveraged recaps were especially popular in the mid- to late-1980s, when many firms found that these transactions could reduce their tax payments.
D) When a firm makes a significant change to its capital structure, the transaction is called a recapitalization.

Question 45

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
Your firm currently has $250 million in debt outstanding with an 8% interest rate. The terms of the loan require the firm to repay $50 million of the balance each year. Suppose that the marginal corporate tax rate is 35% and that the interest tax shields have the same risk as the loan. What is the present value of the interest tax shields from this debt?

Question 46

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff currently maintains a .8 debt to equity ratio, then calculate the value of Flagstaff's interest tax shield.

Question 47

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
Raceway Products has a market debt-to-equity ratio of .60, a corporate tax rate of 40%, and pays 8% interest on its debt. The interest tax shield on Raceway's debt lowers its WACC by what amount?

Question 48

Use the information for the question(s) below.
KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt. KD has had consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
After the recapitalization, the total value of KD as a levered firm is closest to:

A) $470 million
B) $730 million
C) $670 million
D) $530 million

Question 49

Use the information for the question(s) below.
KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt. KD has had consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
The value of KD's unlevered equity is closest to:

A) $600 million
B) $470 million
C) $390 million
D) $400 million

Question 50

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff maintains a debt to equity ratio of 1, then Flagstaff's pre-tax WACC is closest to:

A) 11.0%
B) 10.5%
C) 10.0%
D) 9.0%

Question 51

Use the information for the question(s) below.
LCMS Industries has $70 million in debt outstanding. The firm will pay only interest on this debt (the debt is perpetual). LCMS' marginal tax rate is 35% and the firm pays a rate of 8% interest on its debt.
Assuming that the risk of the tax shield is only 6% even though the debt pays 8%, then the present value of LCMS' interest tax shield is closest to:

A) $24.5 million
B) $18 million
C) $33.0 million
D) $20.0 million

Question 52

Use the information for the question(s) below.
KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt. KD has had consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
The preset value of KD's interest tax shield is closest to:

A) $130 million
B) $200 million
C) $400 million
D) $70 million

Question 53

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff currently maintains a debt to equity ratio of 1, then the value of Flagstaff's interest tax shield is closest to:

A) $10 million
B) $18 million
C) $11 million
D) $24 million

Question 54

Use the information for the question(s) below.
LCMS Industries has $70 million in debt outstanding. The firm will pay only interest on this debt (the debt is perpetual). LCMS' marginal tax rate is 35% and the firm pays a rate of 8% interest on its debt.
The present value of LCMS' interest tax shield is closest to:

A) $45.5 million
B) $20.0 million
C) $24.5 million
D) $35.0 million

Question 55

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff currently maintains a debt to equity ratio of 1, then Flagstaff's after-tax WACC is closest to:

A) 10.25%
B) 10.00%
C) 9.50%
D) 8.75%

Question 56

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
Wyatt Oil has 25 million shares outstanding and has a marginal corporate tax rate of 40%. Wyatt Oil announces that it will payout $40 million in cash to investors through a special dividend. Shareholders had previously assumed that Wyatt Oil would retain this excess cash permanently. The amount that Wyatt Oil's share price can be expected to change upon this announcement is closest to:

A) $0.56
B) $0.64
C) $0.96
D) $1.56

Question 57

Use the information for the question(s) below.
KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt. KD has had consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
After the recapitalization, the value of a share of KD's stock is closest to:

A) $22.35
B) $22.00
C) $22.65
D) $23.50

Question 58

Use the information for the question(s) below.
LCMS Industries has $70 million in debt outstanding. The firm will pay only interest on this debt (the debt is perpetual). LCMS' marginal tax rate is 35% and the firm pays a rate of 8% interest on its debt.
LCMS' annual interest tax shield is closest to:

A) $2.8 million
B) $2.0 million
C) $3.6 million
D) $5.6 million

Question 59

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
If Flagstaff currently maintains a debt to equity ratio of 1, then the value of Flagstaff as a levered firm is closest to:

A) $114 million
B) $100 million
C) $111 million
D) $140 million

Question 60

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
Galt Industries has 125 million shares outstanding and has a marginal corporate tax rate of 35%. Galt announces that it will use $75 million in excess cash to investors repurchase shares. Shareholders had previously assumed that Galt would retain this excess cash permanently. The amount Galt's share price can be expected to change upon this announcement is closest to:

A) $0.21
B) $0.24
C) $0.36
D) $0.39

Question 61

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
Assume that investors in Google pay a 15% tax rate on income from equity and a 35% tax rate on interest income. If Google were to issue sufficient debt to reduce its corporate taxes by $1 billion per year permanently, then the value that would be created is closest to:

A) $6.1 billion
B) $10.2 billion
C) $12.2 billion
D) $14.3 billion

Question 62

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
Assume that investors hold Google stock in retirement accounts that are free from personal taxes. If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently, then the amount that Google needs to borrow is closest to:

A) $14.25 billion
B) $22.00 billion
C) $24.50 billion
D) $40.75 billion

Question 63

Use the table for the question(s) below.
Consider the following top federal tax rates in the United States:
Personal Tax Rates

In 2000, the effective tax rate for debt holders was closest to:

A) 61%
B) 52%
C) 64%
D) 40%

Question 64

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
Assume that investors hold Google stock in retirement accounts that are free from personal taxes. If Google were to issue sufficient debt to reduce its taxes by $600 million per year permanently, then the amount that Google needs to borrow is closest to:

A) $14.25 billion
B) $22.00 billion
C) $24.50 billion
D) $40.75 billion

Question 65

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
Assume that investors hold Google stock in retirement accounts that are free from personal taxes. If Google were to issue sufficient debt to reduce its taxes by $600 million per year permanently, then the value that would be created is closest to:

A) $6.4 billion
B) $8.6 billion
C) $9.8 billion
D) $14.3 billion

Question 66

Which of the following statements is FALSE?

A) The value of a firm is equal to the amount of money the firm can raise by issuing securities.
B) By reducing a firm's corporate tax liability, debt allows the firm to pay more of its cash flows to investors.
C) Equity investors must pay taxes on dividends but not capital gains.
D) For individuals, interest payments received from debt are taxed as income.

Question 67

Use the information for the question(s) below.
Shepard Industries expects free cash flow of $10 million each year. Shepard's corporate tax rate is 35%, and its unlevered cost of equity is 10%. The firm also has outstanding debt of $40 million and it expects to maintain amount of debt permanently.
The value of Shepard Industries without leverage is closest to:

A) $114 million
B) $50 million
C) $100 million
D) $64 million

Question 68

Use the information for the question(s) below.
Shepard Industries expects free cash flow of $10 million each year. Shepard's corporate tax rate is 35%, and its unlevered cost of equity is 10%. The firm also has outstanding debt of $40 million and it expects to maintain amount of debt permanently.
Assume that the corporate tax rate is 40%, the personal tax rate on income from equity is 20% the personal rate on interest income is 36%. The effective tax advantage of a corporate issuing debt would be closest to:

A) 10%
B) 15%
C) 25%
D) 28%

Question 69

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
Assume that investors in Google pay a 15% tax rate on income from equity and a 25% tax rate on interest income. If Google were to issue sufficient debt to reduce its taxes by $600 million per year permanently, then the effective tax advantage of this debt would be closest to:

A) 10%
B) 15%
C) 25%
D) 30%

Question 70

Use the information for the question(s) below.
Shepard Industries expects free cash flow of $10 million each year. Shepard's corporate tax rate is 35%, and its unlevered cost of equity is 10%. The firm also has outstanding debt of $40 million and it expects to maintain amount of debt permanently.
MJ Enterprises has 50 million shares outstanding with a market price of $25 per share and no debt. MJ has had consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $500 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares. Calculate MJ's share price following announcement of the recapitalization plan.

Question 71

Consider the following formula: τ* = The term τ_i is:

A) the effective personal tax rate on interest income.
B) the effective personal tax rate on equity.
C) the effective corporate tax rate on income.
D) the effective tax advantage of debt.

Question 72

Consider the following formula: τ* = The term τ* is:

A) the effective tax advantage of debt.
B) the effective personal tax rate on interest income.
C) the effective personal tax rate on equity.
D) the effective corporate tax rate on income.

Question 73

Which of the following statements is FALSE?

A) To determine the true tax benefit of leverage, we need to evaluate the combined effect of both corporate and personal taxes.
B) A personal tax disadvantage for debt causes the WACC to decline more slowly with leverage than it otherwise would.
C) Personal taxes have an indirect effect on the firm's weighted average cost of capital.
D) In the United States and many other countries, capital gains from equity have historically been taxed more heavily than interest income.

Question 74

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
Assume that investors hold Google stock in retirement accounts that are free from personal taxes. If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently, then the value that would be created is closest to:

A) $14.25 billion
B) $22.00 billion
C) $24.50 billion
D) $40.75 billion

Question 75

Which of the following statements is FALSE?

A) Personal taxes have the potential to offset some of the corporate tax benefits of leverage.
B) The actual interest tax shield depends on the reduction in the total taxes (both corporate and personal) that are paid.
C) The amount of money an investor will pay for a security ultimately depends on the benefits the investor will receive-namely, the cash flows the investor will receive before all taxes have been paid.
D) Just like corporate taxes, personal taxes reduce the cash flows to investors and diminish firm value.

Question 76

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
Assume that investors in Google pay a 15% tax rate on income from equity and a 35% tax rate on interest income. If Google were to issue sufficient debt to reduce its corporate taxes by $1 billion per year permanently, then the value that would be created is closest to:

A) $6.4 billion
B) $8.6 billion
C) $9.8 billion
D) $14.3 billion

Question 77

Which of the following statements is FALSE?

A) Unlike taxes on capital gains or interest income, which are paid annually, taxes on dividends are paid only at the time the investor sells the stock.
B) Deferring the payment of capital gains taxes lowers the present value of the taxes, which can be interpreted as a lower effective capital gains tax rate.
C) Investors with longer holding periods or with accrued losses face a lower tax rate on equity income, decreasing the effective tax advantage of debt.
D) Investors with accrued losses that they can use to offset gains face a zero effective capital gains tax rate.

Question 78

Consider the following formula: τ* = The term τ_e is:

A) the effective personal tax rate on equity.
B) the effective tax advantage of debt.
C) the effective corporate tax rate on income.
D) the effective personal tax rate on interest income.

Question 79

Use the information for the question(s) below.
Shepard Industries expects free cash flow of $10 million each year. Shepard's corporate tax rate is 35%, and its unlevered cost of equity is 10%. The firm also has outstanding debt of $40 million and it expects to maintain amount of debt permanently.
The value of Shepard Industries with leverage is closest to:

A) $64 million
B) $100 million
C) $135 million
D) $114 million

Question 80

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
Assume that investors in Google pay a 15% tax rate on income from equity and a 35% tax rate on interest income. If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently, then the effective tax advantage of this debt would be closest to:

A) 10%
B) 15%
C) 25%
D) 30%