Question 1

Use the information for the question(s) below.
Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade at a price of $24 per share. With has 2 million shares outstanding and $12 million of debt at an interest rate of 5%.
-According to MM Proposition I,the stock price for With is closest to:

Accepted Answer

A)  $8.00 
B)  $24.00 
C)  $6.00 
D)  $12.00 
E)  $18.00

Question 2

A firm undertakes an investment that is financed with $10,000 of equity and $30,000 of debt.If the return on equity is 14%,the cost of debt is 7% and the tax rate is 25%,what is the firm's WACC?

Accepted Answer

A)  6.76% 
B)  9.92% 
C)  7.00% 
D)  8.75% 
E)  7.44%

Question 3

Suppose a firm has $80 million of permanent debt.If the tax rate is 35% and the cost of debt is 8%,what is the value of the interest tax shield each year?

Accepted Answer

A)  $2.2 million 
B)  $6.4 million 
C)  $28 million 
D)  $80 million 
E)  $350 million

Question 4

A financial manager makes a choice of the amount and source of capital based on how the choice will impact

Accepted Answer

A)  debt-equity ratio. 
B)  debt value. 
C)  earnings per share. 
D)  firm value. 
E)  profit.

Question 5

Use the information for the question(s) below.
Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade at a price of $24 per share. With has 2 million shares outstanding and $12 million of debt at an interest rate of 5%.
-Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as With.You have $5000 of your own money to invest and you plan on buying Without stock.Using homemade leverage,how much do you need to borrow in your margin account so that the payoff of your margined purchase of Without stock will be the same as a $5000 investment in With stock?

Accepted Answer

A)  $10,000 
B)  $5250 
C)  $5000 
D)  $2500 
E)  $0

Question 6

A new business will generate a one-time cash flow of $20,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm's unlevered equity cost of capital is 10%,what is the levered value of the firm with perfect capital markets?

Accepted Answer

A)  $18,182 
B)  $20,000 
C)  $19,000 
D)  $22,000 
E)  $18,000

Question 7

Managerial entrenchment means that managers ________ and run the firm for their own best interests.

Accepted Answer

A)  may face little threat of being fired 
B)  are overseen by equity holders 
C)  are overseen by debt holders 
D)  are well compensated 
E)  wish to leave the firm

Question 8

A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 60% equity and 40% debt.If the firm can borrow at 10%,what is the return on levered equity?

Accepted Answer

A)  25% 
B)  35% 
C)  15% 
D)  42% 
E)  17%

Question 9

The relative proportions of debt,equity,and other securities that a firm has outstanding constitute its

Accepted Answer

A)  capital structure. 
B)  leverage. 
C)  retained earnings. 
D)  paid-out capital. 
E)  debt-to-value ratio.

Question 10

Suppose a project financed via an issue of debt requires five annual interest payments of $20 million each year.If the tax rate is 30%,and the present value of the interest tax shield is 25.98 million,what is the firm's cost of debt?

Accepted Answer

A)  3% 
B)  4% 
C)  5% 
D)  6% 
E)  7%

Question 11

Suppose a firm has $50 million of permanent debt.If the tax rate is 25% and the cost of debt is 7%,what is the value of the interest tax shield each year?

Accepted Answer

A)  $3.5 million 
B)  $50 million 
C)  $0.875 million 
D)  $178.6 million 
E)  $12.5 million

Question 12

When a firm commits to large future debt payments to convince the stock market it has great projects,this is an example of

Accepted Answer

A)  market timing. 
B)  adverse selection. 
C)  the pecking order hypothesis. 
D)  the agency cost of debt. 
E)  the signalling theory of debt.

Question 13

Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share.
-Suppose Blank Company has only one project,as forecast above,and an unlevered cost of equity of 8%.If the company borrows $10,000 at 5% to make the investment,what is the return to equity holders if demand is strong?

Accepted Answer

A)  8.0% 
B)  54.0% 
C)  28.6% 
D)  38.0% 
E)  42.3%

Question 14

Financial managers prefer to choose the same debt level no matter which industry they operate in.

Accepted Answer

A) True 
 B)False

Question 15

The tradeoff theory of optimal capital structure weighs the benefits of debt against the costs of

Accepted Answer

A)  financial distress. 
B)  interest payments. 
C)  dividend reinvestment. 
D)  input factors. 
E)  equity.

Question 16

A new business will generate a one-time cash flow of $25,000 after one year.The business will be financed with 20% equity and 80% debt.If the firm's unlevered equity cost of capital is 12%,what is the levered value of the firm with perfect capital markets?

Accepted Answer

A)  $19,882 
B)  $22,321 
C)  $22,000 
D)  $28,000 
E)  $23,000

Question 17

One of the factors that determines the present value (PV)of financial distress costs is

Accepted Answer

A)  costs of unpaid interest arrears. 
B)  loss of dividend payments. 
C)  probability of financial distress. 
D)  employee compensation. 
E)  size of the interest tax shield.

Question 18

Firms in industries such as real estate tend to have ________ distress costs because of a large proportion of tangible assets.

Accepted Answer

A)  high 
B)  low 
C)  unexpected 
D)  varying 
E)  constant

Question 19

An unlevered firm currently has a value of $100 million.The firm has a tax rate of 30%.The firm wishes to replace $50 million of its equity with $50 million of permanent debt.By increasing its leverage,the PV of the expected costs of financial distress would rise from 0 to $10 million.What is the value of the levered firm if it goes ahead with this plan?

Accepted Answer

A)  $105 million 
B)  $115 million 
C)  $100 million 
D)  $125 million 
E)  $110 million

Question 20

Issuing debt provides incentives for managers to run the firm efficiently because

Accepted Answer

A)  debt increases the funds available to managers to run the firm. 
B)  ownership may remain more concentrated, improving monitoring of management. 
C)  managers may take actions that benefit shareholders but harm creditors and lower the value of the firm. 
D)  shareholders prefer to decline new projects to save cash, even if their NPVs are positive. 
E)  managers will be obligated to run the firm in the interests of bondholders.

Exam 16: Capital Structure