Question 1

CT Stores has debt with a book value of $325,000 and a market value of $319,000.The firm's equity has a book value of $526,000 and a market value of $684,000.The tax rate is 21 percent and the cost of capital is 11.2 percent.What is the market value of this firm based on MM Proposition I without taxes?

Accepted Answer

A) $923,250 
B) $1,003,000 
C) $984,300 
D) $851,000 
E) $769,750

Question 2

Your firm has a bond issue with a face value of $250,000 outstanding.These bonds have a coupon rate of 7 percent,pay interest semiannually,and have a current market price equal to 103 percent of face value.What is the amount of the annual tax shield on debt given a tax rate of 21 percent?

Accepted Answer

A) $3,675 
B) $6,309 
C) $4,500 
D) $47,500 
E) $52,500

Question 3

A firm has an equity multiplier of 1.57,an unlevered cost of equity of 14 percent,a levered cost of equity of 15.6 percent,and a tax rate of 21 percent.What is the cost of debt?

Accepted Answer

A) 11.25 percent 
B) 10.50 percent 
C) 10.45 percent 
D) 11.00 percent 
E) 10.33 percent

Question 4

MM Proposition I without taxes proposes that:

Accepted Answer

A) the value of an unlevered firm exceeds that of a levered firm. 
B) there is one ideal capital structure for each firm. 
C) leverage does not affect the value of the firm. 
D) shareholder wealth is directly affected by the capital structure selected. 
E) the value of a levered firm exceeds that of an unlevered firm.

Question 5

MM Proposition II with no taxes supports the argument that a firm's:

Accepted Answer

A) unlevered equity is risk-free. 
B) cost of equity is inversely related to the firm's debt-equity level. 
C) cost of equity is unaffected by the firm's unlevered cost of capital. 
D) WACC will exceed the unlevered firm's cost of equity. 
E) WACC remains constant even if the firm changes its capital structure.

Question 6

Assume an initial scenario where a levered firm has total assets of $8,000,earnings before interest and taxes of $600,400 shares of stock outstanding,a debt-equity ratio of .25,and a cost of debt of 7 percent.Now assume a second scenario where the firm changes to an all-equity structure by issuing new shares to pay off debt while a shareholder holding 10 percent of the stock borrows funds at 7 percent and uses homemade leverage to offset the firm's change in capital structure.Ignore taxes.What are the net earnings for this shareholder under the initial scenario? Under the second scenario?

Accepted Answer

A) $90.00; $90.00 
B) $90.00; $112.50 
C) $48.80; $38.80 
D) $48.80; $48.80 
E) $45.00; $48.80

Question 7

The firm's capital structure refers to the:

Accepted Answer

A) mix of current and fixed assets a firm holds. 
B) amount of capital invested in the firm. 
C) amount of dividends a firm pays. 
D) mix of debt and equity used to finance the firm's assets. 
E) amount of cash versus receivables the firm holds.

Question 8

The tax savings of the firm derived from the deductibility of interest expense is called the:

Accepted Answer

A) tax shield from debt. 
B) depreciable basis. 
C) financing umbrella. 
D) current yield. 
E) tax-loss carryback.

Question 9

A firm has a debt-equity ratio of .55 with a cost of debt of 6.7 percent.If it had no debt,its cost of equity would be 14.5 percent.What is its levered cost of equity assuming there are no taxes or other imperfections?

Accepted Answer

A) 18.96 percent 
B) 15.82 percent 
C) 17.94 percent 
D) 18.79 percent 
E) 13.67 percent

Question 10

The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:

Accepted Answer

A) MM Proposition I with no tax. 
B) MM Proposition II with no tax. 
C) MM Proposition I with tax. 
D) MM Proposition II with tax. 
E) both MM I with and without tax.

Question 11

Anderson's Furniture Outlet has an unlevered cost of capital of 10.3 percent,a tax rate of 21 percent,and expected earnings before interest and taxes of $1,900.The company has $4,000 in bonds outstanding that have an annual coupon of 7 percent.If the bonds are selling at par,what is the cost of equity?

Accepted Answer

A) 11.33 percent 
B) 9.34 percent 
C) 10.72 percent 
D) 9.99 percent 
E) 11.21 percent

Question 12

The Winter Wear Company has expected earnings before interest and taxes of $3,800,an unlevered cost of capital of 15.4 percent and a tax rate of 22 percent.The company also has $2,600 of debt with a coupon rate of 5.7 percent.The debt is selling at par value.What is the value of this firm?

Accepted Answer

A) $15,585 
B) $19,819 
C) $12,115 
D) $12,055 
E) $17,700

Question 13

A firm has a debt-equity ratio of .64,a pretax cost of debt of 8.5 percent,and a required return on assets of 12.6 percent.What is the cost of equity if you ignore taxes?

Accepted Answer

A) 8.06 percent 
B) 8.55 percent 
C) 11.12 percent 
D) 15.22 percent 
E) 16.38 percent

Question 14

A firm has a debt-equity ratio of .64,a cost of equity of 13.04 percent,and a cost of debt of 8 percent.Assume the corporate tax rate is 25 percent.What would be the cost of equity if the firm were all-equity financed?

Accepted Answer

A) 11.30 percent 
B) 11.41 percent 
C) 13.33 percent 
D) 12.42 percent 
E) 12.25 percent

Exam 16: Capital Structure: Basic Concepts