Question 1

Which one of the following is correct based on the static theory of capital structure?

Accepted Answer

A)  A debt-equity ratio of 1 is considered to be the optimal capital structure.
B)  The more debt a firm assumes,the greater the incentive to acquire even more debt until such time as the firm is financed with 100 per cent debt.
C)  At the optimal level of debt a firm also optimises its tax shield on debt.
D)  A firm receives the greatest benefit from debt financing when its tax rate is relatively low.
E)  The costs of financial distress decrease the value of a firm. E

Question 2

The corporate tax rate is 37%.The MaPol Company has a $100 million debenture issue outstanding with a coupon rate of 6.84% per annum.Face value of one debenture is $10 000 and investors require a 7% return on debentures with similar credit rating.What is the present value of the tax shield?

Accepted Answer

A)  $25 300 800
B)  $7 000 000
C)  $6 840 000
D)  $30 160 000
E)  $37 000 000 E

Question 3

Stone House Cafe has a 30 per cent tax rate and total taxes of $35 280.What is the value of the interest tax shield if the interest expense is $16 700?

Accepted Answer

A)  $5010
B)  $6023
C)  $5708
D)  $4887
E)  $5395 A

Question 4

Kelner's Nursery has 8000 bonds outstanding with a face value of $1000 each.The coupon rate is 6.5 per cent and the tax rate is 34 per cent.What is the present value of the interest tax shield?

Accepted Answer

A)  $3.26 million
B)  $2.72 million
C)  $3.09 million
D)  $3.13 million
E)  $2.83 million

Question 5

Which one of the following conditions exists at the point where a firm maximises its value?

Accepted Answer

A)  The debt-equity ratio is 1.0.
B)  Financial distress costs are equal to zero.
C)  The cost of equity is minimised.
D)  WACC is minimised
E)  The tax benefit from an additional dollar of debt is zero.

Question 6

You are comparing two financial policies.The first is all equity.The second involves the use of $2 million of debt.The break-even point between these two policies occurs when the earnings before interest and taxes (EBIT)is $450 000.Given this,it is accurate to say that leverage _____ beneficial to the firm when EBIT is $325 000 and _____ beneficial when EBIT is $625 000.

Accepted Answer

A)  is not;is
B)  is not;is not
C)  is;is not
D)  The answer cannot be determined based on the information provided.
E)  is;is

Question 7

Which one of the following is an implication of M&M Proposition II,without taxes?

Accepted Answer

A)  The risk of equity depends on both the degree of financial leverage and the riskiness of the firm's operations.
B)  WACC decreases as the debt-equity ratio increases.
C)  WACC is unaffected by the capital structure of a firm.
D)  A firm's optimal capital structure is 100 per cent debt.
E)  A firm's capital structure is irrelevant.

Question 8

The legal and administrative costs of bankruptcy are called _____ bankruptcy costs.

Accepted Answer

A)  static
B)  sunk
C)  direct
D)  indirect
E)  overhead

Question 9

Which one of the following statements related to the static theory of capital structure is correct?

Accepted Answer

A)  The linear function of a firm's value has a constant positive slope.
B)  The value of a firm will automatically decrease whenever the debt-equity ratio is decreased.
C)  The actual value of a firm continually rises in direct proportion to the increased use of debt.
D)  A firm begins to lose value as soon as the first dollar of debt is incurred.
E)  A firm's value is maximised when a firm operates at its optimal debt level.

Question 10

Ettalong Electrical Company Ltd has 9000 shares outstanding and no debt.The new CFO is considering issuing $80 000 of debt and using the proceeds to retire 1500 shares.The coupon rate on the debt is 7.5 per cent.What is the break-even level of earnings before interest and taxes between these two capital structure options if the tax rate is 30 per cent?

Accepted Answer

A)  $32 500
B)  $24 000
C)  $36 000
D)  $21 000
E)  $18 500

Question 11

Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases?

Accepted Answer

A)  static theory of capital structure
B)  M&M Proposition I,with taxes
C)  M&M Proposition I,without taxes
D)  M&M Proposition II,without taxes
E)  No theory suggests this.

Question 12

Which one of the following statements is the core principle of M&M Proposition I,without taxes?

Accepted Answer

A)  A firm's WACC is directly related to the firm's debt-equity ratio.
B)  Levered firms have greater value than unlevered firms.
C)  The interest tax shield increases the value of a firm.
D)  A firm's cost of equity is directly related to the firm's debt-equity ratio.
E)  The capital structure of a firm is totally irrelevant.

Question 13

Bartlett Specialists is considering two different capital structures.The first option consists of 15 000 shares of stock.The second option consists of 9000 shares of stock plus $80 000 of debt at an interest rate of 7.5 per cent.Ignore taxes.What is the break-even level of earnings before interest and taxes (EBIT)between these two options?

Accepted Answer

A)  $18 600
B)  $19 400
C)  $20 800
D)  $15 000
E)  $20 000

Question 14

M&M Proposition I,with taxes,states that the value of a levered (VL)firm is equal to:

Accepted Answer

A)  VU  ÷\div÷  (TC  ×	imes×  
D)  
B)  VU - (TC  ×	imes×  
D)  
C)  VU - (TC - R
D)    ×	imes×  D
D)  VU + (TC  ×	imes×  
D)  
E)  VU + (TC - R
D)    ×	imes×  D

Question 15

Which one of the following will generally receive the highest priority in a bankruptcy liquidation,assuming the absolute priority rule is followed?

Accepted Answer

A)  employee wages
B)  bankruptcy administrative expenses
C)  claims by unsecured creditors
D)  contributions to employee superannuation plans
E)  government tax claims

Question 16

When is a firm insolvent from an accounting perspective?

Accepted Answer

A)  when the market value of the firm's equity equals zero
B)  when the firm's revenues cease
C)  when the firm's debt exceeds the value of the firm's equity
D)  when the firm has a negative net worth
E)  when the firm is unable to meet its financial obligations in a timely manner

Question 17

Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $879 000.The current cost of equity is 18.3 per cent and the tax rate is 34 per cent.The company is in the process of issuing $6.2 million of 8.5 per cent annual coupon bonds at par.What is the levered value of the firm?

Accepted Answer

A)  $5 278 164
B)  $6 422 225
C)  $7 385 695
D)  $6 713 185
E)  $5 541 085

Question 18

The BaPol Company has a cost of equity of 14% and a weighted average cost of capital of 13.02%.What is the company's cost of debt,if BaPol Company maintains the debt-equity ratio of 0.44? Consider that there are no taxes.

Accepted Answer

A)  16.68%
B)  13.48%
C)  12.26%
D)  10.80%
E)  17.59%

Question 19

The static theory of capital structure assumes a firm:

Accepted Answer

A)  has an all-equity structure
B)  is operating at the point where financial distress costs are eliminated
C)  is fixed in terms of its assets
D)  pays no taxes
E)  maintains a constant debt-equity ratio

Question 20

Brown's Department Store has a cost of equity of 19.1 per cent,a pre-tax cost of debt of 8 per cent,and a return on assets of 14 per cent.Ignore taxes.What is the debt-equity ratio?

Accepted Answer

A)  0.70
B)  0.80
C)  0.75
D)  0.65
E)  0.85

Exam 13: Leverage and Capital Structure

Which one of the following is correct based on the static theory of capital structure?

The corporate tax rate is 37%.The MaPol Company has a $100 million debenture issue outstanding with a coupon rate of 6.84% per annum.Face value of one debenture is $10 000 and investors require a 7% return on debentures with similar credit rating.What is the present value of the tax shield?

Stone House Cafe has a 30 per cent tax rate and total taxes of $35 280.What is the value of the interest tax shield if the interest expense is $16 700?

Kelner's Nursery has 8000 bonds outstanding with a face value of $1000 each.The coupon rate is 6.5 per cent and the tax rate is 34 per cent.What is the present value of the interest tax shield?

Which one of the following conditions exists at the point where a firm maximises its value?

Which one of the following is an implication of M&M Proposition II,without taxes?

The legal and administrative costs of bankruptcy are called _____ bankruptcy costs.

Which one of the following statements related to the static theory of capital structure is correct?

Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases?

Which one of the following statements is the core principle of M&M Proposition I,without taxes?

M&M Proposition I,with taxes,states that the value of a levered (V_L) firm is equal to:

Which one of the following will generally receive the highest priority in a bankruptcy liquidation,assuming the absolute priority rule is followed?

When is a firm insolvent from an accounting perspective?

The BaPol Company has a cost of equity of 14% and a weighted average cost of capital of 13.02%.What is the company's cost of debt,if BaPol Company maintains the debt-equity ratio of 0.44? Consider that there are no taxes.

The static theory of capital structure assumes a firm:

Brown's Department Store has a cost of equity of 19.1 per cent,a pre-tax cost of debt of 8 per cent,and a return on assets of 14 per cent.Ignore taxes.What is the debt-equity ratio?

Exam 13: Leverage and Capital Structure

Which one of the following is correct based on the static theory of capital structure?

The corporate tax rate is 37%.The MaPol Company has a $100 million debenture issue outstanding with a coupon rate of 6.84% per annum.Face value of one debenture is $10 000 and investors require a 7% return on debentures with similar credit rating.What is the present value of the tax shield?

Stone House Cafe has a 30 per cent tax rate and total taxes of $35 280.What is the value of the interest tax shield if the interest expense is $16 700?

Kelner's Nursery has 8000 bonds outstanding with a face value of $1000 each.The coupon rate is 6.5 per cent and the tax rate is 34 per cent.What is the present value of the interest tax shield?

Which one of the following conditions exists at the point where a firm maximises its value?

Which one of the following is an implication of M&M Proposition II,without taxes?

The legal and administrative costs of bankruptcy are called _____ bankruptcy costs.

Which one of the following statements related to the static theory of capital structure is correct?

Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases?

Which one of the following statements is the core principle of M&M Proposition I,without taxes?

M&M Proposition I,with taxes,states that the value of a levered (VL) firm is equal to:

Which one of the following will generally receive the highest priority in a bankruptcy liquidation,assuming the absolute priority rule is followed?

When is a firm insolvent from an accounting perspective?

The BaPol Company has a cost of equity of 14% and a weighted average cost of capital of 13.02%.What is the company's cost of debt,if BaPol Company maintains the debt-equity ratio of 0.44? Consider that there are no taxes.

The static theory of capital structure assumes a firm:

Brown's Department Store has a cost of equity of 19.1 per cent,a pre-tax cost of debt of 8 per cent,and a return on assets of 14 per cent.Ignore taxes.What is the debt-equity ratio?

M&M Proposition I,with taxes,states that the value of a levered (V_L) firm is equal to: