Question 1

The actual firm value is equal to the M&M Proposition I with tax value minus the financial distress costs.

Accepted Answer

A) True 
 B)False

Question 2

What is ROE for the proposed capital structure if the expected state occurs?

Accepted Answer

A)   11.7%
B)   16.7%
C)   20.0%
D)   22.4%
E)   23.3%F) A) and B)
G) C) and D)

Question 3

The Fabric Mill has debt with both a face and a market value of $6,500. This debt has a coupon rate of 8% and pays interest annually. The expected earnings before interest and taxes are $1,400, the tax rate is 35%, and the unlevered cost of capital is 14%. What is the firm's cost of equity?

Accepted Answer

A)   17.90%
B)   18.56%
C)   22.40%
D)   23.59%
E)   25.14%F) A) and B)
G) None of the above

Question 4

Which of the following is the best definition of M&M Proposition I?

Accepted Answer

A)   The tax saving attained by a firm from interest expense.
B)   Termination of the firm as a going concern.
C)   The value of the firm is independent of its capital structure.
D)   A firm's cost of equity capital is a positive linear function of its capital structure.
E)   Financial restructuring of a failing firm to attempt to continue operations as a going concern.F) C) and D)
G) A) and B)

Question 5

The concept of homemade leverage is most associated with:

Accepted Answer

A)   M&M Proposition I with no tax.
B)   M&M Proposition II with no tax.
C)   M&M Proposition I with tax.
D)   M&M Proposition II with tax.
E)   Static theory proposition.F) B) and E)
G) A) and E)

Question 6

A firm has $500 in debt at a cost of 7%, a 34% tax rate, a total firm value of $1,100, and an unlevered return of 14%. What is the WACC?

Accepted Answer

A)   9.24%
B)   9.74%
C)   9.88%
D)   10.67%
E)   11.84%F) A) and E)
G) A) and C)

Question 7

Which of the following statements is correct?

Accepted Answer

A)   Decisions regarding a firm's debt and equity can be called capital budgeting decisions.
B)   The asset beta is a measure of the unsystematic risk of a firm's assets.
C)   In a purely capital restructuring, the composition of the assets of the firm will change.
D)   The value of the overall firm will not change as a result of a capital restructuring unless the NPV of the restructuring is negative.
E)   The use of personal leverage by an investor to alter the degree of financial leverage of a firm is called homemade leverage.F) A) and E)
G) All of the above

Question 8

United Landscaping is an all equity firm that has 140,000 shares of stock outstanding. The company is in the process of borrowing $1.2 million at 8% interest to repurchase 30,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes?

Accepted Answer

A)   $2.57 million
B)   $4.14 million
C)   $5.60 million
D)   $7.00 million
E)   $8.13 millionF) A) and C)
G) B) and D)

Question 9

You have computed the break-even point between a capital structure that has no debt and one that has debt. Assume there are no taxes. At the break-even level, the:

Accepted Answer

A)   Firm is just earning enough to pay for the cost of the debt.
B)   Firm's earnings before interest and taxes are equal to zero.
C)   Earnings per share for the levered option are exactly double those of the unlevered option.
D)   Advantages of leverage exceed the disadvantages of leverage.
E)   Firm has a debt-equity ratio of.50.F) A) and B)
G) A) and C)

Question 10

The cost of debt is generally lower than the cost of equity; however, according to __________, replacing equity with debt will not change the value of the firm because the savings attributable to the lower cost of debt financing will be offset by the higher required return on the remaining equity.

Accepted Answer

A)   M&M Proposition I with taxes.
B)   M&M Proposition I without taxes.
C)   The static theory of capital structure.
D)   M&M Proposition II without taxes.
E)   M&M Proposition II with taxes.F) A) and D)
G) C) and D)

Question 11

Given that rational investors are risk averse, the cost of debt will generally be lower than the cost of equity; however, M&M Proposition I states that replacing equity with debt will not change the value of the firm. Explain.

Accepted Answer

The student is asked to demonstrate his/...

Question 12

Calculate the company's cost of equity given the following information: return on assets 7.0%; return on debt 3.25%; 25% debt; 75% equity.

Accepted Answer

A)   7.50%
B)   8.25%
C)   9.00%
D)   9.75%
E)   10.50%F) None of the above
G) All of the above

Question 13

All else the same, the financial leverage of a firm will _________________.

Accepted Answer

A)   Decrease as the debt/equity ratio increases.
B)   Decrease as the firm's retained earnings account grows.
C)   Increase by the amount of equity it issues in a given year.
D)   Decrease if the firm has negative net income.
E)   Decrease as the firm uses debt to fund expansion projects.F) A) and B)
G) C) and E)

Question 14

Juno Industrial Products is debating between a leveraged and an unleveraged capital structure. The all equity capital structure would consist of 20,000 shares of stock. The debt and equity option would consist of 14,000 shares of stock plus $170,000 of debt with an interest rate of 8%. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes.

Accepted Answer

A)   $42,208
B)   $44,141
C)   $45,333
D)   $46,667
E)   $48,928F) C) and E)
G) A) and E)

Question 15

The implicit costs associated with corporate default, such as lost sales, are the __________ of the firm.

Accepted Answer

A)   Flotation costs.
B)   Default beta coefficients.
C)   Direct bankruptcy costs.
D)   Indirect bankruptcy costs.
E)   Default risk premium.F) C) and E)
G) A) and B)

Question 16

When the value of a firm's assets exactly equals the value of its debt, the firm:

Accepted Answer

A)   Is economically bankrupt.
B)   Is technically insolvent.
C)   Is legally bankrupt.
D)   Is in liquidation.
E)   Is in default.F) A) and B)
G) C) and E)

Question 17

According to the static theory of capital structure, ____________________.

Accepted Answer

A)   A firm's choice of assets and operations is fixed for all time.
B)   A firm will borrow up to the point where the benefit from an extra dollar of debt is just equal to the tax benefit associated with that debt.
C)   The value of the firm will differ from the M&M value without taxes by the gain from leverage.
D)   The optimal WACC is the same as it is in M&M with taxes.
E)   The value of the firm in M&M with taxes is overstated by the amount of financial distress costs.F) None of the above
G) C) and D)

Question 18

China Importers has $267,000 of debt outstanding that is selling at par and has a coupon rate of 9.5%. The tax rate is 35%. What is the present value of the tax shield?

Accepted Answer

A)   $8,878
B)   $16,487
C)   $93,450
D)   $148,020
E)   $173,550F) C) and E)
G) B) and C)

Question 19

A firm should select the capital structure which:

Accepted Answer

A)   Produces the highest cost of capital.
B)   Maximizes the value of the firm.
C)   Minimizes taxes.
D)   Is fully unlevered.
E)   Has no debt.F) A) and B)
G) A) and C)

Question 20

M&M Proposition I with tax states that the value of a levered firm increases as the:

Accepted Answer

A)   Level of debt decreases.
B)   Tax rate of the firm decreases.
C)   Debt-equity ratio increases.
D)   Unlevered value of the firm decreases.
E)   Inflation rate increases.F) B) and D)
G) A) and D)

Exam 16: Financial Leverage and Capital Structure Policy

United Landscaping is an all equity firm that has 140,000 shares of stock outstanding. The company is in the process of borrowing $1.2 million at 8% interest to repurchase 30,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes?

Correct Answer
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All else the same, the financial leverage of a firm will _________________.

Correct Answer
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Calculate the company's cost of equity given the following information: return on assets 7.0%; return on debt 3.25%; 25% debt; 75% equity.

Correct Answer
verified

A firm should select the capital structure which:

Correct Answer
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M&M Proposition I with tax states that the value of a levered firm increases as the:

Correct Answer
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A firm has $500 in debt at a cost of 7%, a 34% tax rate, a total firm value of $1,100, and an unlevered return of 14%. What is the WACC?

Correct Answer
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The concept of homemade leverage is most associated with:

Correct Answer
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The cost of debt is generally lower than the cost of equity; however, according to __________, replacing equity with debt will not change the value of the firm because the savings attributable to the lower cost of debt financing will be offset by the higher required return on the remaining equity.

Correct Answer
verified

What is ROE for the proposed capital structure if the expected state occurs?

Correct Answer
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Correct Answer
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The actual firm value is equal to the M&M Proposition I with tax value minus the financial distress costs.

Correct Answer
verified

China Importers has $267,000 of debt outstanding that is selling at par and has a coupon rate of 9.5%. The tax rate is 35%. What is the present value of the tax shield?

Correct Answer
verified

The Fabric Mill has debt with both a face and a market value of $6,500. This debt has a coupon rate of 8% and pays interest annually. The expected earnings before interest and taxes are $1,400, the tax rate is 35%, and the unlevered cost of capital is 14%. What is the firm's cost of equity?

Correct Answer
verified

According to the static theory of capital structure, ____________________.

Correct Answer
verified

Given that rational investors are risk averse, the cost of debt will generally be lower than the cost of equity; however, M&M Proposition I states that replacing equity with debt will not change the value of the firm. Explain.

Correct Answer
verified
The student is asked to demonstrate his/...
View Answer

The implicit costs associated with corporate default, such as lost sales, are the __________ of the firm.

Correct Answer
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When the value of a firm's assets exactly equals the value of its debt, the firm:

Correct Answer
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Which of the following is the best definition of M&M Proposition I?

Correct Answer
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You have computed the break-even point between a capital structure that has no debt and one that has debt. Assume there are no taxes. At the break-even level, the:

Correct Answer
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Which of the following statements is correct?

Correct Answer
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Exam 16: Financial Leverage and Capital Structure Policy

United Landscaping is an all equity firm that has 140,000 shares of stock outstanding. The company is in the process of borrowing $1.2 million at 8% interest to repurchase 30,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes?

Correct AnswerverifiedShow Answer

All else the same, the financial leverage of a firm will _________________.

Correct AnswerverifiedShow Answer

Calculate the company's cost of equity given the following information: return on assets 7.0%; return on debt 3.25%; 25% debt; 75% equity.

Correct AnswerverifiedShow Answer

A firm should select the capital structure which:

Correct AnswerverifiedShow Answer

M&M Proposition I with tax states that the value of a levered firm increases as the:

Correct AnswerverifiedShow Answer

A firm has $500 in debt at a cost of 7%, a 34% tax rate, a total firm value of $1,100, and an unlevered return of 14%. What is the WACC?

Correct AnswerverifiedShow Answer

The concept of homemade leverage is most associated with:

Correct AnswerverifiedShow Answer

The cost of debt is generally lower than the cost of equity; however, according to __________, replacing equity with debt will not change the value of the firm because the savings attributable to the lower cost of debt financing will be offset by the higher required return on the remaining equity.

Correct AnswerverifiedShow Answer

What is ROE for the proposed capital structure if the expected state occurs?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The actual firm value is equal to the M&M Proposition I with tax value minus the financial distress costs.

Correct AnswerverifiedShow Answer

China Importers has $267,000 of debt outstanding that is selling at par and has a coupon rate of 9.5%. The tax rate is 35%. What is the present value of the tax shield?

Correct AnswerverifiedShow Answer

The Fabric Mill has debt with both a face and a market value of $6,500. This debt has a coupon rate of 8% and pays interest annually. The expected earnings before interest and taxes are $1,400, the tax rate is 35%, and the unlevered cost of capital is 14%. What is the firm's cost of equity?

Correct AnswerverifiedShow Answer

According to the static theory of capital structure, ____________________.

Correct AnswerverifiedShow Answer

Given that rational investors are risk averse, the cost of debt will generally be lower than the cost of equity; however, M&M Proposition I states that replacing equity with debt will not change the value of the firm. Explain.

Correct AnswerverifiedThe student is asked to demonstrate his/...View AnswerShow Answer

The implicit costs associated with corporate default, such as lost sales, are the __________ of the firm.

Correct AnswerverifiedShow Answer

When the value of a firm's assets exactly equals the value of its debt, the firm:

Correct AnswerverifiedShow Answer

Which of the following is the best definition of M&M Proposition I?

Correct AnswerverifiedShow Answer

You have computed the break-even point between a capital structure that has no debt and one that has debt. Assume there are no taxes. At the break-even level, the:

Correct AnswerverifiedShow Answer

Which of the following statements is correct?

Correct AnswerverifiedShow Answer

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The student is asked to demonstrate his/...
View Answer

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