Question 1

Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?

Accepted Answer

A)   Consumer claims
B)   Dividend payment to preferred shareholders
C)   Company contribution to the employees' retirement account
D)   Payment to an unsecured creditor
E)   Payment of employees' wagesF) A) and E)
G) A) and B)

Question 2

Which one of the following is correct according to pecking-order theory?

Accepted Answer

A)   There is a direct relationship between a company's profits and its debt levels.
B)   Companies avoid external debt except as a last resort.
C)   A company's capital structure is independent of its need for external funding.
D)   Companies stockpile internally generated cash.
E)   Every company has an optimal capital structure.F) A) and D)
G) A) and E)

Question 3

The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as ________ costs.

Accepted Answer

A)   flotation
B)   issue
C)   direct bankruptcy
D)   indirect bankruptcy
E)   unleveredF) None of the above
G) A) and B)

Question 4

Eastern Markets has no debt outstanding and a total market value of $346,500. Earnings before interest and taxes, EBIT, are projected to be $14,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 13 percent higher. If there is a recession, then EBIT will be 32 percent lower. The firm is considering a debt issue of $16,000 with an interest rate of 6.8 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,500 shares outstanding. Ignore taxes. What will be the percentage change in EPS if the economy enters a recessionary period?

Accepted Answer

A)   −35 percent
B)   −41 percent
C)   −32 percent
D)   −28 percent
E)   −30 percentF) A) and D)
G) A) and C)

Question 5

An unlevered company has a cost of capital of 14.6 percent and earnings before interest and taxes of $240,090. A levered company with the same operations and assets has a face value of debt of $85,000 with a coupon rate of 7.5 percent that sells at par. The applicable tax rate is 22 percent. What is the value of the levered company?

Accepted Answer

A)   $1,085,338
B)   $1,398,257
C)   $1,402,509
D)   $1,301,373
E)   $1,001,010F) A) and B)
G) A) and D)

Question 6

Homemade leverage is:

Accepted Answer

A)   the incurrence of debt by a corporation in order to pay dividends to shareholders.
B)   the exclusive use of debt to fund a corporate expansion project.
C)   the use of personal borrowing to alter an individual's exposure to financial leverage.
D)   best defined as an increase in a company's debt level.
E)   the term used to describe the capital structure of a levered firm.F) A) and E)
G) B) and E)

Question 7

ABC and XYZ are identical firms in all respects except for their capital structures. ABC is all-equity financed with $530,000 in stock. XYZ has the same total value but uses both stock and perpetual debt; its stock is worth $310,000 and the interest rate on its debt is 7.9 percent. Both firms expect EBIT to be $62,222. Ignore taxes. The cost of equity for ABC is ________ percent and for XYZ it is ________ percent.

Accepted Answer

A)   11.74; 9.82
B)   11.74; 12.48
C)   11.74; 14.47
D)   12.09; 9.82
E)   12.09; 12.48F) C) and D)
G) C) and E)

Question 8

Which form of financing do companies prefer to use first according to the pecking-order theory?

Accepted Answer

A)   Regular debt
B)   Convertible debt
C)   Common stock
D)   Preferred stock
E)   Internal fundsF) C) and D)
G) B) and C)

Question 9

Which one of the following statements is correct in relation to M&M Proposition II, without taxes?

Accepted Answer

A)   The cost of equity remains constant as the debt-equity ratio increases.
B)   The cost of equity is inversely related to the debt-equity ratio.
C)   The required return on assets is equal to the weighted average cost of capital.
D)   Financial risk determines the return on assets.
E)   Financial risk is unaffected by the debt-equity ratio.F) D) and E)
G) B) and D)

Question 10

KN&J expects its EBIT to be $147,000 every year forever. The company currently has no debt but can borrow at 7.6 percent while its cost of equity is 14.6 percent. The tax rate is 21 percent. What will be the value of the company if it borrows $40,000 and uses the loan proceeds to repurchase shares?

Accepted Answer

A)   $654,452
B)   $646,667
C)   $803,811
D)   $606,667
E)   $681,588F) All of the above
G) A) and C)

Question 11

North Side Inc. has no debt outstanding and a total market value of $168,000. Earnings before interest and taxes, EBIT, are projected to be $18,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 22 percent higher. If there is a recession, then EBIT will be 35 percent lower. The company is considering a $50,000 debt issue with an interest rate of 7.4 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,000 shares outstanding and the tax rate is 21 percent. What will be the percentage change in EPS if the economy has a strong expansion?

Accepted Answer

A)   28.80 percent
B)   31.26 percent
C)   27.69 percent
D)   25.45 percent
E)   22.00 percentF) None of the above
G) B) and E)

Question 12

M&M Proposition II with taxes:

Accepted Answer

A)   has the same general implications as M&M Proposition II without taxes.
B)   states that capital structure is irrelevant to shareholders.
C)   supports the argument that business risk is determined by the capital structure decision.
D)   supports the argument that the cost of equity decreases as the debt-equity ratio increases.
E)   concludes that the capital structure decision is irrelevant to the value of a firm.F) B) and D)
G) B) and C)

Question 13

Key Motors has a cost of equity of 14.26 percent and an unlevered cost of capital of 11.34 percent. The company has $35,000 in debt that is selling at par value. The levered value of the company is $79,000 and the tax rate is 21 percent. What is the pretax cost of debt?

Accepted Answer

A)   5.73 percent
B)   6.18 percent
C)   6.58 percent
D)   6.69 percent
E)   5.92 percentF) B) and D)
G) A) and B)

Question 14

M&M Proposition I with taxes is based on the concept that:

Accepted Answer

A)   the optimal capital structure is the one that is totally financed with equity.
B)   capital structure is irrelevant because investors and companies have differing tax rates.
C)   WACC is unaffected by a change in the company's capital structure.
D)   the value of a taxable company increases as the level of debt increases.
E)   the cost of equity increases as the debt-equity ratio increases.F) A) and E)
G) B) and C)

Question 15

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

Accepted Answer

A)   permits creditors to file a prepack immediately after a firm files for bankruptcy protection.
B)   prevents creditors from submitting any reorganization plans.
C)   prevents companies from filing for bankruptcy protection more than once.
D)   permits key employee retention plans only if the affected employee(s)  has another job offer.
E)   allows the payment of bonuses to all key employees to entice those employees to remain in the company's employ.F) None of the above
G) All of the above

Question 16

Bankruptcy:

Accepted Answer

A)   occurs when total equity is negative.
B)   is a legal proceeding.
C)   occurs when a company cannot meet its financial obligations.
D)   refers to a loss of value for debt holders.
E)   is an inexpensive means of reorganizing a company.F) A) and E)
G) All of the above

Question 17

Georga's Restaurants has 7,000 bonds outstanding with a face value of $1,000 each, a market price of $982, and a coupon rate of 6.95 percent. The interest is paid semiannually. What is the amount of the annual interest tax shield if the tax rate is 23 percent?

Accepted Answer

A)   $111,895
B)   $113,323
C)   $107,750
D)   $110,420
E)   $113,006F) A) and E)
G) B) and D)

Question 18

A firm should select the capital structure that:

Accepted Answer

A)   produces the highest cost of capital.
B)   maximizes the value of the firm.
C)   minimizes taxes.
D)   is fully unlevered.
E)   equates the value of debt with the value of equity.F) All of the above
G) B) and E)

Question 19

If a company has the optimal amount of debt, then the:

Accepted Answer

A)   direct financial distress costs must equal the present value of the interest tax shield.
B)   value of the levered company will exceed the value of the unlevered company.
C)   company has no financial distress costs.
D)   Value of the firm is equal to VL + TCD.
E)   debt-equity ratio is equal to 1.F) None of the above
G) B) and E)

Question 20

The static theory of capital structure advocates that the optimal capital structure for a company:

Accepted Answer

A)   is highly dependent upon a constant debt-equity ratio over time.
B)   remains fixed over time.
C)   is independent of the company's tax rate.
D)   is independent of the company's debt-equity ratio.
E)   equates marginal tax savings from additional debt to the marginal increased bankruptcy costs of that debt.F) A) and B)
G) A) and C)

Exam 16: Financial Leverage and Capital Structure Policy

The static theory of capital structure advocates that the optimal capital structure for a company:

Correct Answer
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Which form of financing do companies prefer to use first according to the pecking-order theory?

Correct Answer
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The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

Correct Answer
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Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?

Correct Answer
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Correct Answer
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M&M Proposition I with taxes is based on the concept that:

Correct Answer
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Which one of the following statements is correct in relation to M&M Proposition II, without taxes?

Correct Answer
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A firm should select the capital structure that:

Correct Answer
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Homemade leverage is:

Correct Answer
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Which one of the following is correct according to pecking-order theory?

Correct Answer
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Correct Answer
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M&M Proposition II with taxes:

Correct Answer
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Correct Answer
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If a company has the optimal amount of debt, then the:

Correct Answer
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KN&J expects its EBIT to be $147,000 every year forever. The company currently has no debt but can borrow at 7.6 percent while its cost of equity is 14.6 percent. The tax rate is 21 percent. What will be the value of the company if it borrows $40,000 and uses the loan proceeds to repurchase shares?

Correct Answer
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Key Motors has a cost of equity of 14.26 percent and an unlevered cost of capital of 11.34 percent. The company has $35,000 in debt that is selling at par value. The levered value of the company is $79,000 and the tax rate is 21 percent. What is the pretax cost of debt?

Correct Answer
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The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as ________ costs.

Correct Answer
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Bankruptcy:

Correct Answer
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Georga's Restaurants has 7,000 bonds outstanding with a face value of $1,000 each, a market price of $982, and a coupon rate of 6.95 percent. The interest is paid semiannually. What is the amount of the annual interest tax shield if the tax rate is 23 percent?

Correct Answer
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Correct Answer
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Exam 16: Financial Leverage and Capital Structure Policy

The static theory of capital structure advocates that the optimal capital structure for a company:

Correct AnswerverifiedShow Answer

Which form of financing do companies prefer to use first according to the pecking-order theory?

Correct AnswerverifiedShow Answer

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

Correct AnswerverifiedShow Answer

Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

M&M Proposition I with taxes is based on the concept that:

Correct AnswerverifiedShow Answer

Which one of the following statements is correct in relation to M&M Proposition II, without taxes?

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A firm should select the capital structure that:

Correct AnswerverifiedShow Answer

Homemade leverage is:

Correct AnswerverifiedShow Answer

Which one of the following is correct according to pecking-order theory?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

M&M Proposition II with taxes:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

If a company has the optimal amount of debt, then the:

Correct AnswerverifiedShow Answer

KN&J expects its EBIT to be $147,000 every year forever. The company currently has no debt but can borrow at 7.6 percent while its cost of equity is 14.6 percent. The tax rate is 21 percent. What will be the value of the company if it borrows $40,000 and uses the loan proceeds to repurchase shares?

Correct AnswerverifiedShow Answer

Key Motors has a cost of equity of 14.26 percent and an unlevered cost of capital of 11.34 percent. The company has $35,000 in debt that is selling at par value. The levered value of the company is $79,000 and the tax rate is 21 percent. What is the pretax cost of debt?

Correct AnswerverifiedShow Answer

The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as ________ costs.

Correct AnswerverifiedShow Answer

Bankruptcy:

Correct AnswerverifiedShow Answer

Georga's Restaurants has 7,000 bonds outstanding with a face value of $1,000 each, a market price of $982, and a coupon rate of 6.95 percent. The interest is paid semiannually. What is the amount of the annual interest tax shield if the tax rate is 23 percent?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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