Question 1

Which one of the following is a marketed claim against the cash flows of a company?

Accepted Answer

A)   Tax payment to the IRS
B)   Dividend payment to shareholders
C)   Payment of employees' wages
D)   Payment for warranty work on a product produced by the company
E)   Payment of legal claim against the companyF) A) and C)
G) A) and B)

Question 2

Which one of the following makes the capital structure of a company irrelevant?

Accepted Answer

A)   Taxes
B)   Interest tax shield
C)   100 percent dividend payout ratio
D)   Debt-equity ratio that is greater than 0 but less than 1
E)   Homemade leverageF) A) and C)
G) All of the above

Question 3

The Book Worm is an unlevered company with an aftertax net income of $118,406. The unlevered cost of capital is 13.8 percent and the tax rate is 21 percent. What is the value of this company?

Accepted Answer

A)   $557,709
B)   $1,320,022
C)   $858,014
D)   $1,378,414
E)   $952,607F) D) and E)
G) A) and C)

Question 4

The interest tax shield is a key reason why:

Accepted Answer

A)   the required rate of return on assets rises when debt is added to the capital structure.
B)   the value of an unlevered company is equal to the value of a levered company.
C)   the net cost of debt is generally less than the cost of equity.
D)   the cost of debt is equal to the cost of equity for a levered company.
E)   companies prefer equity financing over debt financing.F) C) and D)
G) A) and D)

Question 5

The present value of the interest tax shield is expressed as:

Accepted Answer

A)   TCD/RA.
B)   VU + TCD.
C)   TCDRA.
D)   [EBIT(TC
D)  ]/RA.
E)   TCD.F) A) and E)
G) A) and D)

Question 6

M&M Proposition I with no tax supports the argument that:

Accepted Answer

A)   business risk has no effect on the return on assets.
B)   the cost of equity rises as leverage rises.
C)   a company's debt-equity ratio is completely irrelevant.
D)   business risk is irrelevant.
E)   homemade leverage is irrelevant.F) A) and B)
G) A) and E)

Question 7

New Schools is an all-equity company with an expected EBIT of $94,000 every year forever. The company can borrow at 7.4 percent while its cost of equity is 13.9 percent. What will be the value of the company if it converts to 50 percent debt given its total tax rate of 24 percent?

Accepted Answer

A)   $500,916
B)   $575,632
C)   $477,407
D)   $480,690
E)   $532,408F) A) and B)
G) A) and E)

Question 8

Theo currently owns 700 shares of JKL, which is an all-equity firm with 320,000 shares of stock outstanding at a market price of $25 a share. The company's earnings before interest and taxes are $160,000. JKL has decided to issue $500,000 of debt at 7.5 percent interest and use the proceeds to repurchase shares of stock. How many shares of JKL stock must Theo sell to unlever his position if he can loan out funds at 7.5 percent interest? (Assume partial shares can be sold.)

Accepted Answer

A)   38.50
B)   42.50
C)   50.00
D)   43.75
E)   46.67F) A) and C)
G) B) and E)

Question 9

Ignoring taxes, Pewter & Glass has a weighted average cost of capital of 10.82 percent. The company can borrow at 7.4 percent. What is the cost of equity if the debt-equity ratio is .68?

Accepted Answer

A)   12.87%
B)   13.15%
C)   11.09%
D)   15.85%
E)   12.49%F) B) and E)
G) B) and D)

Question 10

The basic lesson of M&M theory is that the value of a company is dependent upon:

Accepted Answer

A)   the company's capital structure.
B)   the total cash flows of that company.
C)   minimizing the marketed claims.
D)   the amount of the company's marketed claims.
E)   size of the stockholders' claims.F) A) and B)
G) B) and E)

Question 11

Financial risk is:

Accepted Answer

A)   the risk inherent in a company's operations.
B)   a type of unsystematic risk.
C)   inversely related to the cost of equity.
D)   dependent upon a company's capital structure.
E)   irrelevant to the value of a company.F) A) and B)
G) A) and C)

Question 12

The proposition that a company borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs is called:

Accepted Answer

A)   the static theory of capital structure.
B)   M&M Proposition I, with taxes.
C)   M&M Proposition II, with taxes.
D)   the pecking-order theory.
E)   the open markets theorem.F) D) and E)
G) C) and E)

Question 13

Winter's Toyland has a debt-equity ratio of .57. The pretax cost of debt is 8.2 percent and the required return on assets is 14.7 percent. What is the company's cost of equity if you ignore taxes?

Accepted Answer

A)   14.70 percent
B)   19.74 percent
C)   15.29 percent
D)   17.46 percent
E)   18.41 percentF) A) and E)
G) C) and D)

Question 14

The June Bug has a $565,000 bond issue outstanding. These bonds have a coupon rate of 6.65 percent, pay interest semiannually, and sell at 98.7 percent of face value. The tax rate is 21 percent. What is the amount of the annual interest tax shield?

Accepted Answer

A)   $7,573
B)   $6,907
C)   $8,333
D)   $7,890
E)   $8,250F) A) and D)
G) A) and B)

Question 15

The value of a firm is maximized when the:

Accepted Answer

A)   cost of equity is maximized.
B)   tax rate equals the cost of capital.
C)   levered cost of capital is maximized.
D)   weighted average cost of capital is minimized.
E)   debt-equity ratio is minimized.F) A) and E)
G) A) and C)

Exam 16: Financial Leverage and Capital Structure Policy

Winter's Toyland has a debt-equity ratio of .57. The pretax cost of debt is 8.2 percent and the required return on assets is 14.7 percent. What is the company's cost of equity if you ignore taxes?

Correct Answer
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The basic lesson of M&M theory is that the value of a company is dependent upon:

Correct Answer
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Financial risk is:

Correct Answer
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The interest tax shield is a key reason why:

Correct Answer
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The present value of the interest tax shield is expressed as:

Correct Answer
verified

The June Bug has a $565,000 bond issue outstanding. These bonds have a coupon rate of 6.65 percent, pay interest semiannually, and sell at 98.7 percent of face value. The tax rate is 21 percent. What is the amount of the annual interest tax shield?

Correct Answer
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The proposition that a company borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs is called:

Correct Answer
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Which one of the following makes the capital structure of a company irrelevant?

Correct Answer
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The Book Worm is an unlevered company with an aftertax net income of $118,406. The unlevered cost of capital is 13.8 percent and the tax rate is 21 percent. What is the value of this company?

Correct Answer
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M&M Proposition I with no tax supports the argument that:

Correct Answer
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Ignoring taxes, Pewter & Glass has a weighted average cost of capital of 10.82 percent. The company can borrow at 7.4 percent. What is the cost of equity if the debt-equity ratio is .68?

Correct Answer
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New Schools is an all-equity company with an expected EBIT of $94,000 every year forever. The company can borrow at 7.4 percent while its cost of equity is 13.9 percent. What will be the value of the company if it converts to 50 percent debt given its total tax rate of 24 percent?

Correct Answer
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Correct Answer
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The value of a firm is maximized when the:

Correct Answer
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Which one of the following is a marketed claim against the cash flows of a company?

Correct Answer
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Exam 16: Financial Leverage and Capital Structure Policy

Winter's Toyland has a debt-equity ratio of .57. The pretax cost of debt is 8.2 percent and the required return on assets is 14.7 percent. What is the company's cost of equity if you ignore taxes?

Correct AnswerverifiedShow Answer

The basic lesson of M&M theory is that the value of a company is dependent upon:

Correct AnswerverifiedShow Answer

Financial risk is:

Correct AnswerverifiedShow Answer

The interest tax shield is a key reason why:

Correct AnswerverifiedShow Answer

The present value of the interest tax shield is expressed as:

Correct AnswerverifiedShow Answer

The June Bug has a $565,000 bond issue outstanding. These bonds have a coupon rate of 6.65 percent, pay interest semiannually, and sell at 98.7 percent of face value. The tax rate is 21 percent. What is the amount of the annual interest tax shield?

Correct AnswerverifiedShow Answer

The proposition that a company borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs is called:

Correct AnswerverifiedShow Answer

Which one of the following makes the capital structure of a company irrelevant?

Correct AnswerverifiedShow Answer

The Book Worm is an unlevered company with an aftertax net income of $118,406. The unlevered cost of capital is 13.8 percent and the tax rate is 21 percent. What is the value of this company?

Correct AnswerverifiedShow Answer

M&M Proposition I with no tax supports the argument that:

Correct AnswerverifiedShow Answer

Ignoring taxes, Pewter & Glass has a weighted average cost of capital of 10.82 percent. The company can borrow at 7.4 percent. What is the cost of equity if the debt-equity ratio is .68?

Correct AnswerverifiedShow Answer

New Schools is an all-equity company with an expected EBIT of $94,000 every year forever. The company can borrow at 7.4 percent while its cost of equity is 13.9 percent. What will be the value of the company if it converts to 50 percent debt given its total tax rate of 24 percent?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The value of a firm is maximized when the:

Correct AnswerverifiedShow Answer

Which one of the following is a marketed claim against the cash flows of a company?

Correct AnswerverifiedShow Answer

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