Question 1

An unlevered firm has a cost of capital of 17.5 percent and earnings before interest and taxes of $327,500.A levered firm with the same operations and assets has both a book value and a face value of debt of $650,000 with a 7.5 percent annual coupon.The applicable tax rate is 38 percent.What is the value of the levered firm?

Accepted Answer

A)  $1,397,212
B)  $1,398,256
C)  $1,402,509
D)  $1,407,286
E)  $1,414,414F) D) and E)
G) C) and D)

Question 2

Which one of the following statements related to Chapter 7 bankruptcy is correct?

Accepted Answer

A)  A firm in Chapter 7 bankruptcy is reorganizing its operations such that it can return to being a viable concern.
B)  Under a Chapter 7 bankruptcy, a trustee will assume control of the firm's assets until those assets can be liquidated.
C)  Chapter 7 bankruptcies are always involuntary on the part of the firm.
D)  Under a Chapter 7 bankruptcy, the claims of creditors are paid prior to the administrative costs of the bankruptcy.
E)  Chapter 7 bankruptcy allows a firm to restructure its equity such that new shares of stock are generally issued prior to the firm coming out of bankruptcy.F) B) and C)
G) C) and D)

Question 3

A firm may file for Chapter 11 bankruptcy:
I.in an attempt to gain a competitive advantage.
II.using a prepack.
III.while allowing the current management to continue running the firm.
IV.only after the firm becomes insolvent.

Accepted Answer

A)  I and III only
B)  I and II only
C)  I, II, and IV only
D)  I, II, and III only
E)  I, II, III, and IVF) A) and D)
G) A) and B)

Question 4

Winter's Toyland has a debt-equity ratio of 0.65.The pre-tax cost of debt is 8.7 percent and the required return on assets is 16.1 percent.What is the cost of equity if you ignore taxes?

Accepted Answer

A)  19.31 percent
B)  19.74 percent
C)  20.29 percent
D)  20.46 percent
E)  20.91 percentF) A) and B)
G) A) and C)

Question 5

M & M Proposition I with tax supports the theory that:

Accepted Answer

A)  a firm's weighted average cost of capital decreases as the firm's debt-equity ratio increases.
B)  the value of a firm is inversely related to the amount of leverage used by the firm.
C)  the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield.
D)  a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm.
E)  a firm's cost of equity increases as the debt-equity ratio of the firm decreases.F) A) and D)
G) None of the above

Question 6

Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Assume there are no taxes.

Accepted Answer

A)  At the break-even point, there is no advantage to debt.
B)  The earnings per share will equal zero when EBIT is zero for a levered firm.
C)  The advantages of leverage are inversely related to the level of EBIT.
D)  The use of leverage at any level of EBIT increases the EPS.
E)  EPS are more sensitive to changes in EBIT when a firm is unlevered.F) All of the above
G) B) and D)

Question 7

The capital structure that maximizes the value of a firm also:

Accepted Answer

A)  minimizes financial distress costs.
B)  minimizes the cost of capital.
C)  maximizes the present value of the tax shield on debt.
D)  maximizes the value of the debt.
E)  maximizes the value of the unlevered firm.F) None of the above
G) A) and E)

Question 8

L.A.Clothing has expected earnings before interest and taxes of $48,900, an unlevered cost of capital of 14.5 percent, and a tax rate of 34 percent.The company also has $8,000 of debt that carries a 7 percent coupon.The debt is selling at par value.What is the value of this firm?

Accepted Answer

A)  $222,579.31
B)  $223,333.33
C)  $224,108.16
D)  $225,299.31
E)  $225,476.91F) A) and E)
G) C) and E)

Question 9

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 borrowing or lending of money by individual shareholders as a means of adjusting their level of financial leverage.
D)  best defined as an increase in a firm's debt-equity ratio.
E)  the term used to describe the capital structure of a levered firm.F) D) and E)
G) A) and B)

Question 10

M & M Proposition II with taxes:

Accepted Answer

A)  has the same general implications as M & M Proposition II without taxes.
B)  states that a firm's capital structure is irrelevant.
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) A) and B)
G) D) and E)

Question 11

Pete is the CFO of Dexter International.He would like to increase the debt-equity ratio of the firm but is concerned that the firm's shareholders may not be willing to accept additional financial leverage.Pete has come to you for advice.What is your recommendation?

Accepted Answer

The capital structure of the firm is irr...

Question 12

Down Bedding has an unlevered cost of capital of 14 percent, a cost of debt of 7.8 percent, and a tax rate of 32 percent.What is the target debt-equity ratio if the targeted cost of equity is 15.51 percent?

Accepted Answer

A)  .24
B)  .29
C)  .36
D)  .52
E)  .71F) D) and E)
G) C) and E)

Question 13

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs.

Accepted Answer

A)  flotation
B)  direct bankruptcy
C)  indirect bankruptcy
D)  financial solvency
E)  capital structureF) A) and B)
G) D) and E)

Question 14

Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by $1,000.Which of the following terms is used to describe this tax savings?

Accepted Answer

A)  interest tax shield
B)  interest credit
C)  financing shield
D)  current tax yield
E)  tax-loss interestF) D) and E)
G) A) and B)

Question 15

Miller's Dry Goods is an all equity firm with 48,000 shares of stock outstanding at a market price of $50 a share.The company's earnings before interest and taxes are $128,000.Miller's has decided to add leverage to its financial operations by issuing $250,000 of debt at 8 percent interest.The debt will be used to repurchase shares of stock.You own 400 shares of Miller's stock.You also loan out funds at 8 percent interest.How many shares of Miller's stock must you sell to offset the leverage that Miller's is assuming? Assume you loan out all of the funds you receive from the sale of stock.Ignore taxes.

Accepted Answer

A)  35.6 shares
B)  40.0 shares
C)  41.67 shares
D)  47.5 shares
E)  50.1 sharesF) A) and E)
G) A) and D)

Question 16

Which of the following statements are correct in relation to M & M Proposition II with no taxes?
I.The required return on assets is equal to the weighted average cost of capital.
II.Financial risk is determined by the debt-equity ratio.
III.Financial risk determines the return on assets.
IV.The cost of equity declines when the amount of leverage used by a firm rises.

Accepted Answer

A)  I and III only
B)  II and IV only
C)  I and II only
D)  III and IV only
E)  I and IV onlyF) B) and D)
G) A) and E)

Question 17

Bright Morning Foods has expected earnings before interest and taxes of $48,600, an unlevered cost of capital of 13.2 percent, and debt with both a book and face value of $25,000.The debt has an 8.5 percent coupon.The tax rate is 34 percent.What is the value of the firm?

Accepted Answer

A)  $245,500
B)  $247,600
C)  $251,500
D)  $264,800
E)  $271,300F) A) and C)
G) None of the above

Question 18

Kelso Electric is debating between a leveraged and an unleveraged capital structure.The all equity capital structure would consist of 40,000 shares of stock.The debt and equity option would consist of 25,000 shares of stock plus $280,000 of debt with an interest rate of 7 percent.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)  $46,333
D)  $49,667
E)  $52,267F) C) and D)
G) A) and D)

Question 19

The basic lesson of M & M Theory is that the value of a firm is dependent upon:

Accepted Answer

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

Question 20

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) C) and E)
G) None of the above

Exam 16: Dividends and Payout Policy

Homemade leverage is:

Correct Answer
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Correct Answer
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The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs.

Correct Answer
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Winter's Toyland has a debt-equity ratio of 0.65.The pre-tax cost of debt is 8.7 percent and the required return on assets is 16.1 percent.What is the cost of equity if you ignore taxes?

Correct Answer
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Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Assume there are no taxes.

Correct Answer
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Correct Answer
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Pete is the CFO of Dexter International.He would like to increase the debt-equity ratio of the firm but is concerned that the firm's shareholders may not be willing to accept additional financial leverage.Pete has come to you for advice.What is your recommendation?

Correct Answer
verified
The capital structure of the firm is irr...
View Answer

Bright Morning Foods has expected earnings before interest and taxes of $48,600, an unlevered cost of capital of 13.2 percent, and debt with both a book and face value of $25,000.The debt has an 8.5 percent coupon.The tax rate is 34 percent.What is the value of the firm?

Correct Answer
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Correct Answer
verified

L.A.Clothing has expected earnings before interest and taxes of $48,900, an unlevered cost of capital of 14.5 percent, and a tax rate of 34 percent.The company also has $8,000 of debt that carries a 7 percent coupon.The debt is selling at par value.What is the value of this firm?

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

Correct Answer
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Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by $1,000.Which of the following terms is used to describe this tax savings?

Correct Answer
verified

Which one of the following statements related to Chapter 7 bankruptcy is correct?

Correct Answer
verified

Down Bedding has an unlevered cost of capital of 14 percent, a cost of debt of 7.8 percent, and a tax rate of 32 percent.What is the target debt-equity ratio if the targeted cost of equity is 15.51 percent?

Correct Answer
verified

A firm should select the capital structure that:

Correct Answer
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A firm may file for Chapter 11 bankruptcy: I.in an attempt to gain a competitive advantage. II.using a prepack. III.while allowing the current management to continue running the firm. IV.only after the firm becomes insolvent.

Correct Answer
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M & M Proposition II with taxes:

Correct Answer
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The capital structure that maximizes the value of a firm also:

Correct Answer
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M & M Proposition I with tax supports the theory that:

Correct Answer
verified

Exam 16: Dividends and Payout Policy

Homemade leverage is:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs.

Correct AnswerverifiedShow Answer

Winter's Toyland has a debt-equity ratio of 0.65.The pre-tax cost of debt is 8.7 percent and the required return on assets is 16.1 percent.What is the cost of equity if you ignore taxes?

Correct AnswerverifiedShow Answer

Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Assume there are no taxes.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Pete is the CFO of Dexter International.He would like to increase the debt-equity ratio of the firm but is concerned that the firm's shareholders may not be willing to accept additional financial leverage.Pete has come to you for advice.What is your recommendation?

Correct AnswerverifiedThe capital structure of the firm is irr...View AnswerShow Answer

Bright Morning Foods has expected earnings before interest and taxes of $48,600, an unlevered cost of capital of 13.2 percent, and debt with both a book and face value of $25,000.The debt has an 8.5 percent coupon.The tax rate is 34 percent.What is the value of the firm?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

L.A.Clothing has expected earnings before interest and taxes of $48,900, an unlevered cost of capital of 14.5 percent, and a tax rate of 34 percent.The company also has $8,000 of debt that carries a 7 percent coupon.The debt is selling at par value.What is the value of this firm?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The basic lesson of M & M Theory is that the value of a firm is dependent upon:

Correct AnswerverifiedShow Answer

Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by $1,000.Which of the following terms is used to describe this tax savings?

Correct AnswerverifiedShow Answer

Which one of the following statements related to Chapter 7 bankruptcy is correct?

Correct AnswerverifiedShow Answer

Down Bedding has an unlevered cost of capital of 14 percent, a cost of debt of 7.8 percent, and a tax rate of 32 percent.What is the target debt-equity ratio if the targeted cost of equity is 15.51 percent?

Correct AnswerverifiedShow Answer

A firm should select the capital structure that:

Correct AnswerverifiedShow Answer

A firm may file for Chapter 11 bankruptcy: I.in an attempt to gain a competitive advantage. II.using a prepack. III.while allowing the current management to continue running the firm. IV.only after the firm becomes insolvent.

Correct AnswerverifiedShow Answer

M & M Proposition II with taxes:

Correct AnswerverifiedShow Answer

The capital structure that maximizes the value of a firm also:

Correct AnswerverifiedShow Answer

M & M Proposition I with tax supports the theory that:

Correct AnswerverifiedShow Answer

Correct Answer
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Correct Answer
verified
The capital structure of the firm is irr...
View Answer

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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