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Which one of the following represents the present value of the interest tax shield?


A) D × (1 - Tc)
B) D/(1 - Tc)
C) D/Tc
D) D - D(Tc)
E) Tc × D

F) A) and C)
G) B) and D)

Correct Answer

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Great Lakes Shipping is an all-equity firm with anticipated earnings before interest and taxes of $439,000 annually forever.The present cost of equity is 16.4 percent.Currently,the firm has no debt but is considering borrowing $1.25 million at 8.5 percent interest.The tax rate is 36 percent.What is the value of the levered firm?


A) $2,163,171
B) $2,406,519
C) $2,588,547
D) $2,666,667
E) $2,818,181

F) B) and E)
G) A) and B)

Correct Answer

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


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

F) None of the above
G) D) and E)

Correct Answer

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You are comparing two possible capital structures for a firm.The first option is an all-equity firm.The second option involves the use of $3.8 million of debt.The break-even point between these two financing options occurs when the earnings before interest and taxes (EBIT) are $428,000.Given this,you know that leverage is beneficial to the firm:


A) whenever EBIT is less than $428,000.
B) only when EBIT is $428,000.
C) whenever EBIT exceeds $428,000.
D) only if the debt is decreased by $428,000.
E) only if the debt is increased by $428,000.

F) A) and D)
G) B) and E)

Correct Answer

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Granny's Home Remedy has a $30 million bond issue outstanding with a coupon rate of 7.75 percent and a current yield of 7.67 percent.What is the present value of the tax shield if the tax rate is 34 percent?


A) $632,400
B) $625,872
C) $1.20 million
D) $8.16 million
E) $10.2 million

F) A) and B)
G) A) and C)

Correct Answer

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Which one of the following is minimized when the value of a firm is maximized?


A) Return on equity
B) WACC
C) Debt
D) Taxes
E) Bankruptcy costs

F) A) and B)
G) A) and C)

Correct Answer

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Ready To Go is an all-equity firm specializing in hot ready-to-eat meals.Management has estimated the firm's earnings before interest and taxes will be $175,000 annually forever.The present cost of equity is 15.1 percent.Currently,the firm has no debt but is considering borrowing $750,000 at 9 percent interest.The tax rate is 34 percent.What is the value of the unlevered firm?


A) $623,017
B) $646,511
C) $704,141
D) $764,901
E) $855,200

F) A) and D)
G) B) and D)

Correct Answer

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A prepack:


A) guarantees full payment to all creditors but lengthens the time span of the debt.
B) is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan.
C) protects the interests of both the current creditors and the existing shareholders.
D) applies only if a firm files under Chapter 7 of the bankruptcy code.
E) extends the time that a firm is protected by the bankruptcy process.

F) A) and B)
G) A) and C)

Correct Answer

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Weston Mines has a cost of equity of 20.8 percent,a pretax cost of debt of 9.4 percent,and a return on assets of 17.1 percent.Ignore taxes.What is the debt-equity ratio?


A) 0.39
B) 0.41
C) 0.48
D) 0.56
E) 0.62

F) A) and E)
G) B) and C)

Correct Answer

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Which one of the following statements is correct?


A) All Chapter 7 bankruptcy filings must include a "workout" agreement.
B) Firms must remain in bankruptcy for at least 18 months.
C) Key employee retention plans (KERPs) are no longer legal.
D) Labor contracts cannot be modified through the bankruptcy process.
E) A firm can file for Chapter 11 bankruptcy even if the firm is solvent.

F) A) and C)
G) C) and D)

Correct Answer

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The Outlet Mall has a cost of equity of 16.8 percent,a pretax cost of debt of 8.1 percent,and a return on assets of 14.5 percent.Ignore taxes.What is the debt-equity ratio?


A) 0.18
B) 0.39
C) 0.44
D) 0.52
E) 0.57

F) B) and E)
G) A) and D)

Correct Answer

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Which one of the following is a direct bankruptcy cost?


A) Loss of customer goodwill resulting from a bankruptcy filing
B) Legal and accounting fees related to a bankruptcy proceeding
C) Management time spent on a bankruptcy proceeding
D) Any financial distress cost
E) Costs a firm spends trying to avoid bankruptcy

F) B) and C)
G) B) and E)

Correct Answer

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Room and Board has determined that $36,000 is the break-even level of earnings before interest and taxes for the two capital structures it is considering.The one structure consists of all equity with 14,000 shares of stock.The second structure consists of 10,000 shares of stock and $80,000 of debt.What is the interest rate on the debt?


A) 7.72 percent
B) 8.19 percent
C) 9.97 percent
D) 11.43 percent
E) 12.86 percent

F) All of the above
G) A) and B)

Correct Answer

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Which one of the following is a key provision of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005?


A) Disallowance of bankruptcy prepacks
B) Right granted to creditors to file their own reorganization plan once a firm is in bankruptcy for 18 months
C) Disallowance of all management bonus payments while a firm is in bankruptcy
D) Requirement that only creditors can file reorganization plans for a bankrupt firm
E) Requirement for all Chapter 11 bankruptcies to be converted to Chapter 7 bankruptcies after 18 months

F) All of the above
G) A) and B)

Correct Answer

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


A) Claims by unsecured creditors
B) Employee wages
C) Government tax claims
D) Contributions to employee retirement plans
E) Bankruptcy administrative expenses

F) B) and C)
G) A) and E)

Correct Answer

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Assume both corporate taxes and financial distress costs apply to a firm.Given this,the static theory of capital structure illustrates that:


A) a firm's value and its weighted average cost of capital are inversely related.
B) a firm's value and its tax rate are inversely related.
C) the maximum value of a firm is obtained when a firm is financed solely with debt.
D) the value of a firm rises as the interest rate on debt rises.
E) the value of a firm rises as both the interest rate on debt and the tax rate rise.

F) B) and D)
G) A) and B)

Correct Answer

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The Christmas Tree Farms,Inc.currently has 45,000 shares of stock outstanding and no debt.The price per share is $17.50.The firm is considering borrowing funds at 7.5 percent interest and using the proceeds to repurchase 4,000 shares of stock.Ignore taxes.How much is the firm borrowing?


A) $52,500
B) $70,000
C) $110,500
D) $125,000
E) $140,000

F) B) and D)
G) A) and B)

Correct Answer

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Which one of the following is the equity risk arising from the daily operations of a firm?


A) Strategic risk
B) Financial risk
C) Liquidity risk
D) Industry risk
E) Business risk

F) A) and D)
G) B) and C)

Correct Answer

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Delta Mowers has a debt-equity ratio of 1.2.Its WACC is 10.1 percent,and its cost of debt is 7.5 percent.There is no corporate tax.What is the firm's cost of equity capital?


A) 12.60 percent
B) 13.22 percent
C) 13.83 percent
D) 14.29 percent
E) 14.80 percent

F) B) and C)
G) All of the above

Correct Answer

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Which one of the following states that a firm's cost of equity capital is a positive linear function of the firm's capital structure?


A) Static theory of capital structure
B) M&M Proposition I
C) M&M Proposition II
D) Homemade leverage theory
E) WACC

F) A) and E)
G) A) and D)

Correct Answer

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