Question 1

The Pizza Palace has a cost of equity of 15.3 percent and an unlevered cost of capital of 11.8 percent.The company has $22,000 in debt that is selling at par value.The levered value of the firm is $41,000 and the tax rate is 34 percent.What is the pre-tax cost of debt?

Accepted Answer

A)  4.73 percent
B)  6.18 percent
C)  6.59 percent
D)  7.22 percent
E)  9.92 percentF) None of the above
G) A) and C)

Question 2

ABC Co.and XYZ Co.are identical firms in all respects except for their capital structure.ABC is all equity financed with $480,000 in stock.XYZ uses both stock and perpetual debt; its stock is worth $240,000 and the interest rate on its debt is 9 percent.Both firms expect EBIT to be $58,400.Ignore taxes.The cost of equity for ABC is _____ percent,and for XYZ it is ______ percent.

Accepted Answer

A)  12.17; 12.68
B)  12.17; 13.33
C)  12.17; 15.33
D)  12.29; 12.68
E)  12.29; 13.33F) A) and E)
G) C) and E)

Question 3

Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business.The process this firm underwent is known as a:

Accepted Answer

A)  merger.
B)  repurchase program.
C)  liquidation.
D)  reorganization.
E)  divestiture.F) A) and B)
G) B) and E)

Question 4

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 C)
G) A) and B)

Question 5

Which form of financing do firms 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) All of the above
G) C) and D)

Question 6

Johnson Tire Distributors has debt with both a face and a market value of $12,000.This debt has a coupon rate of 6 percent and pays interest annually.The expected earnings before interest and taxes are $2,100,the tax rate is 30 percent,and the unlevered cost of capital is 11.7 percent.What is the firm's cost of equity?

Accepted Answer

A)  22.46 percent
B)  22.87 percent
C)  23.20 percent
D)  23.59 percent
E)  25.14 percentF) C) and D)
G) B) and E)

Question 7

Percy's Wholesale Supply has earnings before interest and taxes of $106,000.Both the book and the market value of debt is $170,000.The unlevered cost of equity is 15.5 percent while the pre-tax cost of debt is 8.6 percent.The tax rate is 38 percent.What is the firm's weighted average cost of capital?

Accepted Answer

A)  11.94 percent
B)  12.65 percent
C)  13.45 percent
D)  14.01 percent
E)  14.37 percentF) A) and C)
G) B) and E)

Question 8

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)  the capital structure of a firm does not matter because investors can use homemade leverage.
C)  a firm's WACC is unaffected by a change in the firm's capital structure.
D)  the value of a firm increases as the firm's debt increases because of the interest tax shield.
E)  the cost of equity increases as the debt-equity ratio of a firm increases.F) B) and E)
G) A) and D)

Question 9

Hanover Tech is currently an all equity firm that has 320,000 shares of stock outstanding with a market price of $19 a share.The current cost of equity is 15.4 percent and the tax rate is 34 percent.The firm is considering adding $1.2 million of debt with a coupon rate of 8 percent to its capital structure.The debt will be sold at par value.What is the levered value of the equity?

Accepted Answer

A)  $5.209 million
B)  $5.288 million
C)  $5.312 million
D)  $6.512 million
E)  $6.708 millionF) A) and E)
G) B) and C)

Question 10

The business risk of a firm:

Accepted Answer

A)  depends on the firm's level of unsystematic risk.
B)  is inversely related to the required return on the firm's assets.
C)  is dependent upon the relative weights of the debt and equity used to finance the firm.
D)  has a positive relationship with the firm's cost of equity.
E)  has no relationship with the required return on a firm's assets according to M & M Proposition II.F) A) and D)
G) C) and D)

Question 11

Which one of the following is a direct bankruptcy cost?

Accepted Answer

A)  company CEO's time spent in bankruptcy court
B)  maintaining cash reserves
C)  maintaining a debt-equity ratio that is lower than the optimal ratio
D)  losing a key company employee
E)  paying an outside accountant fees to prepare bankruptcy reportsF) None of the above
G) C) and D)

Question 12

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) All of the above
G) B) and D)

Question 13

The Jean Outlet is an all equity firm that has 146,000 shares of stock outstanding.The company has decided to borrow the $1.1 million to repurchase 7,500 shares of its stock from the estate of a deceased shareholder.What is the total value of the firm if you ignore taxes?

Accepted Answer

A)  $18,387,702
B)  $18,500,000
C)  $19,666,667
D)  $21,413,333
E)  $22,293,333F) C) and D)
G) A) and D)

Question 14

M & M Proposition II is the proposition that:

Accepted Answer

A)  the capital structure of a firm has no effect on the firm's value.
B)  the cost of equity depends on the return on debt, the debt-equity ratio, and the tax rate.
C)  a firm's cost of equity is a linear function with a slope equal to (RA - R
D)  .
D)  the cost of equity is equivalent to the required rate of return on a firm's assets.
E)  the size of the pie does not depend on how the pie is sliced.F) B) and E)
G) B) and D)

Question 15

D.L.Tuckers has $21,000 of debt outstanding that is selling at par and has a coupon rate of 7.5 percent.The tax rate is 32 percent.What is the present value of the tax shield?

Accepted Answer

A)  $504
B)  $615
C)  $644
D)  $6,200
E)  $6,720F) C) and E)
G) A) and E)

Question 16

The Green Paddle has a cost of equity of 12.1 percent and a pre-tax cost of debt of 7.6 percent.The debt-equity ratio is 0.65 and the tax rate is 32 percent.What is Green Paddle's unlevered cost of capital?

Accepted Answer

A)  10.72 percent
B)  11.85 percent
C)  14.29 percent
D)  14.46 percent
E)  15.08 percentF) A) and B)
G) All of the above

Question 17

A firm is technically insolvent when:

Accepted Answer

A)  it has a negative book value.
B)  total debt exceeds total equity.
C)  it is unable to meet its financial obligations.
D)  it files for bankruptcy protection.
E)  the market value of its stock is less than its book value.F) C) and E)
G) None of the above

Question 18

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 B)
G) A) and D)

Exam 16: Financial Leverage and Capital Structure Policy

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

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The Green Paddle has a cost of equity of 12.1 percent and a pre-tax cost of debt of 7.6 percent.The debt-equity ratio is 0.65 and the tax rate is 32 percent.What is Green Paddle's unlevered cost of capital?

Correct Answer
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A firm is technically insolvent when:

Correct Answer
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Correct Answer
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Correct Answer
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Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business.The process this firm underwent is known as a:

Correct Answer
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M & M Proposition II is the proposition that:

Correct Answer
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D.L.Tuckers has $21,000 of debt outstanding that is selling at par and has a coupon rate of 7.5 percent.The tax rate is 32 percent.What is the present value of the tax shield?

Correct Answer
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The Jean Outlet is an all equity firm that has 146,000 shares of stock outstanding.The company has decided to borrow the $1.1 million to repurchase 7,500 shares of its stock from the estate of a deceased shareholder.What is the total value of the firm if you ignore taxes?

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

Correct Answer
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The business risk of a firm:

Correct Answer
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Which one of the following is a direct bankruptcy cost?

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

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

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

Correct Answer
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The Pizza Palace has a cost of equity of 15.3 percent and an unlevered cost of capital of 11.8 percent.The company has $22,000 in debt that is selling at par value.The levered value of the firm is $41,000 and the tax rate is 34 percent.What is the pre-tax cost of debt?

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

Correct AnswerverifiedShow Answer

The concept of homemade leverage is most associated with:

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The Green Paddle has a cost of equity of 12.1 percent and a pre-tax cost of debt of 7.6 percent.The debt-equity ratio is 0.65 and the tax rate is 32 percent.What is Green Paddle's unlevered cost of capital?

Correct AnswerverifiedShow Answer

A firm is technically insolvent when:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business.The process this firm underwent is known as a:

Correct AnswerverifiedShow Answer

M & M Proposition II is the proposition that:

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D.L.Tuckers has $21,000 of debt outstanding that is selling at par and has a coupon rate of 7.5 percent.The tax rate is 32 percent.What is the present value of the tax shield?

Correct AnswerverifiedShow Answer

The Jean Outlet is an all equity firm that has 146,000 shares of stock outstanding.The company has decided to borrow the $1.1 million to repurchase 7,500 shares of its stock from the estate of a deceased shareholder.What is the total value of the firm if you ignore taxes?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

The business risk of a firm:

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Which one of the following is a direct bankruptcy cost?

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

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

The Pizza Palace has a cost of equity of 15.3 percent and an unlevered cost of capital of 11.8 percent.The company has $22,000 in debt that is selling at par value.The levered value of the firm is $41,000 and the tax rate is 34 percent.What is the pre-tax cost of debt?

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Correct AnswerverifiedShow Answer

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