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Exam 13: Leverage and Capital Structure

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Question 1

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Chick 'N Fish is considering two different capital structures.The first option is an all-equity firm with22,500 shares of stock.The second option consists of 18,750 shares of stock plus $120,000 of debt at an interest rate of 7.8 percent.Ignore taxes.What is the break-even level of earnings before interest and taxes (EBIT) between these two options?

A) $62,813
B) $54,204
C) $60,410
D) $56,150
E) $61,290

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

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Question 2

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Delta Mowers has a debt-equity ratio of .6.Its WACC is 11.8 percent,and its cost of debt is 7.7 percent.There is no corporate tax.What is the firm's cost of equity capital?

A) 12.60 percent
B) 14.26 percent
C) 13.83 percent
D) 14.29 percent
E) 14.80 percent

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

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Question 3

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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?

Ernst Electrical has 7,500 shares of stock outstanding and no debt.The new CFO is considering issuing $50,000 of debt and using the proceeds to retire 600 shares of stock.The coupon rate on the debt is 8.5 percent.What is the break-even level of earnings before interest and taxes between these two capital structure options?

A firm is considering two different capital structures.The first option is an all-equity firm with 40,000 shares of stock.The second option is 28,000 shares of stock plus some debt.Ignoring taxes,the break-even level of earnings before interest and taxes between these two options is $52,000.How much money is the firm considering borrowing if the interest rate is 9 percent?

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Sand Mountain Resort has a tax rate of 32 percent.Its total interest payment for the year just ended was $41,000.What is the interest tax shield for the year?

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:

Forbidden Fruit Extracts expects its earnings before interest and taxes to be $287,600 a year forever.Currently,the firm has no debt.The cost of equity is 15.4 percent and the tax rate is 34 percent.The company is in the process of issuing $3 million of bonds at par that carry an annual coupon rate of 7.6 percent.What is the unlevered value of the firm?

Marcos & Sons has no debt.Its current total value is $13 million.What will the company's value be if it sells $5 million in debt and has a tax rate of 35 percent? Assume all debt proceeds are used to repurchase equity.

Northern Wood Products is an all-equity firm with 14,000 shares of stock outstanding and a total market value of $585,480.Based on its current capital structure,the firm is expected to have earnings before interest and taxes of $46,800 if the economy is normal,$21,200 if the economy is in a recession,and $56,000 if the economy booms.Ignore taxes.Management is considering issuing $150,000 of debt at a coupon rate of 7 percent.If the firm issues the debt,the proceeds will be used to repurchase stock.What will the earnings per share be if the debt is issued and the economy is in a recession? (Round the number of shares repurchased down to the nearest whole share.)

Green Tea House has a tax rate of 35 percent and an interest tax shield valued at $8,046 for the year.How much did the firm pay in annual interest?

Shoe Box Stores is currently an all-equity firm with 25,000 shares of stock outstanding.Management is considering changing the capital structure to 35 percent debt.The interest rate on the debt would be 8 percent.Ignore taxes.Jamie owns 600 shares of Shoe Box Stores stock that is priced at $22 a share.What should Jamie do if she prefers the all-equity structure but Shoe Box Stores adopts the new capital structure?

The Bethlehem Inn is an all-equity firm with 9,000 shares outstanding at a value per share of $26.80.The firm is issuing $39,932 of debt and using the proceeds to reduce the number of outstanding shares.How many shares of stock will be outstanding once the debt is issued? Ignore taxes.

Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases?

M& M Proposition II,without taxes,states that the:

Stevenson's Bakery is an all-equity company that has projected perpetual earnings before interest and taxes of $43,700 a year.The cost of equity is 15.2 percent and the tax rate is 34 percent.The company can borrow money at 7.15 percent.If the company borrows $50,000,what will be its levered value?

Bruno's is considering changing from its current all-equity capital structure to 30 percent debt.There are currently 7,500 shares outstanding at a price per share of $39.EBIT is expected to remain constant at $23,000.The interest rate on new debt is 7.5 percent and there are no taxes.Tracie owns $12,675 worth of stock in the company.The firm has a 100 percent payout.What would Tracie's cash flow be under the new capital structure assuming that she keeps all of her shares?

Granny's Home Remedy has a $27 million bond issue outstanding with a coupon rate of 8.75 percent and a current yield of 8.13 percent.What is the present value of the tax shield if the tax rate is 35 percent?

The Park Place has a return on assets of 12.9 percent,a cost of equity of 16.2 percent,and a pretax cost of debt of 7.7 percent.What is the debt-equity ratio? Ignore taxes.