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Cross Town Cookies is an all-equity firm with a total market value of $4,187,100.The firm has 127,500 shares of stock outstanding.Management is considering issuing $300,000 of debt at an interest rate of 6 percent and using the proceeds to repurchase shares.The projected earnings before interest and taxes are $215,600.What are the anticipated earnings per share if the debt is issued? Ignore taxes.(Round the number of shares repurchased down to the nearest whole share.)


A) $1.59
B) $1.76
C) $1.38
D) $1.67
E) $1.47

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

Correct Answer

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Newborn Nursery has 12,000 bonds outstanding with a face value of $1,000 each.The coupon rate is 6.9 percent and the tax rate is 34 percent.What is the present value of the interest tax shield?


A) $4.14 million
B) $4.86 million
C) $3.87 million
D) $3.92 million
E) $4.08 million

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

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Flour Mills is an all-equity firm with a total market value of $891,860.The firm has 38,000 shares of stock outstanding.Management is considering issuing $275,000 of debt at an interest rate of 7.5 percent and using the proceeds on a stock repurchase.Ignore taxes.How many shares can the firm repurchase if it issues the debt securities? (Round the number of shares repurchased down to the nearest whole share.)


A) 11,717 shares
B) 11,618 shares
C) 11,647 shares
D) 11,656 shares
E) 11,699 shares

F) All of the above
G) None of the above

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When is a firm insolvent from an accounting perspective?


A) When the firm is unable to meet its financial obligations in a timely manner
B) When the firm's debt exceeds the value of the firm's equity
C) When the firm has a negative net worth
D) When the firm's revenues cease
E) When the market value of the firm's equity equals zero

F) D) and E)
G) All of the above

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A firm has a weighted average cost of capital of 11.28 percent and a cost of equity of 14.7 percent.The debt-equity ratio is .72.There are no taxes.What is the firm's cost of debt?


A) 6.53 percent
B) 6.27 percent
C) 6.44 percent
D) 7.23 percent
E) 7.08 percent

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

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Jericho Snacks is an all-equity firm with estimated earnings before interest and taxes of $624,000 annually forever.Currently,the firm has no debt but is considering borrowing $725,000 at 6.75 percent interest.The tax rate is 35 percent and the current cost of equity is 15.2 percent.What is the value of the levered firm?


A) $3,187,271
B) $2,769,535
C) $3,307,271
D) $2,922,171
E) $3,506,418

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

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The Piano Movers can borrow at 7.8 percent.The firm currently has no debt,and the cost of equity is 15 percent.The current value of the firm is $680,000.What will the value be if the firm borrows $140,000 and uses the proceeds to repurchase shares? The corporate tax rate is 35 percent.


A) $820,000
B) $540,000
C) $750,000
D) $571,000
E) $729,000

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

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Roller Coaster's has a WACC of 11.6 percent,ignoring taxes.It has a target capital structure of 60 percent equity and 40 percent debt and a cost of equity of 14.27 percent.What is the cost of debt?


A) 5.5 percent
B) 7.6 percent
C) 9.3 percent
D) 9.4 percent
E) 18.7 percent

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

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Jasper Industrial has no debt outstanding and a total market value of $216,000.Earnings before interest and taxes,EBIT,are projected to be $15,000 if economic conditions are normal.If there is strong expansion in the economy,then EBIT will be 12 percent higher.If there is a recession,then EBIT will be 15 percent lower.There are currently 8,600 shares outstanding.Ignore taxes.What is the percentage change in EPS when a normal economy slips into recession?


A) -15.5 percent
B) -15.2 percent
C) -;15.0 percent
D) -16.1 percent
E) -14.8 percent

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

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

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Bird Houses is an all-equity firm with a total market value of $388,980 and18,000 shares of stock outstanding.Management is considering issuing $68,000 of debt at an interest rate of 6.5 percent and using the proceeds on a stock repurchase.Ignore taxes.How many shares will the firm repurchase if it issues the debt securities? (Round the number of shares repurchased down to the nearest whole share.)


A) 3,167 shares
B) 3,116 shares
C) 3,021 shares
D) 3,207 shares
E) 3,146 shares

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

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The Outlet Mall has a cost of equity of 16.3 percent,a pretax cost of debt of 7.9 percent,and a return on assets of 13.4 percent.Ignore taxes.What is the debt-equity ratio?


A) .46
B) .53
C) .44
D) .59
E) .57

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

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The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as:


A) M& M Proposition I.
B) capital restructuring.
C) homemade leverage.
D) M& M Proposition II.
E) financial risk management

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

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Taunton's is an all-equity firm that has 160,000 shares of stock outstanding.Neal,the financial vice president,is considering borrowing $275,000 at 7.45 percent interest to repurchase 25,000 shares.Ignoring taxes,what is the current value of the firm?


A) $1,260,000
B) $1,800,000
C) $1,485,000
D) $1,520,000
E) $1,760,000

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

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Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt?


A) M& M Proposition I, with taxes
B) M& M Proposition II, with taxes
C) M& M Proposition I, without taxes
D) Homemade leverage proposition
E) Static theory of capital structure

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

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Katz is an all-equity development company that has 52,000 shares of stock outstanding at a market price of $32 a share.The firm's earnings before interest and taxes are $46,000.Katz has decided to issue $176,000 of debt at a rate of 8 percent and use the proceeds to repurchase shares.What should Leslie do if she owns 500 shares of Katz stock and wants to use homemade leverage to offset the leverage being assumed by the firm?


A) Borrow money and buy an additional 53 shares
B) Borrow money and buy an additional 56 shares
C) Sell 48 shares and loan out the proceeds
D) Sell 56 shares and loan out the proceeds
E) Sell 53 shares and loan out the proceeds

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

Correct Answer

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Which statement is true?


A) A prepack is a plan of liquidation used to distribute a firm's assets.
B) Bankruptcy courts have "cram-down" powers.
C) The absolute priority rule must be strictly followed in all bankruptcy proceedings.
D) Creditors cannot force a firm into bankruptcy even though they might like to do so.
E) A reorganization plan can be approved only if the firm's creditors all agree with the plan.

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

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Which one of the following conditions exists at the point where a firm maximizes its value?


A) The tax benefit from an additional dollar of debt is zero.
B) Financial distress costs are equal to zero.
C) The debt-equity ratio is 1.0.
D) WACC is minimized.
E) The cost of equity is minimized

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

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Which one of the following best defines legal bankruptcy?


A) Negotiating new payment terms with a firm's creditors
B) A temporary technical insolvency
C) A legal proceeding for liquidating or reorganizing a business
D) The internal process of revising the capital structure of a firm
E) The failure of a firm to meet its financial obligations in a timely manner

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

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An all-equity firm has a return on assets of 13.3 percent.The firm is considering converting to a debt-equity ratio of .48.The pretax cost of debt is 8.6 percent.Ignoring taxes,what will the cost of equity be if the firm switches to the levered capital structure?


A) 16.01 percent
B) 15.28 percent
C) 16.60 percent
D) 17.03 percent
E) 15.56 percent

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

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