Question 1

Pewter & Glass is an all equity firm that has 80,000 shares of stock outstanding.The company is in the process of borrowing $600,000 at 9 percent interest to repurchase 12,000 shares of the outstanding stock.What is the value of this firm if you ignore taxes?

Accepted Answer

A)   $2.5 million
B)   $4.0 million
C)   $5.0 million
D)   $5.5 million
E)   $6.0 millionF) B) and C)
G) A) and B)

Question 2

The optimal capital structure has been achieved when the:

Accepted Answer

A)   debt-equity ratio is equal to 1.
B)   weight of equity is equal to the weight of debt.
C)   cost of equity is maximized given a pre-tax cost of debt.
D)   debt-equity ratio is such that the cost of debt exceeds the cost of equity.
E)   debt-equity ratio results in the lowest possible weighted average cost of capital.F) A) and B)
G) C) and E)

Question 3

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

Question 4

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

Question 5

Corporations in the U.S.tend to:

Accepted Answer

A)   minimize taxes.
B)   underutilize debt.
C)   rely less on equity financing than they should.
D)   have relatively similar debt-equity ratios across industry lines.
E)   rely more heavily on debt than on equity as the major source of financing.F) B) and D)
G) B) and E)

Question 6

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 E)
G) D) and E)

Question 7

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

Question 8

The SLG Corp.uses no debt.The weighted average cost of capital is 11 percent.The current market value of the equity is $31 million and the corporate tax rate is 34 percent.What is EBIT?

Accepted Answer

A)   $4,180,000
B)   $4,821,194
C)   $5,166,667
D)   $6,230,018
E)   $6,568,500F) B) and D)
G) A) and B)

Question 9

You currently own 600 shares of JKL,Inc.JKL is an all equity firm that has 75,000 shares of stock outstanding at a market price of $40 a share.The company's earnings before interest and taxes are $140,000.JKL has decided to issue $1 million of debt at 8 percent interest.This debt will be used to repurchase shares of stock.How many shares of JKL stock must you sell to unlever your position if you can loan out funds at 8 percent interest?

Accepted Answer

A)   120 shares
B)   150 shares
C)   180 shares
D)   200 shares
E)   250 sharesF) B) and D)
G) B) and E)

Question 10

Which one of the following is the equity risk related to a firm's capital structure policy?

Accepted Answer

A)   market
B)   systematic
C)   extrinsic
D)   business
E)   financialF) A) and C)
G) A) and E)

Question 11

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

Question 12

The interest tax shield is a key reason why:

Accepted Answer

A)   the required rate of return on assets rises when debt is added to the capital structure.
B)   the value of an unlevered firm is equal to the value of a levered firm.
C)   the net cost of debt to a firm is generally less than the cost of equity.
D)   the cost of debt is equal to the cost of equity for a levered firm.
E)   firms prefer equity financing over debt financing.F) B) and C)
G) All of the above

Question 13

The value of a firm is maximized when the:

Accepted Answer

A)   cost of equity is maximized.
B)   tax rate is zero.
C)   levered cost of capital is maximized.
D)   weighted average cost of capital is minimized.
E)   debt-equity ratio is minimized.F) A) and E)
G) None of the above

Question 14

Stacy owns 38 percent of The Town Centre.She has decided to retire and wants to sell all of her shares in this closely held,all equity firm.The other shareholders have agreed to have the firm borrow $650,000 to purchase her shares of stock.What is the total market value of The Town Centre? Ignore taxes.

Accepted Answer

A)   $1,710,526
B)   $1,748,219
C)   $1,771,089
D)   $1,801,406
E)   $1,808,649F) A) and B)
G) C) and D)

Question 15

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 B)
G) All of the above

Question 16

Bruce & Co.expects its EBIT to be $100,000 every year forever.The firm can borrow at 10 percent.Bruce currently has no debt,and its cost of equity is 20 percent.The tax rate is 34 percent.What will the value of Bruce & Co.be if the firm borrows $54,000 and uses the loan proceeds to repurchase shares?

Accepted Answer

A)   $280,130
B)   $346,600
C)   $348,360
D)   $378,900
E)   $381,520F) A) and E)
G) All of the above

Question 17

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) B) and D)
G) B) and E)

Question 18

Sewer's Paradise is an all equity firm that has 5,000 shares of stock outstanding at a market price of $15 a share.The firm's management has decided to issue $30,000 worth of debt and use the funds to repurchase shares of the outstanding stock.The interest rate on the debt will be 10 percent.What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes.

Accepted Answer

A)   $1.46
B)   $1.50
C)   $1.67
D)   $1.88
E)   $1.94F) C) and D)
G) D) and E)

Question 19

The static theory of capital structure advocates that the optimal capital structure for a firm:

Accepted Answer

A)   is dependent on a constant debt-equity ratio over time.
B)   remains fixed over time.
C)   is independent of the firm's tax rate.
D)   is independent of the firm's weighted average cost of capital.
E)   equates the tax savings from an additional dollar of debt to the increased bankruptcy costs related to that additional dollar of debt.F) All of the above
G) A) and C)

Question 20

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

Exam 16: Financial Leverage and Capital Structure Policy

Correct Answer
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The static theory of capital structure advocates that the optimal capital structure for a firm:

Correct Answer
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Correct Answer
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Corporations in the U.S.tend to:

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

Correct Answer
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The SLG Corp.uses no debt.The weighted average cost of capital is 11 percent.The current market value of the equity is $31 million and the corporate tax rate is 34 percent.What is EBIT?

Correct Answer
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A firm should select the capital structure that:

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

Correct Answer
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The value of a firm is maximized when the:

Correct Answer
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Which one of the following is the equity risk related to a firm's capital structure policy?

Correct Answer
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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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Correct Answer
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The interest tax shield is a key reason why:

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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Correct Answer
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The optimal capital structure has been achieved when the:

Correct Answer
verified

Pewter & Glass is an all equity firm that has 80,000 shares of stock outstanding.The company is in the process of borrowing $600,000 at 9 percent interest to repurchase 12,000 shares of the outstanding stock.What is the value of this firm if you ignore taxes?

Correct Answer
verified

Exam 16: Financial Leverage and Capital Structure Policy

Correct AnswerverifiedShow Answer

The static theory of capital structure advocates that the optimal capital structure for a firm:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Corporations in the U.S.tend to:

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

The SLG Corp.uses no debt.The weighted average cost of capital is 11 percent.The current market value of the equity is $31 million and the corporate tax rate is 34 percent.What is EBIT?

Correct AnswerverifiedShow Answer

A firm should select the capital structure that:

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

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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?

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

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The value of a firm is maximized when the:

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Which one of the following is the equity risk related to a firm's capital structure policy?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

The interest tax shield is a key reason why:

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

Correct AnswerverifiedShow Answer

The optimal capital structure has been achieved when the:

Correct AnswerverifiedShow Answer

Pewter & Glass is an all equity firm that has 80,000 shares of stock outstanding.The company is in the process of borrowing $600,000 at 9 percent interest to repurchase 12,000 shares of the outstanding stock.What is the value of this firm if you ignore taxes?

Correct AnswerverifiedShow Answer

Correct Answer
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