Question 1

A Winnipeg firm is considering two separate capital structures. The first is an all equity plan consisting of 25,000 shares of stock. The second plan would consist of 10,000 shares of stock and $90,000 in debt at a cost of 8%. Ignore taxes. What is the break-even EBIT?

Accepted Answer

A)   $12,000
B)   $15,000
C)   $18,000
D)   $19,000
E)   $21,000F) All of the above
G) A) and D)

Question 2

Marshall's has a debt-equity ratio of.60. The pre-tax cost of debt is 9.1% and the required return on assets is 14%. What is the cost of equity if you ignore taxes?

Accepted Answer

A)   11.06%
B)   11.34%
C)   13.87%
D)   15.48%
E)   16.94%F) D) and E)
G) C) and D)

Question 3

In general, observed capital structures:

Accepted Answer

A)   Tend to overweigh debt in relation to equity.
B)   Are easily explained in terms of earnings volatility.
C)   Are easily explained by analyzing the types of assets owned by the various firms.
D)   Tend to be those which maximize the use of the firm's available tax shelters.
E)   Vary significantly across industries.F) A) and E)
G) A) and D)

Question 4

Tax rate will affect the optimal level of debt for a firm.

Accepted Answer

A) True 
 B)False

Question 5

An unlevered firm has a cost of capital of 14% and earnings before interest and taxes of $150,000. A levered firm with the same operations and assets has both a book value and a market value of debt of $700,000 with a 7% annual coupon. The applicable tax rate is 35%. What is the value of the levered firm?

Accepted Answer

A)   $696,429
B)   $907,679
C)   $941,429
D)   $1,184,929
E)   $1,396,429F) A) and E)
G) A) and B)

Question 6

Which of the following is the best definition of business risk?

Accepted Answer

A)   The costs that are directly associated with bankruptcy, such as legal and administrative expenses.
B)   The cost of capital of a firm that has no debt.
C)   Theory that a firm borrows up to the point where the tax benefit from an extra dollar in debt is exactly equal to the cost that comes from the increased probability of financial distress.
D)   The equity risk that comes from the nature of the firm's operating activities.
E)   The tax saving attained by a firm from interest expense.F) B) and D)
G) A) and B)

Question 7

Salem Mills has an unlevered cost of capital of 14%, a cost of debt of 9%, and a tax rate of 34%. What is the target debt-equity ratio if the targeted cost of equity is 16.5%?

Accepted Answer

A)   63
B)   69
C)   73
D)   76
E)   84F) D) and E)
G) C) and D)

Question 8

Trudy's Pizza is an unlevered firm with an after-tax net income of $47,000. The unlevered cost of capital is 7.5% and the tax rate is 35%. What is the value of this firm?

Accepted Answer

A)   $219,333
B)   $328,333
C)   $407,334
D)   $626,667
E)   $733,333F) C) and E)
G) A) and E)

Question 9

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 B)
G) None of the above

Question 10

Joe's BBQ Grill has $21,000 of debt outstanding that is selling at par and has a coupon rate of 6.5%. The tax rate is 35%. What is the present value of the tax shield?

Accepted Answer

A)   $478
B)   $790
C)   $1,365
D)   $4,780
E)   $7,350F) None of the above
G) All of the above

Question 11

M&M Proposition I with taxes states that the:

Accepted Answer

A)   Debt-equity ratio does not affect the total value of a firm.
B)   Cost of equity financing increases as the debt-equity ratio rises.
C)   Value of a levered firm is equal to the present value of the interest tax shield plus the value of an unlevered firm.
D)   Required return on assets is determined by the level of financial risk.
E)   Return on equity is dependent upon the marginal tax rate and the debt-equity ratio.F) B) and E)
G) None of the above

Question 12

Which one of the following statements is correct?

Accepted Answer

A)   The greater the volatility of EBIT, the more a firm should borrow.
B)   Firms with a large percentage of assets invested in intangibles, should borrow more than a comparable firm with a minimal investment in intangibles.
C)   A firm with a high annual depreciation write-off benefits more from leverage than a comparable firm with a low annual depreciation write-off.
D)   The static model of capital structure identifies the precise debt-equity ratio that optimizes the value of the firm.
E)   Firms with high tax rates have a greater incentive to borrow than firms with low tax rates.F) A) and B)
G) A) and C)

Question 13

The static theory of capital structure supports the theory that value-maximizing managers will:

Accepted Answer

A)   Look to the asset side of the balance sheet to increase firm value since the mix of debt and equity selected is unlikely to affect firm value.
B)   Not concern themselves with the capital structure of the firm as it is an irrelevant issue.
C)   Select the capital structure for which the cost associated with the probability of financial distress equals the benefit of the interest tax shield.
D)   Select an all equity capital structure to ensure the value of the firm is maximized.
E)   Select the capital structure which maximizes the interest tax shield.F) A) and E)
G) B) and E)

Question 14

The theory that a change in the capital structure weights is exactly offset by the change in the cost of equity is known as:

Accepted Answer

A)   Homemade leverage.
B)   Financial leverage.
C)   The targeted capital structure theory.
D)   M&M Proposition I.
E)   M&M Proposition II.F) A) and D)
G) B) and D)

Question 15

When a firm is operating at its target capital structure point, shareholder value is maximized.

Accepted Answer

A) True 
 B)False

Question 16

A Calgary firm with no debt has 200,000 shares outstanding valued at $20 each. Its cost of equity is 12%. The firm is considering adding $1 million in debt to its capital structure. The coupon rate would be 8% and the bonds would sell for par value. The firm's tax rate is 34%. How much will the firm be worth after adding the debt?

Accepted Answer

A)   $4.033 million
B)   $4.180 million
C)   $4.340 million
D)   $4.660 million
E)   $5.000 millionF) C) and E)
G) A) and B)

Question 17

All else the same, which of the following is true about the interest tax shield of a firm with positive EBIT?

Accepted Answer

A)   The higher the corporate tax rate, the less valuable the interest tax shield.
B)   If the firm dramatically increases its depreciation expense, it may have more of a need for an interest tax shield.
C)   The interest tax shield becomes more valuable as the size of the debt load increases.
D)   The interest tax shield increases as a firm reduces its level of outstanding debt.
E)   Since the interest tax shield is valuable, the firm would rather pay a high coupon rate on its bonds than a low coupon rate.F) D) and E)
G) A) and D)

Question 18

The White Hills Co. has expected earnings before interest and taxes of $8,100, an unlevered cost of capital of 11%, and debt with both a book and market value of $12,000. The debt has an annual 8% coupon. The tax rate is 34%. What is the value of the firm?

Accepted Answer

A)   $48,600
B)   $50,000
C)   $52,680
D)   $56,667
E)   $60,600F) All of the above
G) C) and D)

Question 19

Based on M&M without taxes and with taxes, how much time should a financial manager spend analyzing the capital structure of their firm? How about based on the static theory?

Accepted Answer

Under either M&M scenario, the financial...

Question 20

You own 20% of Holiday Travels, Inc. You have decided to retire and want to sell your shares in this closely held, all equity firm. The other shareholders have agreed to have the firm borrow $800,000 to purchase your 500 shares of stock. What is the total value of Holiday Travels Inc. if you ignore taxes?

Accepted Answer

A)   $2.9 million
B)   $3.2 million
C)   $3.7 million
D)   $4.0 million
E)   $4.8 millionF) A) and E)
G) B) and C)

Exam 16: Financial Leverage and Capital Structure Policy

M&M Proposition I with taxes states that the:

Correct Answer
verified

The static theory of capital structure supports the theory that value-maximizing managers will:

Correct Answer
verified

Correct Answer
verified

Based on M&M without taxes and with taxes, how much time should a financial manager spend analyzing the capital structure of their firm? How about based on the static theory?

Correct Answer
verified
Under either M&M scenario, the financial...
View Answer

Marshall's has a debt-equity ratio of.60. The pre-tax cost of debt is 9.1% and the required return on assets is 14%. What is the cost of equity if you ignore taxes?

Correct Answer
verified

When a firm is operating at its target capital structure point, shareholder value is maximized.

Correct Answer
verified

Salem Mills has an unlevered cost of capital of 14%, a cost of debt of 9%, and a tax rate of 34%. What is the target debt-equity ratio if the targeted cost of equity is 16.5%?

Correct Answer
verified

Trudy's Pizza is an unlevered firm with an after-tax net income of $47,000. The unlevered cost of capital is 7.5% and the tax rate is 35%. What is the value of this firm?

Correct Answer
verified

All else the same, which of the following is true about the interest tax shield of a firm with positive EBIT?

Correct Answer
verified

The value of a firm is maximized when the:

Correct Answer
verified

Joe's BBQ Grill has $21,000 of debt outstanding that is selling at par and has a coupon rate of 6.5%. The tax rate is 35%. What is the present value of the tax shield?

Correct Answer
verified

A Winnipeg firm is considering two separate capital structures. The first is an all equity plan consisting of 25,000 shares of stock. The second plan would consist of 10,000 shares of stock and $90,000 in debt at a cost of 8%. Ignore taxes. What is the break-even EBIT?

Correct Answer
verified

The White Hills Co. has expected earnings before interest and taxes of $8,100, an unlevered cost of capital of 11%, and debt with both a book and market value of $12,000. The debt has an annual 8% coupon. The tax rate is 34%. What is the value of the firm?

Correct Answer
verified

Correct Answer
verified

The theory that a change in the capital structure weights is exactly offset by the change in the cost of equity is known as:

Correct Answer
verified

Correct Answer
verified

Which one of the following statements is correct?

Correct Answer
verified

Tax rate will affect the optimal level of debt for a firm.

Correct Answer
verified

Which of the following is the best definition of business risk?

Correct Answer
verified

In general, observed capital structures:

Correct Answer
verified

Exam 16: Financial Leverage and Capital Structure Policy

M&M Proposition I with taxes states that the:

Correct AnswerverifiedShow Answer

The static theory of capital structure supports the theory that value-maximizing managers will:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Based on M&M without taxes and with taxes, how much time should a financial manager spend analyzing the capital structure of their firm? How about based on the static theory?

Correct AnswerverifiedUnder either M&M scenario, the financial...View AnswerShow Answer

Marshall's has a debt-equity ratio of.60. The pre-tax cost of debt is 9.1% and the required return on assets is 14%. What is the cost of equity if you ignore taxes?

Correct AnswerverifiedShow Answer

When a firm is operating at its target capital structure point, shareholder value is maximized.

Correct AnswerverifiedShow Answer

Salem Mills has an unlevered cost of capital of 14%, a cost of debt of 9%, and a tax rate of 34%. What is the target debt-equity ratio if the targeted cost of equity is 16.5%?

Correct AnswerverifiedShow Answer

Trudy's Pizza is an unlevered firm with an after-tax net income of $47,000. The unlevered cost of capital is 7.5% and the tax rate is 35%. What is the value of this firm?

Correct AnswerverifiedShow Answer

All else the same, which of the following is true about the interest tax shield of a firm with positive EBIT?

Correct AnswerverifiedShow Answer

The value of a firm is maximized when the:

Correct AnswerverifiedShow Answer

Joe's BBQ Grill has $21,000 of debt outstanding that is selling at par and has a coupon rate of 6.5%. The tax rate is 35%. What is the present value of the tax shield?

Correct AnswerverifiedShow Answer

A Winnipeg firm is considering two separate capital structures. The first is an all equity plan consisting of 25,000 shares of stock. The second plan would consist of 10,000 shares of stock and $90,000 in debt at a cost of 8%. Ignore taxes. What is the break-even EBIT?

Correct AnswerverifiedShow Answer

The White Hills Co. has expected earnings before interest and taxes of $8,100, an unlevered cost of capital of 11%, and debt with both a book and market value of $12,000. The debt has an annual 8% coupon. The tax rate is 34%. What is the value of the firm?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The theory that a change in the capital structure weights is exactly offset by the change in the cost of equity is known as:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which one of the following statements is correct?

Correct AnswerverifiedShow Answer

Tax rate will affect the optimal level of debt for a firm.

Correct AnswerverifiedShow Answer

Which of the following is the best definition of business risk?

Correct AnswerverifiedShow Answer

In general, observed capital structures:

Correct AnswerverifiedShow Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
Under either M&M scenario, the financial...
View Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified