Question 1

According to the capital structure theories we examined, a firm benefits by having debt since the interest expense is deductible for tax purposes, creating an interest tax shield. The interest tax shield, on the other hand, increases in value the higher the coupon rate on the debt and the higher the tax rate. Ignoring financial distress costs, shouldn't the firm then choose to pay as high a coupon rate as possible?

Accepted Answer

This odd question challenges the student...

Question 2

The Tee Company has total assets of $20,000 and total debt of $8,000. The yield-to-maturity on its bonds is 9%. The cost of capital with no debt is 15%. The tax rate is 34%. What is the WACC?

Accepted Answer

A)   8.64%
B)   10.58%
C)   10.88%
D)   11.39%
E)   12.96%

Question 3

Your firm has a $475,000 bond issue outstanding. These bonds have a 7.5% coupon, pay interest semi-annually, and have a current market price equal to 99.6% of face value. What is the amount of the annual interest tax shield given a tax rate of 34%?

Accepted Answer

A)   $12,064
B)   $12,087
C)   $12,113
D)   $23,418
E)   $23,513

Question 4

The unlevered cost of capital is _________________.

Accepted Answer

A)   The cost of capital for a firm with no equity in its capital structure.
B)   The cost of capital for a firm with no debt in its capital structure.
C)   The interest tax shield times pretax net income.
D)   The cost of preferred stock for a firm with equal parts debt and common stock in its capital structure.
E)   Equal to the profit margin for a firm with some debt in its capital structure.

Question 5

Which of the following is the best definition of M&M Proposition II?

Accepted Answer

A)   The tax saving attained by a firm from interest expense.
B)   Termination of the firm as a going concern.
C)   The value of the firm is independent of its capital structure.
D)   A firm's cost of equity capital is a positive linear function of its capital structure.
E)   Financial restructuring of a failing firm to attempt to continue operations as a going concern.

Question 6

Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of 8%. The tax rate is 34%. What is the present value of the tax shield?

Accepted Answer

A)   $2,823
B)   $2,887
C)   $4,080
D)   $4,500
E)   $4,633

Question 7

Which one of the following statements is correct concerning the relationship between a capital structure with debt and one without debt? Assume there are no taxes.

Accepted Answer

A)   When a firm is operating at a point where the actual earnings before interest and taxes (EBIT)  exceed the break-even level, then adding debt to the capital structure will increase the earnings per share (EPS) .
B)   The earnings per share will equal zero when EBIT is zero for a levered firm.
C)   The advantages of leverage primarily occur when EBIT is just barely positive.
D)   The firm's EPS will always be higher if the firm uses leverage.
E)   EPS are more sensitive to changes in EBIT when a firm is unlevered.

Question 8

Bertha's Boutique has 2,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 9%. The interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 34%?

Accepted Answer

A)   $58,500
B)   $60,100
C)   $60,750
D)   $61,200
E)   $62,250

Question 9

In relation to M&M Proposition II with no taxes, financial risk is determined by the debt-equity ratio.

Accepted Answer

A) True 
 B)False

Question 10

Your firm has a debt-equity ratio of.60. Your pre-tax cost of debt is 9% and your required return on assets is 14%. What is your cost of equity if you ignore taxes?

Accepted Answer

A)   16.4%
B)   16.7%
C)   17.0%
D)   17.3%
E)   17.5%

Question 11

The fact that individual investors can alter the amount of financial leverage to which they are exposed is referred to as:

Accepted Answer

A)   Capital structure targeting.
B)   Adjusting the business risk.
C)   The static theory of capital structure.
D)   Homemade leverage.
E)   M&M Proposition II.

Question 12

Which of the following is the best definition of liquidation?

Accepted Answer

A)   The tax saving attained by a firm from interest expense.
B)   Termination of the firm as a going concern.
C)   The value of the firm is independent of its capital structure.
D)   A firm's cost of equity capital is a positive linear function of its capital structure.
E)   Financial restructuring of a failing firm to attempt to continue operations as a going concern.

Question 13

The option of keeping a financially distressed firm as an operating concern is called a(n) :

Accepted Answer

A)   Liquidation.
B)   Reorganization.
C)   Acquisition.
D)   Merger.
E)   Technical solvency.

Question 14

The Rose Bush has a cost of equity of 14.5% and a pre-tax cost of debt of 9%. The debt-equity ratio is.70 and the tax rate is.35. What is The Rose Bush's unlevered cost of capital?

Accepted Answer

A)   11.84%
B)   12.78%
C)   14.29%
D)   14.46%
E)   15.08%

Question 15

When taxes are factored in, debt financing lowers a firm's cost of equity.

Accepted Answer

A) True 
 B)False

Question 16

Hanover Tech is currently an all equity firm that has 130,000 shares of stock outstanding with a market price of $36 a share. The current cost of equity is 14% and the tax rate is 35%. The firm is considering adding $1.5 million of debt with a coupon rate of 7% to its capital structure. The debt will be sold at par value. What is the levered value of the equity?

Accepted Answer

A)   $3.180m
B)   $3.520m
C)   $3.705m
D)   $4.875m
E)   $5.205m

Question 17

Castle Home Builders has an unlevered cost of capital of 12%, 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 14%?

Accepted Answer

A)   .94
B)   .96
C)   .99
D)   1.01
E)   1.04

Question 18

Which one of the following statements concerning bankruptcy is correct?

Accepted Answer

A)   A firm is considered bankrupt when it becomes delinquent on a loan payment.
B)   The administrative expenses of a bankruptcy are classified as indirect bankruptcy costs.
C)   Bankruptcy costs may offset the tax-related gains from leverage.
D)   The higher cost of capital which a firm pays in order to avoid excessive debt is considered a direct cost of bankruptcy.
E)   Bankruptcy is a relatively inexpensive process.

Question 19

The financial management goal as it pertains to the capital structure of a firm is to operate at the point where the debt-equity mix:

Accepted Answer

A)   Creates the largest tax shield for the firm.
B)   Maximizes the financial distress costs.
C)   Maximizes the value of the firm.
D)   Minimizes the potential bankruptcy costs.
E)   Minimizes the yield-to-maturity on debt.

Question 20

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

Accepted Answer

A)   There is a positive linear relationship between the amount of debt in a levered firm and its value.
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 weighted average cost of capital increases as the debt-equity ratio of the firm rises.

Exam 16: Financial Leverage and Capital Structure Policy

Castle Home Builders has an unlevered cost of capital of 12%, 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 14%?

Correct Answer
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The unlevered cost of capital is _________________.

Correct Answer
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Your firm has a $475,000 bond issue outstanding. These bonds have a 7.5% coupon, pay interest semi-annually, and have a current market price equal to 99.6% of face value. What is the amount of the annual interest tax shield given a tax rate of 34%?

Correct Answer
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The Tee Company has total assets of $20,000 and total debt of $8,000. The yield-to-maturity on its bonds is 9%. The cost of capital with no debt is 15%. The tax rate is 34%. What is the WACC?

Correct Answer
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In relation to M&M Proposition II with no taxes, financial risk is determined by the debt-equity ratio.

Correct Answer
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The fact that individual investors can alter the amount of financial leverage to which they are exposed is referred to as:

Correct Answer
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Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of 8%. The tax rate is 34%. What is the present value of the tax shield?

Correct Answer
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Which one of the following statements is correct concerning the relationship between a capital structure with debt and one without debt? Assume there are no taxes.

Correct Answer
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Bertha's Boutique has 2,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 9%. The interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 34%?

Correct Answer
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Which of the following is the best definition of liquidation?

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

Correct Answer
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Correct Answer
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The option of keeping a financially distressed firm as an operating concern is called a(n) :

Correct Answer
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Your firm has a debt-equity ratio of.60. Your pre-tax cost of debt is 9% and your required return on assets is 14%. What is your cost of equity if you ignore taxes?

Correct Answer
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The financial management goal as it pertains to the capital structure of a firm is to operate at the point where the debt-equity mix:

Correct Answer
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Which one of the following statements concerning bankruptcy is correct?

Correct Answer
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Correct Answer
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This odd question challenges the student...
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The Rose Bush has a cost of equity of 14.5% and a pre-tax cost of debt of 9%. The debt-equity ratio is.70 and the tax rate is.35. What is The Rose Bush's unlevered cost of capital?

Correct Answer
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When taxes are factored in, debt financing lowers a firm's cost of equity.

Correct Answer
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Which of the following is the best definition of M&M Proposition II?

Correct Answer
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Exam 16: Financial Leverage and Capital Structure Policy

Castle Home Builders has an unlevered cost of capital of 12%, 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 14%?

Correct AnswerverifiedShow Answer

The unlevered cost of capital is _________________.

Correct AnswerverifiedShow Answer

Your firm has a $475,000 bond issue outstanding. These bonds have a 7.5% coupon, pay interest semi-annually, and have a current market price equal to 99.6% of face value. What is the amount of the annual interest tax shield given a tax rate of 34%?

Correct AnswerverifiedShow Answer

The Tee Company has total assets of $20,000 and total debt of $8,000. The yield-to-maturity on its bonds is 9%. The cost of capital with no debt is 15%. The tax rate is 34%. What is the WACC?

Correct AnswerverifiedShow Answer

In relation to M&M Proposition II with no taxes, financial risk is determined by the debt-equity ratio.

Correct AnswerverifiedShow Answer

The fact that individual investors can alter the amount of financial leverage to which they are exposed is referred to as:

Correct AnswerverifiedShow Answer

Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of 8%. The tax rate is 34%. What is the present value of the tax shield?

Correct AnswerverifiedShow Answer

Which one of the following statements is correct concerning the relationship between a capital structure with debt and one without debt? Assume there are no taxes.

Correct AnswerverifiedShow Answer

Bertha's Boutique has 2,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 9%. The interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 34%?

Correct AnswerverifiedShow Answer

Which of the following is the best definition of liquidation?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The option of keeping a financially distressed firm as an operating concern is called a(n) :

Correct AnswerverifiedShow Answer

Your firm has a debt-equity ratio of.60. Your pre-tax cost of debt is 9% and your required return on assets is 14%. What is your cost of equity if you ignore taxes?

Correct AnswerverifiedShow Answer

The financial management goal as it pertains to the capital structure of a firm is to operate at the point where the debt-equity mix:

Correct AnswerverifiedShow Answer

Which one of the following statements concerning bankruptcy is correct?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedThis odd question challenges the student...View AnswerShow Answer

The Rose Bush has a cost of equity of 14.5% and a pre-tax cost of debt of 9%. The debt-equity ratio is.70 and the tax rate is.35. What is The Rose Bush's unlevered cost of capital?

Correct AnswerverifiedShow Answer

When taxes are factored in, debt financing lowers a firm's cost of equity.

Correct AnswerverifiedShow Answer

Which of the following is the best definition of M&M Proposition II?

Correct AnswerverifiedShow Answer

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This odd question challenges the student...
View Answer

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