Question 1

Which of the following statements is FALSE?

Accepted Answer

A) Aside from taxes,another important difference between debt and equity financing is that debt payments must be made to avoid bankruptcy,whereas firms have no similar obligation to pay dividends or realize capital gains. 
B) Increasing the level of debt increases the probability of bankruptcy. 
C) A firm receives a tax benefit only if it is paying taxes in the first place. 
D) To the extent that a firm has other tax shields,its taxable earnings will be increased and it will rely more heavily on the interest tax shield. 
A) Aside from taxes,another important difference between debt and equity financing is that debt payments must be made to avoid bankruptcy,whereas firms have no similar obligation to pay dividends or realize capital gains. 
B) Increasing the level of debt increases the probability of bankruptcy. 
C) A firm receives a tax benefit only if it is paying taxes in the first place. 
D) To the extent that a firm has other tax shields,its taxable earnings will be increased and it will rely more heavily on the interest tax shield.

Question 2

Which of the following statements is FALSE?

Accepted Answer

A) Personal taxes have the potential to offset some of the corporate tax benefits of leverage. 
B) The actual interest tax shield depends on the reduction in the total taxes (both corporate and personal)that are paid. 
C) The amount of money an investor will pay for a security ultimately depends on the benefits the investor will receive-namely,the cash flows the investor will receive before all taxes have been paid. 
D) Just like corporate taxes,personal taxes reduce the cash flows to investors and diminish firm value. 
A) Personal taxes have the potential to offset some of the corporate tax benefits of leverage. 
B) The actual interest tax shield depends on the reduction in the total taxes (both corporate and personal)that are paid. 
C) The amount of money an investor will pay for a security ultimately depends on the benefits the investor will receive-namely,the cash flows the investor will receive before all taxes have been paid. 
D) Just like corporate taxes,personal taxes reduce the cash flows to investors and diminish firm value.

Question 3

Which of the following statements regarding recapitalizations is FALSE?

Accepted Answer

A) With a recapitalization,even though leverage reduces the total value of equity,shareholders capture the benefits of the interest tax shield up front. 
B) The share price always rises after the completion of the recapitalization. 
C) Leveraged recaps were especially popular in the mid- to late-1980s,when many firms found that these transactions could reduce their tax payments. 
D) When a firm makes a significant change to its capital structure,the transaction is called a recapitalization. 
A) With a recapitalization,even though leverage reduces the total value of equity,shareholders capture the benefits of the interest tax shield up front. 
B) The share price always rises after the completion of the recapitalization. 
C) Leveraged recaps were especially popular in the mid- to late-1980s,when many firms found that these transactions could reduce their tax payments. 
D) When a firm makes a significant change to its capital structure,the transaction is called a recapitalization.

Question 4

Use the table for the question(s)below.
Consider the following income statement for Kroger Inc.(all figures in $ Millions):  
-The total amount available to pay out to all the investors in Kroger in 2006 is closest to:

Accepted Answer

A) $990 million. 
B) $1525 million. 
C) $1500 million. 
D) $2035 million. 
A) $990 million. 
B) $1525 million. 
C) $1500 million. 
D) $2035 million.

Question 5

Consider the following formula: τ* =   The term τi is:

Accepted Answer

A) the effective personal tax rate on interest income. 
B) the effective personal tax rate on equity. 
C) the effective corporate tax rate on income. 
D) the effective tax advantage of debt. 
A) the effective personal tax rate on interest income. 
B) the effective personal tax rate on equity. 
C) the effective corporate tax rate on income. 
D) the effective tax advantage of debt.

Question 6

Which of the following statements is FALSE?

Accepted Answer

A) To determine the benefit of leverage for the value of the firm,we must compute the present value of the stream of future interest tax shields the firm will receive. 
B) Because the cash flows of the levered firm are equal to the sum of the cash flows from the unlevered firm plus the interest tax shield,by the Law of One Price the same must be true for the present values of these cash flows. 
C) By increasing the amount paid to debt holders through interest payments,the amount of the pre-tax cash flows that must be paid as taxes increases. 
D) When a firm uses debt,the interest tax shield provides a corporate tax benefit each year. 
A) To determine the benefit of leverage for the value of the firm,we must compute the present value of the stream of future interest tax shields the firm will receive. 
B) Because the cash flows of the levered firm are equal to the sum of the cash flows from the unlevered firm plus the interest tax shield,by the Law of One Price the same must be true for the present values of these cash flows. 
C) By increasing the amount paid to debt holders through interest payments,the amount of the pre-tax cash flows that must be paid as taxes increases. 
D) When a firm uses debt,the interest tax shield provides a corporate tax benefit each year.

Question 7

Use the following information to answer the question(s)below.
Google Corporation has no debt on its balance sheet in 2008,but paid $1.6 billion in taxes.Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
-Assume that investors hold Google stock in retirement accounts that are free from personal taxes.If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently,then the amount that Google needs to borrow is closest to:

Accepted Answer

A) $14.25 billion. 
B) $22.00 billion. 
C) $24.50 billion. 
D) $40.75 billion. 
A) $14.25 billion. 
B) $22.00 billion. 
C) $24.50 billion. 
D) $40.75 billion.

Question 8

KAHR Incorporated will have EBIT this coming year of $45 million.It will also spend $18 million on total capital expenditures,increase its net working capital by $7 million,and have $9 million in depreciation expenses.KAHR is currently an all-equity firm with a corporate tax rate of 21% and a cost of capital of 10%.If the interest rate on new KAHR debt is 8%,how much should KAHR borrow today if they want to maximize their interest tax shield?

Accepted Answer

Amount to issue = EB

Question 9

Which of the following statements is FALSE?

Accepted Answer

A) The tax deductibility of interest lowers the effective cost of debt financing for the firm. 
B) When a firm uses debt financing,the cost of the interest it must pay is offset to some extent by the tax savings from the interest tax shield. 
C) With tax-deductible interest,the effective after-tax borrowing rate is r(τ
C) . 
D) The WACC represents the cost of capital for the free cash flow generated by the firm's assets. 
A) The tax deductibility of interest lowers the effective cost of debt financing for the firm. 
B) When a firm uses debt financing,the cost of the interest it must pay is offset to some extent by the tax savings from the interest tax shield. 
C) With tax-deductible interest,the effective after-tax borrowing rate is r(τ
C) . 
D) The WACC represents the cost of capital for the free cash flow generated by the firm's assets.

Question 10

Which of the following statements is FALSE?

Accepted Answer

A) Unlike taxes on capital gains or interest income,which are paid annually,taxes on dividends are paid only at the time the investor sells the stock. 
B) Deferring the payment of capital gains taxes lowers the present value of the taxes,which can be interpreted as a lower effective capital gains tax rate. 
C) Investors with longer holding periods or with accrued losses face a lower tax rate on equity income,decreasing the effective tax advantage of debt. 
D) Investors with accrued losses that they can use to offset gains face a zero effective capital gains tax rate. 
A) Unlike taxes on capital gains or interest income,which are paid annually,taxes on dividends are paid only at the time the investor sells the stock. 
B) Deferring the payment of capital gains taxes lowers the present value of the taxes,which can be interpreted as a lower effective capital gains tax rate. 
C) Investors with longer holding periods or with accrued losses face a lower tax rate on equity income,decreasing the effective tax advantage of debt. 
D) Investors with accrued losses that they can use to offset gains face a zero effective capital gains tax rate.

Question 11

Use the table for the question(s)below.
Consider the following income statement for Kroger Inc.(all figures in $ Millions):  
-The interest rate tax shield for Kroger in 2005 is closest to:

Accepted Answer

A) $362 million. 
B) $36 million. 
C) $102 million. 
D) $195 million. 
A) $362 million. 
B) $36 million. 
C) $102 million. 
D) $195 million.

Question 12

Which of the following statements is FALSE?

Accepted Answer

A) A biotech firm might be developing drugs with tremendous potential,but it has yet to receive any revenue from these drugs.Such a firm will not have taxable earnings.In that case,a tax-optimal capital structure does not include debt. 
B) No corporate tax benefit arises from incurring interest payments in excess of EBIT. 
C) The optimal level of leverage from a tax saving perspective is the level such that interest equals EBIT. 
D) In general,as a firm's interest expense approaches its expected taxable earnings,the marginal tax advantage of debt increases,limiting the amount of equity the firm should use. 
A) A biotech firm might be developing drugs with tremendous potential,but it has yet to receive any revenue from these drugs.Such a firm will not have taxable earnings.In that case,a tax-optimal capital structure does not include debt. 
B) No corporate tax benefit arises from incurring interest payments in excess of EBIT. 
C) The optimal level of leverage from a tax saving perspective is the level such that interest equals EBIT. 
D) In general,as a firm's interest expense approaches its expected taxable earnings,the marginal tax advantage of debt increases,limiting the amount of equity the firm should use.

Question 13

Use the information for the question(s)below.
Fly by Night Aviation (FBNA)expects to have net income next year of $24 million and interest expense of $3 million.FBNA's corporate tax rate is 21%.
-FBNA's EBIT is closest to:

Accepted Answer

A) $33 million. 
B) $40 million. 
C) $45 million. 
D) $60 million. 
A) $33 million. 
B) $40 million. 
C) $45 million. 
D) $60 million.

Question 14

Use the table for the question(s)below.
Consider the following income statement for Kroger Inc.(all figures in $ Millions):  
-Calculate the interest tax shield,the total amount available to payout to all the investors,and the income that would be available to equity holders if Kroger was not levered for the year 2004.

Accepted Answer

The answer of Use the table for the question(s)below.
Consider the...

Question 15

Use the following information to answer the question(s)below.
Google Corporation has no debt on its balance sheet in 2008,but paid $1.6 billion in taxes.Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
-Assume that investors hold Google stock in retirement accounts that are free from personal taxes.If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently,then the value that would be created is closest to:

Accepted Answer

A) $14.25 billion. 
B) $22.00 billion. 
C) $24.50 billion. 
D) $40.75 billion. 
A) $14.25 billion. 
B) $22.00 billion. 
C) $24.50 billion. 
D) $40.75 billion.

Question 16

Use the following information to answer the question(s)below.
Wyatt Oil issued $100 million in perpetual debt (at par)with an annual coupon of 7%.Wyatt will pay interest only on this debt.Wyatt's corporate tax rate is expected to be 21% for the foreseeable future.
-The present value of Wyatt's annual interest tax shield is closest to:

Accepted Answer

A) $4.2 million. 
B) $7.0 million. 
C) $21 million. 
D) $60 million. 
A) $4.2 million. 
B) $7.0 million. 
C) $21 million. 
D) $60 million.

Question 17

Which of the following statements is FALSE?

Accepted Answer

A) Given a 21% corporate tax rate,for every $1 in new permanent debt that the firm issues,the value of the firm increases by $0.79. 
B) The firm's marginal tax rate may fluctuate due to changes in the tax code and changes in the firm's income bracket. 
C) Many large firms have a policy of maintaining a certain amount of debt on their balance sheets. 
D) Typically,the level of future interest payments varies due to changes the firm makes in the amount of debt outstanding,changes in the interest rate on that debt,and the risk that the firm may default and fail to make an interest payment. 
A) Given a 21% corporate tax rate,for every $1 in new permanent debt that the firm issues,the value of the firm increases by $0.79. 
B) The firm's marginal tax rate may fluctuate due to changes in the tax code and changes in the firm's income bracket. 
C) Many large firms have a policy of maintaining a certain amount of debt on their balance sheets. 
D) Typically,the level of future interest payments varies due to changes the firm makes in the amount of debt outstanding,changes in the interest rate on that debt,and the risk that the firm may default and fail to make an interest payment.

Question 18

Use the information for the question(s)below.
KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt.KD has had consistently stable earnings,and pays a 21% tax rate.Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
-If KD can repurchase its existing shares at $20 per share,what will the new share price be after the transaction?

Accepted Answer

A) $22.35 
B) $22.00 
C) $22.65 
D) $22.10 
A) $22.35 
B) $22.00 
C) $22.65 
D) $22.10

Question 19

Use the table for the question(s)below.
Consider the following historical top federal tax rates in the United States:
Personal Tax Rates  
-In 2000,the effective tax rate for debt holders was closest to:

Accepted Answer

A) 61%. 
B) 52%. 
C) 64%. 
D) 40%. 
A) 61%. 
B) 52%. 
C) 64%. 
D) 40%.

Question 20

Use the following information to answer the question(s)below.
Google Corporation has no debt on its balance sheet in 2008,but paid $1.6 billion in taxes.Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
-Assume that investors in Google pay a 15% tax rate on income from equity and a 35% tax rate on interest income.If Google were to issue sufficient debt to reduce its corporate taxes by $1 billion per year permanently,then the value that would be created is closest to:

Accepted Answer

A) $6.1 billion. 
B) $10.2 billion. 
C) $12.2 billion. 
D) $14.3 billion. 
A) $6.1 billion. 
B) $10.2 billion. 
C) $12.2 billion. 
D) $14.3 billion.

Exam 15: Debt and Taxes

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements regarding recapitalizations is FALSE?

Use the table for the question(s)below. Consider the following income statement for Kroger Inc.(all figures in $ Millions): -The total amount available to pay out to all the investors in Kroger in 2006 is closest to:

Consider the following formula: τ* = The term τi is:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Use the table for the question(s)below. Consider the following income statement for Kroger Inc.(all figures in $ Millions): -The interest rate tax shield for Kroger in 2005 is closest to:

Which of the following statements is FALSE?

Use the information for the question(s)below. Fly by Night Aviation (FBNA)expects to have net income next year of $24 million and interest expense of $3 million.FBNA's corporate tax rate is 21%. -FBNA's EBIT is closest to:

Which of the following statements is FALSE?

Use the table for the question(s)below. Consider the following historical top federal tax rates in the United States: Personal Tax Rates -In 2000,the effective tax rate for debt holders was closest to:

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Financial Distress,managerial Incentives,and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Real Options

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

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