Question 1

Which of the following statements is FALSE?

Accepted Answer

A) Once investors know the recap will occur,the share price will rise immediately to a level that reflects the value of the interest tax shield that the firm will receive from its recapitalization. 
B) When securities are fairly priced,the original shareholders of a firm capture the full benefit of the interest tax shield from an increase in leverage. 
C) In the presence of corporate taxes,we do not include the interest tax shield as one of the firm's assets on its market value balance sheet. 
D) We can analyze the recapitalization using the market value balance sheet;it states that the total market value of a firm's securities must equal the total market value of the firm's assets. 
A) Once investors know the recap will occur,the share price will rise immediately to a level that reflects the value of the interest tax shield that the firm will receive from its recapitalization. 
B) When securities are fairly priced,the original shareholders of a firm capture the full benefit of the interest tax shield from an increase in leverage. 
C) In the presence of corporate taxes,we do not include the interest tax shield as one of the firm's assets on its market value balance sheet. 
D) We can analyze the recapitalization using the market value balance sheet;it states that the total market value of a firm's securities must equal the total market value of the firm's assets.

Question 2

Your firm currently has $250 million in debt outstanding with an 8% interest rate.The terms of the loan require the firm to repay $50 million of the balance each year.Suppose that the corporate tax rate is 21% and that the interest tax shields have the same risk as the loan.What is the present value of the interest tax shields from this debt?

Accepted Answer

($ amounts in millions) @#IMG-DLM& Inter

Question 3

Rearden Metal has no debt,and maintains a policy of holding $50 million in excess cash reserves,invested in risk-free treasury securities currently yielding 4%.If Rearden has a 21% corporate tax rate,the cost of permanently maintaining this $50 million reserve is closest to:

Accepted Answer

A) $0.8 million. 
B) $1.2 million. 
C) $10.5 million. 
D) $30.0 million. 
A) $0.8 million. 
B) $1.2 million. 
C) $10.5 million. 
D) $30.0 million.

Question 4

Wyatt Oil has 25 million shares outstanding and has a marginal corporate tax rate of 40%.Wyatt Oil announces that it will pay out $40 million in cash to investors through a special dividend.Shareholders had previously assumed that Wyatt Oil would retain this excess cash permanently.The amount that Wyatt Oil's share price can be expected to change upon this announcement is closest to:

Accepted Answer

A) $0.56. 
B) $0.34. 
C) $0.96. 
D) $1.56. 
A) $0.56. 
B) $0.34. 
C) $0.96. 
D) $1.56.

Question 5

Which of the following statements is FALSE?

Accepted Answer

A) Even after adjusting for personal taxes,the value of an unlevered firm exceeds the value of a levered firm,and there is no tax advantage to using debt financing. 
B) In Modigliani and Miller's setting of perfect capital markets,firms could use any combination of debt and equity to finance their investments without changing the value of the firm. 
C) When firms raise new capital from investors,they do so primarily by issuing debt. 
D) In most years aggregate equity issues are negative,meaning that firms are reducing the amount of equity outstanding by buying shares. 
A) Even after adjusting for personal taxes,the value of an unlevered firm exceeds the value of a levered firm,and there is no tax advantage to using debt financing. 
B) In Modigliani and Miller's setting of perfect capital markets,firms could use any combination of debt and equity to finance their investments without changing the value of the firm. 
C) When firms raise new capital from investors,they do so primarily by issuing debt. 
D) In most years aggregate equity issues are negative,meaning that firms are reducing the amount of equity outstanding by buying shares.

Question 6

Rearden Metal currently has no debt and an equity cost of capital of 14%.Suppose that Rearden decides to increase its leverage and maintain a market debt-to-value ratio of 1/2.Suppose Rearden's debt cost of capital is 8% and its corporate tax rate is 21%.Assuming that Rearden's pre-tax WACC remains constant,then with the addition of leverage its effective after-tax WACC will be closest to:

Accepted Answer

A) 10.8%. 
B) 12.4%. 
C) 12.8%. 
D) 13.6%. 
A) 10.8%. 
B) 12.4%. 
C) 12.8%. 
D) 13.6%.

Question 7

Which of the following statements is FALSE?

Accepted Answer

A) The value of a firm is equal to the amount of money the firm can raise by issuing securities. 
B) By reducing a firm's corporate tax liability,debt allows the firm to pay more of its cash flows to investors. 
C) Equity investors must pay taxes on dividends but not capital gains. 
D) For individuals,interest payments received from debt are taxed as income. 
A) The value of a firm is equal to the amount of money the firm can raise by issuing securities. 
B) By reducing a firm's corporate tax liability,debt allows the firm to pay more of its cash flows to investors. 
C) Equity investors must pay taxes on dividends but not capital gains. 
D) For individuals,interest payments received from debt are taxed as income.

Question 8

Use the information for the question(s)below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,and this free cash flow is expected to grow at a rate of 3% per year thereafter.Flagstaff has an equity cost of capital of 13%,a debt cost of capital of 7%,and it has a 35% corporate tax rate.
-If Flagstaff currently maintains a .5 debt to equity ratio,then the value of Flagstaff as an all-equity firm would be closest to:

Accepted Answer

A) $80 million. 
B) $100 million. 
C) $73 million. 
D) $115 million. 
A) $80 million. 
B) $100 million. 
C) $73 million. 
D) $115 million.

Question 9

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.
-Assume that five years have passed since Wyatt issued this debt.While tax rates have remained at 21%,interest rates have dropped so that Wyatt's current cost of debt capital is now only 4%.Wyatt's annual interest tax shield is now closest to:

Accepted Answer

A) $1.47 million. 
B) $4.20 million. 
C) $40.0 million. 
D) $60.0 million. 
A) $1.47 million. 
B) $4.20 million. 
C) $40.0 million. 
D) $60.0 million.

Question 10

Which of the following statements is FALSE?

Accepted Answer

A) The higher the firm's leverage,the more the firm exploits the tax advantage of debt,and the lower its WACC. 
B) Corporate taxes lower the effective cost of debt financing,which translates into a reduction in the weighted average cost of capital. 
C) Because the firm's free cash flow is computed without considering the firm's leverage,we account for the benefit of the interest tax shield by calculating the WACC using the before-tax cost of debt. 
D) The reduction in the WACC increases with the amount of debt financing. 
A) The higher the firm's leverage,the more the firm exploits the tax advantage of debt,and the lower its WACC. 
B) Corporate taxes lower the effective cost of debt financing,which translates into a reduction in the weighted average cost of capital. 
C) Because the firm's free cash flow is computed without considering the firm's leverage,we account for the benefit of the interest tax shield by calculating the WACC using the before-tax cost of debt. 
D) The reduction in the WACC increases with the amount of debt financing.

Question 11

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 taxes by $1 billion per year permanently,then the effective tax advantage of this debt would be closest to:

Accepted Answer

A) 10%. 
B) 15%. 
C) 25%. 
D) 30%. 
A) 10%. 
B) 15%. 
C) 25%. 
D) 30%.

Question 12

Consider the following formula: rwacc =   rE +   rD -   rDτc
The term   rDτc represents:

Accepted Answer

A) the reduction due to the interest tax shield. 
B) the present value of the interest tax shield. 
C) the present value of the future interest payments. 
D) the interest tax shield each year. 
A) the reduction due to the interest tax shield. 
B) the present value of the interest tax shield. 
C) the present value of the future interest payments. 
D) the interest tax shield each year.

Question 13

With its current leverage,WELS Corporation will have free cash flow of $4 million.If WELS corporate tax rate is 21% and it pays 8% interest on its debt,how much additional debt can WELS issue this year and still receive the benefit of the interest tax shield next year?

Accepted Answer

Divide FCF by the interest rat

Question 14

Use the information for the question(s)below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,and this free cash flow is expected to grow at a rate of 3% per year thereafter.Flagstaff has an equity cost of capital of 13%,a debt cost of capital of 7%,and it has a 35% corporate tax rate.
-If Flagstaff currently maintains a debt to equity ratio of 1,then the value of Flagstaff as an all-equity firm would be closest to:

Accepted Answer

A) $73 million. 
B) $80 million. 
C) $115 million. 
D) $100 million. 
A) $73 million. 
B) $80 million. 
C) $115 million. 
D) $100 million.

Question 15

Use the information for the question(s)below.
LCMS Industries has $70 million in debt outstanding.The firm will pay only interest on this debt (the debt is perpetual).LCMS' corporate tax rate is 21% and the firm pays a rate of 8% interest on its debt.
-Assuming that the risk of the tax shield is only 6% even though the debt pays 8%,then the present value of LCMS' interest tax shield is closest to:

Accepted Answer

A) $24.5 million. 
B) $18 million. 
C) $19.6 million. 
D) $20.0 million. 
A) $24.5 million. 
B) $18 million. 
C) $19.6 million. 
D) $20.0 million.

Question 16

Use the information for the question(s)below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,and this free cash flow is expected to grow at a rate of 3% per year thereafter.Flagstaff has an equity cost of capital of 13%,a debt cost of capital of 7%,and it has a 21% corporate tax rate.
-If Flagstaff currently maintains a .8 debt to equity ratio,then calculate the value of Flagstaff's interest tax shield.

Accepted Answer

rwacc = @#IMG-DLM& rE + @#IMG-DLM& rD (Pre-tax)
rwacc = @#IMG-DLM& .13

Question 17

Assume that the corporate tax rate is 21%,the personal tax rate on income from equity is 15% and the personal rate on interest income is 36%.The effective tax advantage of a corporation issuing debt would be closest to:

Accepted Answer

A) -4.9%. 
B) 15.0%. 
C) 25.0%. 
D) 28.0%. 
A) -4.9%. 
B) 15.0%. 
C) 25.0%. 
D) 28.0%.

Question 18

Consider the following formula: VL = VU +   The term   represents:

Accepted Answer

A) the value of the firm with leverage. 
B) the present value of the interest tax shield. 
C) the present value of the future interest payments. 
D) the interest tax shield each year. 
A) the value of the firm with leverage. 
B) the present value of the interest tax shield. 
C) the present value of the future interest payments. 
D) the interest tax shield each year.

Question 19

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.
-The present value of KD's interest tax shield is closest to:

Accepted Answer

A) $130 million. 
B) $200 million. 
C) $400 million. 
D) $42 million. 
A) $130 million. 
B) $200 million. 
C) $400 million. 
D) $42 million.

Question 20

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,assuming an average dividend payout ratio of 50%,the effective tax rate for equity holders was closest to:

Accepted Answer

A) 69%. 
B) 65%. 
C) 55%. 
D) 30%. 
A) 69%. 
B) 65%. 
C) 55%. 
D) 30%.

Exam 15: Debt and Taxes

Which of the following statements is FALSE?

Rearden Metal has no debt,and maintains a policy of holding $50 million in excess cash reserves,invested in risk-free treasury securities currently yielding 4%.If Rearden has a 21% corporate tax rate,the cost of permanently maintaining this $50 million reserve is closest to:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Consider the following formula: rwacc = rE + rD - rDτc The term rDτc represents:

With its current leverage,WELS Corporation will have free cash flow of $4 million.If WELS corporate tax rate is 21% and it pays 8% interest on its debt,how much additional debt can WELS issue this year and still receive the benefit of the interest tax shield next year?

Assume that the corporate tax rate is 21%,the personal tax rate on income from equity is 15% and the personal rate on interest income is 36%.The effective tax advantage of a corporation issuing debt would be closest to:

Consider the following formula: VL = VU + The term represents:

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,assuming an average dividend payout ratio of 50%,the effective tax rate for equity 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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