Question 1

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

Accepted Answer

A)  A company 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 company'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 can be issued. 
A)  A company 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 company'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 can be issued. B

Question 2

W.V. Trees has a debt-equity ratio of .64, a WACC of 10.8 percent, a pretax cost of debt of 7.9 percent, and a tax rate of 24 percent. What is the unlevered cost of equity capital?

Accepted Answer

A)  11.92 percent 
B)  12.97 percent 
C)  13.08 percent 
D)  13.13 percent 
E)  13.45 percent 
A)  11.92 percent 
B)  12.97 percent 
C)  13.08 percent 
D)  13.13 percent 
E)  13.45 percent A

Question 3

SLG Corp. is an all-equity firm with a weighted average cost of capital of 10.02 percent. The current market value of the equity is $13.4 million and the total tax rate is 22 percent. What is EBIT?

Accepted Answer

A)  $1,966,667 
B)  $2,021,194 
C)  $1,721,385 
D)  $2,095,385 
E)  $1,943,182 
A)  $1,966,667 
B)  $2,021,194 
C)  $1,721,385 
D)  $2,095,385 
E)  $1,943,182 C

Question 4

LP Gas has a cost of equity of 16.31 percent and a pretax cost of debt of 7.8 percent. The debt-equity ratio is .56 and the tax rate is 21 percent. What is the unlevered cost of capital?

Accepted Answer

A)  13.70 percent 
B)  13.85 percent 
C)  14.01 percent 
D)  14.26 percent 
E)  14.08 percent 
A)  13.70 percent 
B)  13.85 percent 
C)  14.01 percent 
D)  14.26 percent 
E)  14.08 percent

Question 5

Which one of the following states that the value of a company is unrelated to the company's capital structure?

Accepted Answer

A)  Homemade leverage 
B)  M&M Proposition I, no tax 
C)  M&M Proposition II, no tax 
D)  Pecking-order theory 
E)  Static theory of capital structure 
A)  Homemade leverage 
B)  M&M Proposition I, no tax 
C)  M&M Proposition II, no tax 
D)  Pecking-order theory 
E)  Static theory of capital structure

Question 6

Naylor's is an all-equity firm with 48,000 shares of stock outstanding at a market price of $25 a share. The company has earnings before interest and taxes of $87,000. Naylor's has decided to issue $400,000 of debt at 7.3 percent and use the proceeds to repurchase shares. Currently, Angela owns 600 shares of Naylor's stock. How many shares of this stock will she continue to own if she unlevers this position? Assume she can loan out funds at 7.3 percent interest. Ignore taxes.

Accepted Answer

A)  200 
B)  333 
C)  400 
D)  425 
E)  267 
A)  200 
B)  333 
C)  400 
D)  425 
E)  267

Question 7

Which one of these statements related to Chapter 11 bankruptcy is correct?

Accepted Answer

A)  Prepacks apply only to Chapter 7, not Chapter 11, bankruptcies. 
B)  Senior management must be replaced prior to exiting a Chapter 11 bankruptcy. 
C)  A company can only file for Chapter 11 after it becomes totally insolvent. 
D)  Companies sometimes file for Chapter 11 in an attempt to gain a competitive advantage. 
E)  Chapter 11 involves the total liquidation of the bankrupt firm. 
A)  Prepacks apply only to Chapter 7, not Chapter 11, bankruptcies. 
B)  Senior management must be replaced prior to exiting a Chapter 11 bankruptcy. 
C)  A company can only file for Chapter 11 after it becomes totally insolvent. 
D)  Companies sometimes file for Chapter 11 in an attempt to gain a competitive advantage. 
E)  Chapter 11 involves the total liquidation of the bankrupt firm.

Question 8

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 company underwent is known as a:

Accepted Answer

A)  merger. 
B)  repurchase program. 
C)  liquidation. 
D)  reorganization. 
E)  divestiture. 
A)  merger. 
B)  repurchase program. 
C)  liquidation. 
D)  reorganization. 
E)  divestiture.

Question 9

Miller's Dry Goods is an all-equity firm with 40,000 shares of stock outstanding at a market price of $50 a share. The company's earnings before interest and taxes are $160,000. Miller's has decided to add leverage to its financial operations by issuing $200,000 of debt at 7 percent interest and using the proceeds to repurchase shares of stock. Jen owns 500 shares of Miller's stock and can loan out funds at 7 percent interest. How many shares of Miller's stock must Jen sell to offset the leverage that Miller's is assuming? (Assume Jen loans out all of the funds she receives from the sale of stock. Ignore taxes.)

Accepted Answer

A)  125 shares 
B)  100 shares 
C)  50 shares 
D)  25 shares 
E)  75 shares 
A)  125 shares 
B)  100 shares 
C)  50 shares 
D)  25 shares 
E)  75 shares

Question 10

D. L. Tuckers has $57,000 of debt outstanding that is selling at par and has a coupon rate of 7.15 percent. The tax rate is 21 percent. What is the present value of the tax shield?

Accepted Answer

A)  $11,647 
B)  $12,791 
C)  $13,106 
D)  $12,200 
E)  $11,970 
A)  $11,647 
B)  $12,791 
C)  $13,106 
D)  $12,200 
E)  $11,970

Question 11

M&M Proposition I with tax implies that the:

Accepted Answer

A)  weighted average cost of capital decreases as the debt-equity ratio increases. 
B)  value of a company is inversely related to the amount of leverage used by that company. 
C)  value of an unlevered company equals the value of a levered company plus the value of the interest tax shield. 
D)  cost of capital is the same regardless of the mix of debt and equity used. 
E)  cost of equity increases as the debt-equity ratio decreases. 
A)  weighted average cost of capital decreases as the debt-equity ratio increases. 
B)  value of a company is inversely related to the amount of leverage used by that company. 
C)  value of an unlevered company equals the value of a levered company plus the value of the interest tax shield. 
D)  cost of capital is the same regardless of the mix of debt and equity used. 
E)  cost of equity increases as the debt-equity ratio decreases.

Question 12

Which one of the following provides the greatest tendency to increase the percentage of debt included in a company's optimal capital structure?

Accepted Answer

A)  Exceptionally high depreciation expenses 
B)  Very low marginal tax rate 
C)  Substantial tax shields from other sources 
D)  Low probability of financial distress 
E)  Minimal taxable income 
A)  Exceptionally high depreciation expenses 
B)  Very low marginal tax rate 
C)  Substantial tax shields from other sources 
D)  Low probability of financial distress 
E)  Minimal taxable income

Question 13

Hanover Tech is currently an all-equity company that has 145,000 shares of stock outstanding with a market price of $22 a share. The current cost of equity is 13.9 percent and the tax rate is 21 percent. The company is considering adding $1.5 million of debt with a coupon rate of 7.5 percent to its capital structure. The debt will be sold at par value. What is the levered value of the equity?

Accepted Answer

A)  $2.209 million 
B)  $2.005 million 
C)  $2.312 million 
D)  $2.012 million 
E)  $2.108 million 
A)  $2.209 million 
B)  $2.005 million 
C)  $2.312 million 
D)  $2.012 million 
E)  $2.108 million

Question 14

The concept of homemade leverage is most associated with:

Accepted Answer

A)  M&M Proposition I with no tax. 
B)  M&M Proposition II with no tax. 
C)  M&M Proposition I with tax. 
D)  M&M Proposition II with tax. 
E)  the static theory proposition. 
A)  M&M Proposition I with no tax. 
B)  M&M Proposition II with no tax. 
C)  M&M Proposition I with tax. 
D)  M&M Proposition II with tax. 
E)  the static theory proposition.

Question 15

The symbol "RU" refers to the cost of capital for a(n) ________ while "RA" represents the:

Accepted Answer

A)  privately owned entity; unlevered cost of capital. 
B)  all-equity company; weighted average cost of capital. 
C)  levered company; cost of capital for an all-equity company. 
D)  levered company; weighted average cost of capital. 
E)  unlevered company; average cost of equity. 
A)  privately owned entity; unlevered cost of capital. 
B)  all-equity company; weighted average cost of capital. 
C)  levered company; cost of capital for an all-equity company. 
D)  levered company; weighted average cost of capital. 
E)  unlevered company; average cost of equity.

Question 16

Douglass & Frank has a debt-equity ratio of .61. The pretax cost of debt is 7.8 percent while the unlevered cost of capital is 12.6 percent. What is the cost of equity if the tax rate is 21 percent?

Accepted Answer

A)  13.75 percent 
B)  14.91 percent 
C)  14.25 percent 
D)  14.33 percent 
E)  14.14 percent 
A)  13.75 percent 
B)  14.91 percent 
C)  14.25 percent 
D)  14.33 percent 
E)  14.14 percent

Question 17

Noelle owns 12 percent of The Toy Factory. 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 company borrow the $248,000 needed to repurchase her shares of stock. What is the total market value of the company? Ignore taxes.

Accepted Answer

A)  $2,066,667 
B)  $2,489,111 
C)  $2,608,515 
D)  $2,414,141 
E)  $2,333,333 
A)  $2,066,667 
B)  $2,489,111 
C)  $2,608,515 
D)  $2,414,141 
E)  $2,333,333

Question 18

Katlin Markets is debating between a levered and an unlevered capital structure. The all-equity capital structure would consist of 60,000 shares of stock. The debt and equity option would consist of 45,000 shares of stock plus $250,000 of debt with an interest rate of 7.25 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes.

Accepted Answer

A)  $50,500 
B)  $68,200 
C)  $81,400 
D)  $66,667 
E)  $72,500 
A)  $50,500 
B)  $68,200 
C)  $81,400 
D)  $66,667 
E)  $72,500

Question 19

The optimal capital structure:

Accepted Answer

A)  will be the same for all companies within the same industry. 
B)  will remain constant over time unless the company changes its primary operations. 
C)  will vary over time as taxes and market conditions change. 
D)  places more emphasis on operations than on financing. 
E)  is unaffected by changes in the financial markets. 
A)  will be the same for all companies within the same industry. 
B)  will remain constant over time unless the company changes its primary operations. 
C)  will vary over time as taxes and market conditions change. 
D)  places more emphasis on operations than on financing. 
E)  is unaffected by changes in the financial markets.

Question 20

The Jean Outlet is an all-equity firm that has 64,000 shares of stock outstanding. The company has decided to borrow $120,000 to repurchase 1,500 shares of its stock from the estate of a deceased shareholder. What is the total value of the firm if you ignore taxes?

Accepted Answer

A)  $5,340,000 
B)  $4,638,000 
C)  $5,068,700 
D)  $4,950,000 
E)  $5,120,000 
A)  $5,340,000 
B)  $4,638,000 
C)  $5,068,700 
D)  $4,950,000 
E)  $5,120,000

Exam 16: Financial Leverage and Capital Structure Policy

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

W.V. Trees has a debt-equity ratio of .64, a WACC of 10.8 percent, a pretax cost of debt of 7.9 percent, and a tax rate of 24 percent. What is the unlevered cost of equity capital?

SLG Corp. is an all-equity firm with a weighted average cost of capital of 10.02 percent. The current market value of the equity is $13.4 million and the total tax rate is 22 percent. What is EBIT?

LP Gas has a cost of equity of 16.31 percent and a pretax cost of debt of 7.8 percent. The debt-equity ratio is .56 and the tax rate is 21 percent. What is the unlevered cost of capital?

Which one of the following states that the value of a company is unrelated to the company's capital structure?

Which one of these statements related to Chapter 11 bankruptcy is correct?

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 company underwent is known as a:

D. L. Tuckers has $57,000 of debt outstanding that is selling at par and has a coupon rate of 7.15 percent. The tax rate is 21 percent. What is the present value of the tax shield?

M&M Proposition I with tax implies that the:

Which one of the following provides the greatest tendency to increase the percentage of debt included in a company's optimal capital structure?

The concept of homemade leverage is most associated with:

The symbol "RU" refers to the cost of capital for a(n) ________ while "RA" represents the:

Douglass & Frank has a debt-equity ratio of .61. The pretax cost of debt is 7.8 percent while the unlevered cost of capital is 12.6 percent. What is the cost of equity if the tax rate is 21 percent?

The optimal capital structure:

The Jean Outlet is an all-equity firm that has 64,000 shares of stock outstanding. The company has decided to borrow $120,000 to repurchase 1,500 shares of its stock from the estate of a deceased shareholder. What is the total value of the firm if you ignore taxes?

Introduction to Corporate Finance

Financial Statements, Taxes, and Cash Flow

Working with Financial Statements

Long-Term Financial Planning and Growth

Introduction to Valuation: The Time Value of Money

Discounted Cash Flow Valuation

Interest Rates and Bond Valuation

Stock Valuation

Net Present Value and Other Investment Criteria

Making Capital Investment Decisions

Project Analysis and Evaluation

Some Lessons from Capital Market History

Return, Risk, and the Security Market Line

Cost of Capital

Raising Capital

Dividends and Payout Policy

Short Term Finance and Planning

Cash and Liquidity Management

Credit and Inventory Management

International Corporate Finance

Behavioral Finance: Implications for Financial Management

Enterprise Risk Management

Options and Corporate Finance

Option Valuation

Mergers and Acquisitions

Leasing

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