Question 1

Calculate the WACC for a firm with a debt-equity ratio of .6.The debt pays 12% interest and the equity is expected to return 14%.Assume a 40% tax rate and risk-free debt.

Accepted Answer

A) 11.45% 
B) 12.50% 
C) 13.55% 
D) 14.60% 
A) 11.45% 
B) 12.50% 
C) 13.55% 
D) 14.60% A

Question 2

In an MM world, restructuring the firm will not change its overall value.

Accepted Answer

A) True 
 B)False  True

Question 3

An implicit cost of adding debt to the capital structure is that it:

Accepted Answer

A) Adds interest expense to the operating statement 
B) Increases the required return on equity 
C) Reduces the expected return on assets 
D) Decreases the firm's beta 
A) Adds interest expense to the operating statement 
B) Increases the required return on equity 
C) Reduces the expected return on assets 
D) Decreases the firm's beta B

Question 4

According to MM II, as a firm's debt-to-equity ratio decreases:

Accepted Answer

A) Its financial risk increases 
B) Its operating risk increases 
C) The required rate of return on equity increases 
D) The required rate of return on equity decreases 
A) Its financial risk increases 
B) Its operating risk increases 
C) The required rate of return on equity increases 
D) The required rate of return on equity decreases

Question 5

When corporate taxes and the cost of financial distress are taken into consideration, the market value of a firm equals the value if all-equity financed _____ the PV of the tax shield _____ the costs of financial distress.

Accepted Answer

A) Plus; plus 
B) Minus; plus 
C) Plus; minus 
D) Minus; minus 
A) Plus; plus 
B) Minus; plus 
C) Plus; minus 
D) Minus; minus

Question 6

Which of the following statements is true regarding the trade-off theory:

Accepted Answer

A) Target debt ratios are similar among firms in the same industry 
B) Riskier firms tend to rely mostly on debt financing 
C) Riskier firms should have high target debt ratios 
D) Less risky firms ought to have a greater amount of debt financing 
A) Target debt ratios are similar among firms in the same industry 
B) Riskier firms tend to rely mostly on debt financing 
C) Riskier firms should have high target debt ratios 
D) Less risky firms ought to have a greater amount of debt financing

Question 7

Debt may be the preferred form of external financing for many firms because:

Accepted Answer

A) Most firms already have too much equity 
B) Tax rates on equity are lower 
C) Debt will not adversely affect the firm's financial ratios 
D) Equity issuance is considered by investors to be a negative sign 
A) Most firms already have too much equity 
B) Tax rates on equity are lower 
C) Debt will not adversely affect the firm's financial ratios 
D) Equity issuance is considered by investors to be a negative sign

Question 8

Calculate the firm's expected return on its assets if its expected return on debt is 10%, their expected return on equity is 20%, and its WACC is 14%:

Accepted Answer

A) 14% 
B) 15% 
C) 16% 
D) Cannot be calculated 
A) 14% 
B) 15% 
C) 16% 
D) Cannot be calculated

Question 9

When large firms file for bankruptcy:

Accepted Answer

A) The proceedings involve costly delays and legal tangles, and the business continues to deteriorate 
B) Their purpose is usually to nurse the firm back to health and enable it to face the world again 
C) Their benefit is that their creditors will be forced by law to give up their claims on the firm 
D) Their creditors often try to seize the assets as soon as possible 
A) The proceedings involve costly delays and legal tangles, and the business continues to deteriorate 
B) Their purpose is usually to nurse the firm back to health and enable it to face the world again 
C) Their benefit is that their creditors will be forced by law to give up their claims on the firm 
D) Their creditors often try to seize the assets as soon as possible

Question 10

Any financial benefit derived from the interest tax shield accrues to the:

Accepted Answer

A) Bondholders 
B) Shareholders 
C) Bondholders and shareholders, equally 
D) Shareholders and the federal government 
A) Bondholders 
B) Shareholders 
C) Bondholders and shareholders, equally 
D) Shareholders and the federal government

Question 11

The possibility of bankruptcy will do all of the following except:

Accepted Answer

A) Increase financial distress costs 
B) Reduce the current market value of the firm 
C) Reduce the interest rate on debt 
D) Reduce the possible payoff to stockholders 
A) Increase financial distress costs 
B) Reduce the current market value of the firm 
C) Reduce the interest rate on debt 
D) Reduce the possible payoff to stockholders

Question 12

Calculate the return and risk premium on the common stock after the refinancing.

Accepted Answer

r_equi_ty = r_assets + D/E *(r_assets - r_debt)

Question 13

The interest tax shield is equal to the:

Accepted Answer

A) Difference between interest expense and income taxes 
B) Amount of interest paid in a given year 
C) Product of the interest expense and the tax rate 
D) Product of the debt principal and the interest rate on debt 
A) Difference between interest expense and income taxes 
B) Amount of interest paid in a given year 
C) Product of the interest expense and the tax rate 
D) Product of the debt principal and the interest rate on debt

Question 14

Equity Inc.is currently an all-equity financed firm.It has 10,000 shares outstanding that sell for $20 each.The firm has an operating income of $30,000 and pays no taxes.The firm contemplates a restructuring that would issue $50,000 in 8% debt, which will be used to repurchase stock.Show the value of the firm, EPS, and rate of return on the stock before and after the proposed restructuring.What changed?

Accepted Answer

The EPS and return on equity increased a

Question 15

What happens to an all-equity firm's EPS when $1 million of 20% debt is issued and proceeds used to repurchase two-thirds of the stock if operating income equals $1.5 million and EPS were $2 when the firm was all equity financed? Ignore taxes.

Accepted Answer

A) EPS increase to $2.60 
B) EPS increase to $3.00 
C) EPS increase to $4.80 
D) EPS increase to $5.20 
A) EPS increase to $2.60 
B) EPS increase to $3.00 
C) EPS increase to $4.80 
D) EPS increase to $5.20

Question 16

Calculate the WACC for a firm with a debt-equity ratio of 1.5.The debt pays 10% interest and the equity is expected to return 16%.Assume a 35% tax rate and risk-free debt.

Accepted Answer

If D/E = 1.5, then debt = 60%

Question 17

What is the amount of the annual interest tax shield for a firm with $3 million in debt that pays 12% interest if the firm is in the 35% tax bracket?

Accepted Answer

A) $126,000 
B) $234,000 
C) $360,000 
D) $1,050,000 Interest tax shield = interest expense x tax rate
= $360,000 x .35 
A) $126,000 
B) $234,000 
C) $360,000 
D) $1,050,000 Interest tax shield = interest expense x tax rate
= $360,000 x .35

Question 18

When corporate taxes are considered, how does leverage affect the WACC?

Accepted Answer

A) An increase in leverage will be offset by a decrease in equity financing, thus leaving WACC unchanged 
B) Changes in leverage will affect the WACC only if the interest rate on debt changes 
C) Increased leverage will increase the WACC 
D) Increased leverage will decrease the WACC 
A) An increase in leverage will be offset by a decrease in equity financing, thus leaving WACC unchanged 
B) Changes in leverage will affect the WACC only if the interest rate on debt changes 
C) Increased leverage will increase the WACC 
D) Increased leverage will decrease the WACC

Question 19

Calculate the required return on the company stock.

Accepted Answer

rS1U1B1assetsS1U1B0 = .5 * rS1U1B1equityS1U1B0 + .5 * rS1U1B1debtS1U1B0

Question 20

Discuss how agency problems can develop between shareholders and bondholders when the firm is experiencing financial distress.

Accepted Answer

Managers/owners may not have the proper

Exam 16: Debt Policy

Calculate the WACC for a firm with a debt-equity ratio of .6.The debt pays 12% interest and the equity is expected to return 14%.Assume a 40% tax rate and risk-free debt.

In an MM world, restructuring the firm will not change its overall value.

An implicit cost of adding debt to the capital structure is that it:

According to MM II, as a firm's debt-to-equity ratio decreases:

When corporate taxes and the cost of financial distress are taken into consideration, the market value of a firm equals the value if all-equity financed _____ the PV of the tax shield _____ the costs of financial distress.

Which of the following statements is true regarding the trade-off theory:

Debt may be the preferred form of external financing for many firms because:

Calculate the firm's expected return on its assets if its expected return on debt is 10%, their expected return on equity is 20%, and its WACC is 14%:

When large firms file for bankruptcy:

Any financial benefit derived from the interest tax shield accrues to the:

The possibility of bankruptcy will do all of the following except:

Calculate the return and risk premium on the common stock after the refinancing.

The interest tax shield is equal to the:

What happens to an all-equity firm's EPS when $1 million of 20% debt is issued and proceeds used to repurchase two-thirds of the stock if operating income equals $1.5 million and EPS were $2 when the firm was all equity financed? Ignore taxes.

Calculate the WACC for a firm with a debt-equity ratio of 1.5.The debt pays 10% interest and the equity is expected to return 16%.Assume a 35% tax rate and risk-free debt.

What is the amount of the annual interest tax shield for a firm with $3 million in debt that pays 12% interest if the firm is in the 35% tax bracket?

When corporate taxes are considered, how does leverage affect the WACC?

Calculate the required return on the company stock.

Discuss how agency problems can develop between shareholders and bondholders when the firm is experiencing financial distress.

Goals and Governance of the Firm

Financial Markets and Institutions

Accounting and Finance

Measuring Corporate Performance

The Time Value of Money

Valuing Bonds

Valuing Stocks

Net Present Value and Other Investment Criteria

Using Discounted Cash-Flow Analysis to Make Investment Decisions

Project Analysis

Introduction to Risk, Return, and the Opportunity Cost of Capital

Risk, Return, and Capital Budgeting

The Weighted-Average Cost of Capital and Company Valuation

Introduction to Corporate Financing and Governance

Venture Capital, Ipos, and Seasoned Offerings

Payout Policy

Long-Term Financial Planning

Short-Term Financial Planning

Working Capital Management

Mergers, Acquisitions, and Corporate Control

International Financial Management

Options

Risk Management

Conclusion

What We Do and Do Not Know About Finance

Filters

When corporate taxes and the cost of financial distress are taken into consideration, the market value of a firm equals the value if all-equity financed _ the PV of the tax shield _ the costs of financial distress.