Question 1

What is the after-tax cost of debt for a firm in the 35% tax bracket that pays 15% on its debt?

Accepted Answer

A)  5.25% 
B)  9.75% 
C)  12.17% 
D)  20.25% 
A)  5.25% 
B)  9.75% 
C)  12.17% 
D)  20.25% B

Question 2

Assume a firm is financed with 30% debt on which it pays interest of 9%.What is the expected return on equity if the expected return on assets is 14%? Ignore taxes.

Accepted Answer

A)  16.14% 
B)  17.86% 
C)  14.92% 
D)  15.50% 
A)  16.14% 
B)  17.86% 
C)  14.92% 
D)  15.50% A

Question 3

Loan covenants can ensure that companies will accept all positive-NPV investments and reject negative ones.

Accepted Answer

A) True 
 B)False  False

Question 4

When asked about key factors of debt policy,financial managers commonly mention the tax advantage of debt and the importance of maintaining their credit rating.

Accepted Answer

A) True 
 B)False

Question 5

When a firm pays tax,MM's Proposition I no longer holds,and the capital structure of the firm can be important due to the:

Accepted Answer

A)  lower tax rates on dividends than on debt. 
B)  higher tax rates on retained earnings than on debt. 
C)  interest tax shield. 
D)  higher operating income from lower dividends. 
A)  lower tax rates on dividends than on debt. 
B)  higher tax rates on retained earnings than on debt. 
C)  interest tax shield. 
D)  higher operating income from lower dividends.

Question 6

What is the expected rate of return to equity holders if the firm has a tax rate of 35%,the interest rate on debt is 10%,WACC is 15%,and the debt-asset ratio is 60%?

Accepted Answer

A)  12.50% 
B)  21.25% 
C)  22.50% 
D)  27.75% 
A)  12.50% 
B)  21.25% 
C)  22.50% 
D)  27.75%

Question 7

Which one of these statements correctly applies to an unlevered firm that pays no taxes?

Accepted Answer

A)  The return on equity exceeds the WACC. 
B)  The return on assets equals the return on equity and also equals WACC. 
C)  The return on assets equals the return on equity and exceeds WACC. 
D)  The return on equity equals WACC and exceeds the return on assets. 
A)  The return on equity exceeds the WACC. 
B)  The return on assets equals the return on equity and also equals WACC. 
C)  The return on assets equals the return on equity and exceeds WACC. 
D)  The return on equity equals WACC and exceeds the return on assets.

Question 8

Firms facing financial distress may pass up positive NPV projects rather than commit new equity because:

Accepted Answer

A)  they prefer to finance with debt. 
B)  the benefits are shared with the bondholders. 
C)  no cash is available for dividends. 
D)  there is no interest tax shield associated with equity. 
A)  they prefer to finance with debt. 
B)  the benefits are shared with the bondholders. 
C)  no cash is available for dividends. 
D)  there is no interest tax shield associated with equity.

Question 9

An increase in a firm's financial leverage will:

Accepted Answer

A)  increase the variability in earnings per share. 
B)  always reduce the operating risk of the firm. 
C)  increase the value of the firm in an MM world. 
D)  increase the WACC. 
A)  increase the variability in earnings per share. 
B)  always reduce the operating risk of the firm. 
C)  increase the value of the firm in an MM world. 
D)  increase the WACC.

Question 10

According to the trade-off theory,capital structure is a trade-off between:

Accepted Answer

A)  tangible and intangible asset risk. 
B)  high and low target debt ratios. 
C)  tax savings and financial distress costs. 
D)  tax shields and equity financing. 
A)  tangible and intangible asset risk. 
B)  high and low target debt ratios. 
C)  tax savings and financial distress costs. 
D)  tax shields and equity financing.

Question 11

Which of the following pair of firms do you think should be more highly levered: A biotech firm which may need a large cash injection if its drug trials are successful,or a company with a well-established market and large cash reserves?

Accepted Answer

The company with a w

Question 12

MM proposition I states that a firm's value is unaffected by its:

Accepted Answer

A)  required rate of return on equity. 
B)  operating income, in the absence of taxes. 
C)  interest rate paid on debt. 
D)  mixture of debt and equity. 
A)  required rate of return on equity. 
B)  operating income, in the absence of taxes. 
C)  interest rate paid on debt. 
D)  mixture of debt and equity.

Question 13

Financial slack:

Accepted Answer

A)  is associated with high leverage 
B)  allows firms to take advantage of good investment opportunities 
C)  solves any agency costs when managers want to empire-build 
D)  is a term that describes a lazy CFO 
A)  is associated with high leverage 
B)  allows firms to take advantage of good investment opportunities 
C)  solves any agency costs when managers want to empire-build 
D)  is a term that describes a lazy CFO

Question 14

When debt is risky:

Accepted Answer

A)  bondholders shift some of the firm risk to equityholders. 
B)  equityholders shift some of the firm risk to bondholders. 
C)  the value of the interest tax shield is at its highest. 
D)  there is more overall risk in the firm. 
A)  bondholders shift some of the firm risk to equityholders. 
B)  equityholders shift some of the firm risk to bondholders. 
C)  the value of the interest tax shield is at its highest. 
D)  there is more overall risk in the firm.

Question 15

The present value of the costs of financial distress increases as the debt ratio increases because the:

Accepted Answer

A)  expected return on assets increases. 
B)  present value of the interest tax shield is greater. 
C)  equity tax shield is depleted. 
D)  probability of default is greater. 
A)  expected return on assets increases. 
B)  present value of the interest tax shield is greater. 
C)  equity tax shield is depleted. 
D)  probability of default is greater.

Question 16

What is the proportion of debt financing for a firm that expects a 24% return on equity,a 16% return on assets,and a 12% return on debt? Ignore taxes.

Accepted Answer

A)  54.0% 
B)  60.0% 
C)  66.7% 
D)  75.0% 
A)  54.0% 
B)  60.0% 
C)  66.7% 
D)  75.0%

Question 17

In the absence of taxes,which one of the following would not be expected to change with changes in the firm's capital structure?

Accepted Answer

A)  Weighted-average cost of capital 
B)  Expected return on equity 
C)  Expected return on assets 
D)  Expected earnings per share 
A)  Weighted-average cost of capital 
B)  Expected return on equity 
C)  Expected return on assets 
D)  Expected earnings per share

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

How much debt is outstanding if the present value of a perpetual tax shield is $300,000,the tax rate is 35% and the interest rate on the debt is 10%?

Accepted Answer

A)  $300,000 
B)  $857,143 
C)  $3,000,000 
D)  $3,750,000 
A)  $300,000 
B)  $857,143 
C)  $3,000,000 
D)  $3,750,000

Question 20

As long as investors can borrow or lend on their own account on the same terms as the firm,they will not pay extra for firm leverage.

Accepted Answer

A) True 
 B)False

Exam 16: Debt Policy

What is the after-tax cost of debt for a firm in the 35% tax bracket that pays 15% on its debt?

Assume a firm is financed with 30% debt on which it pays interest of 9%.What is the expected return on equity if the expected return on assets is 14%? Ignore taxes.

Loan covenants can ensure that companies will accept all positive-NPV investments and reject negative ones.

When asked about key factors of debt policy,financial managers commonly mention the tax advantage of debt and the importance of maintaining their credit rating.

When a firm pays tax,MM's Proposition I no longer holds,and the capital structure of the firm can be important due to the:

What is the expected rate of return to equity holders if the firm has a tax rate of 35%,the interest rate on debt is 10%,WACC is 15%,and the debt-asset ratio is 60%?

Which one of these statements correctly applies to an unlevered firm that pays no taxes?

Firms facing financial distress may pass up positive NPV projects rather than commit new equity because:

An increase in a firm's financial leverage will:

According to the trade-off theory,capital structure is a trade-off between:

Which of the following pair of firms do you think should be more highly levered: A biotech firm which may need a large cash injection if its drug trials are successful,or a company with a well-established market and large cash reserves?

MM proposition I states that a firm's value is unaffected by its:

Financial slack:

When debt is risky:

The present value of the costs of financial distress increases as the debt ratio increases because the:

What is the proportion of debt financing for a firm that expects a 24% return on equity,a 16% return on assets,and a 12% return on debt? Ignore taxes.

In the absence of taxes,which one of the following would not be expected to change with changes in the firm's capital structure?

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

How much debt is outstanding if the present value of a perpetual tax shield is $300,000,the tax rate is 35% and the interest rate on the debt is 10%?

As long as investors can borrow or lend on their own account on the same terms as the firm,they will not pay extra for firm leverage.

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

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