Question 1

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

Accepted Answer

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

Question 2

MJ Enterprises has 50 million shares outstanding with a market price of $25 per share and no debt.MJ has had consistently stable earnings,and pays a 35% tax rate.Management plans to borrow $500 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.Calculate MJ's share price following announcement of the recapitalization plan.

Accepted Answer

V^U = (50 million shares)× $25 per share = $1250 million Tax Shield = Debt × τ_c = $500 million × .35 = $175 million V^{L = VU} + Interest Tax shield = 1250M + 175M = 1425M/50M shares = 28.50

Question 3

i)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) $23.50 
A) $22.35 
B) $22.00 
C) $22.65 
D) $23.50 B

Question 4

After the recapitalization,the total value of KD as a levered firm is closest to:

Accepted Answer

A) $470 million 
B) $730 million 
C) $670 million 
D) $530 million 
A) $470 million 
B) $730 million 
C) $670 million 
D) $530 million

Question 5

Use the information for the question(s)below.
Shepard Industries expects free cash flow of $10 million each year.Shepard's corporate tax rate is 35%,and its unlevered cost of equity is 10%.The firm also has outstanding debt of $40 million and it expects to maintain amount of debt permanently.
-The value of Shepard Industries without leverage is closest to:

Accepted Answer

A) $114 million 
B) $50 million 
C) $100 million 
D) $64 million 
A) $114 million 
B) $50 million 
C) $100 million 
D) $64 million

Question 6

Which of the following statements is FALSE?

Accepted Answer

A) The data show a clear preference for equity as a source of external financing for the total population of U.S.firms. 
B) Debt as a fraction of firm value has varied in a range from 30-45% for the average firm. 
C) Capital expenditures greatly exceed firms' external financing,implying that most investment and growth is supported by internally generated funds,such as retained earnings. 
D) Firms in growth industries like biotechnology or high technology carry very little debt,whereas airlines,auto makers,utilities,and financial firms have high leverage ratios. 
A) The data show a clear preference for equity as a source of external financing for the total population of U.S.firms. 
B) Debt as a fraction of firm value has varied in a range from 30-45% for the average firm. 
C) Capital expenditures greatly exceed firms' external financing,implying that most investment and growth is supported by internally generated funds,such as retained earnings. 
D) Firms in growth industries like biotechnology or high technology carry very little debt,whereas airlines,auto makers,utilities,and financial firms have high leverage ratios.

Question 7

Use the table for the question(s)below.
Consider the following 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 8

If Flagstaff currently maintains a debt to equity ratio of 1,then the value of Flagstaff as a levered firm is closest to:

Accepted Answer

A) $114 million 
B) $100 million 
C) $111 million 
D) $140 million 
A) $114 million 
B) $100 million 
C) $111 million 
D) $140 million

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

In 2005,assuming an average dividend payout ratio of 50%,the effective tax rate for equity holders was closest to:

Accepted Answer

A) 30% 
B) 55% 
C) 45% 
D) 50% 
A) 30% 
B) 55% 
C) 45% 
D) 50%

Question 11

The Grant Corporation is considering permanently adding $500 million of debt to its capital structure.Grant's corporate tax rate is 35% and investors pay a tax rate of 40% on their interest income and 20% on their income from capital gains and dividends.Calculate the present value of the interest tax shield provided by this new debt.

Accepted Answer

τ* = @#IMG-DLM& 
= @#IMG-DLM& 
= 0.13333

Question 12

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 marginal tax rate is expected to be 40% for the foreseeable future.
-Wyatt's annual interest tax shield is closest to:

Accepted Answer

A) $2.8 million 
B) $4.2 million 
C) $7.0 million 
D) $40 million 
A) $2.8 million 
B) $4.2 million 
C) $7.0 million 
D) $40 million

Question 13

If Flagstaff currently maintains a .5 debt to equity ratio,then the value of Flagstaff as a levered firm is closest to:

Accepted Answer

A) $114 million 
B) $100 million 
C) $111 million 
D) $140 million 
A) $114 million 
B) $100 million 
C) $111 million 
D) $140 million

Question 14

If Flagstaff currently maintains a .5 debt to equity ratio,then Flagstaff's after-tax WACC is closest to:

Accepted Answer

A) 10.00% 
B) 10.25% 
C) 9.50% 
D) 8.75% 
A) 10.00% 
B) 10.25% 
C) 9.50% 
D) 8.75%

Question 15

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 marginal corporate tax rate is 35% 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

@#IMG-DLM& 
Interest expense = beginning

Question 16

Consider the following formula:
Τ* =  
The term τe is:

Accepted Answer

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

Question 17

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 a 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 a 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 18

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 19

Wyatt Oil has 25 million shares outstanding and has a marginal corporate tax rate of 40%.Wyatt Oil announces that it will payout $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) $0.64 
C) $0.96 
D) $1.56 
A) $0.56 
B) $0.64 
C) $0.96 
D) $1.56

Question 20

IF FBNA increases leverage so that its interest expense rises by $1 million,then the amount its unlevered EBIT will change is closest to:

Accepted Answer

A) $0 
B) -$400,000 
C) $600,000 
D) $400,000 
A) $0 
B) -$400,000 
C) $600,000 
D) $400,000

Exam 15: Debt and Taxes

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

i)If KD can repurchase its existing shares at $20 per share,what will the new share price be after the transaction?

After the recapitalization,the total value of KD as a levered firm is closest to:

Which of the following statements is FALSE?

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

If Flagstaff currently maintains a debt to equity ratio of 1,then the value of Flagstaff as a levered firm is closest to:

Which of the following statements is FALSE?

In 2005,assuming an average dividend payout ratio of 50%,the effective tax rate for equity holders was closest to:

If Flagstaff currently maintains a .5 debt to equity ratio,then the value of Flagstaff as a levered firm is closest to:

If Flagstaff currently maintains a .5 debt to equity ratio,then Flagstaff's after-tax WACC is closest to:

Consider the following formula: Τ* = The term τe is:

Which of the following statements is FALSE?

IF FBNA increases leverage so that its interest expense rises by $1 million,then the amount its unlevered EBIT will change is 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

Filters

Consider the following formula: Τ* = The term τ_e is: