Question 1

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. C

Question 2

Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
-If Rosewood had no interest expense,its net income would be closest to:

Accepted Answer

A)  $405 million 
B)  $160 million 
C)  $450 million 
D)  $290 million 
A)  $405 million 
B)  $160 million 
C)  $450 million 
D)  $290 million D

Question 3

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' marginal tax rate is 35% and the firm pays a rate of 8% interest on its debt.
-Assuming that the risk is the same as the loan,the present value of LCMS' interest tax shield is closest to:

Accepted Answer

A)  $45.5 million 
B)  $20.0 million 
C)  $24.5 million 
D)  $35.0 million 
A)  $45.5 million 
B)  $20.0 million 
C)  $24.5 million 
D)  $35.0 million C

Question 4

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ millions):
  
-The total amount available to pay out to all the investors in Kroger in 2006 is closest to:

Accepted Answer

A)  $990 million 
B)  $1,525 million 
C)  $1,500 million 
D)  $2,035 million 
A)  $990 million 
B)  $1,525 million 
C)  $1,500 million 
D)  $2,035 million

Question 5

Use the information for the question(s) below.
Flagstaff Enterprises is 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 is in the 35% corporate tax bracket.
-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 6

Use the information for the question(s) below.
Flagstaff Enterprises is 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 is in the 35% corporate tax bracket.
-If Flagstaff currently maintains a debt to equity ratio of 1,then Flagstaff's after-tax WACC is closest to:

Accepted Answer

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

Question 7

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 Canadian 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 Canadian 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 8

Which of the following statements is false?

Accepted Answer

A)  To determine the benefit of leverage for the value of the firm, we must compute the present value of the stream of future interest tax shields the firm will receive. 
B)  Because the cash flows of the levered firm are equal to the sum of the cash flows from the unlevered firm plus the interest tax shield, by the Law of One Price the same must be true for the present values of these cash flows. 
C)  By increasing the amount paid to debt holders through interest payments, the amount of the pretax cash flows that must be paid as taxes increases. 
D)  When a firm uses debt, the interest tax shield provides a corporate tax benefit each year. 
A)  To determine the benefit of leverage for the value of the firm, we must compute the present value of the stream of future interest tax shields the firm will receive. 
B)  Because the cash flows of the levered firm are equal to the sum of the cash flows from the unlevered firm plus the interest tax shield, by the Law of One Price the same must be true for the present values of these cash flows. 
C)  By increasing the amount paid to debt holders through interest payments, the amount of the pretax cash flows that must be paid as taxes increases. 
D)  When a firm uses debt, the interest tax shield provides a corporate tax benefit each year.

Question 9

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 this amount of debt permanently.
-The value of Shepard Industries with leverage is closest to:

Accepted Answer

A)  $64 million 
B)  $100 million 
C)  $135 million 
D)  $114 million 
A)  $64 million 
B)  $100 million 
C)  $135 million 
D)  $114 million

Question 10

Which of the following statements is false?

Accepted Answer

A)  To determine the true tax benefit of leverage, we need to evaluate the combined effect of both corporate and personal taxes. 
B)  A personal tax disadvantage for debt causes the WACC to decline more slowly with leverage than it otherwise would. 
C)  Personal taxes have an indirect effect on the firm's weighted average cost of capital. 
D)  In Canada and many other countries, capital gains from equity have historically been taxed more heavily than interest income. 
A)  To determine the true tax benefit of leverage, we need to evaluate the combined effect of both corporate and personal taxes. 
B)  A personal tax disadvantage for debt causes the WACC to decline more slowly with leverage than it otherwise would. 
C)  Personal taxes have an indirect effect on the firm's weighted average cost of capital. 
D)  In Canada and many other countries, capital gains from equity have historically been taxed more heavily than interest income.

Question 11

Which of the following statements is false?

Accepted Answer

A)  Even though firms have not issued new equity, the market value of equity has risen over time as firms have grown. 
B)  While firms seem to prefer debt when raising external funds, not all investment is externally funded. 
C)  To receive the full tax benefits of leverage a firm needs to use 100% debt financing. 
D)  If bankruptcy is costly, these costs might offset the tax advantages of debt financing. 
A)  Even though firms have not issued new equity, the market value of equity has risen over time as firms have grown. 
B)  While firms seem to prefer debt when raising external funds, not all investment is externally funded. 
C)  To receive the full tax benefits of leverage a firm needs to use 100% debt financing. 
D)  If bankruptcy is costly, these costs might offset the tax advantages of debt financing.

Question 12

Use the information for the question(s) below.
Flagstaff Enterprises is 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 is in the 35% corporate tax bracket.
-If Flagstaff currently maintains a debt to equity ratio of 1,then the value of Flagstaff's interest tax shield is closest to:

Accepted Answer

A)  $10 million 
B)  $18 million 
C)  $11 million 
D)  $24 million 
A)  $10 million 
B)  $18 million 
C)  $11 million 
D)  $24 million

Question 13

The Government of Canada,in its 2008 budget,proposed a new account called a ________,which would expand the opportunity for Canadians to have investments with no application of personal taxes.

Accepted Answer

A)  Tax-Free Savings Account 
B)  Registered Retirement Saving Plan 
C)  Registered Education Saving Plan 
D)  Registered Income Trust Plan 
A)  Tax-Free Savings Account 
B)  Registered Retirement Saving Plan 
C)  Registered Education Saving Plan 
D)  Registered Income Trust Plan

Question 14

Use the information for the question(s) below.
Flagstaff Enterprises is 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 is in the 35% corporate tax bracket.
-If Flagstaff currently maintains a .5 debt to equity ratio,then the value of Flagstaff's interest tax shield is closest to:

Accepted Answer

A)  $11 million 
B)  $18 million 
C)  $10 million 
D)  $24 million 
A)  $11 million 
B)  $18 million 
C)  $10 million 
D)  $24 million

Question 15

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 a 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 a 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 16

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ millions):
  
-The interest rate tax shield for Kroger in 2004 is closest to:

Accepted Answer

A)  $268 million 
B)  $393 million 
C)  $211 million 
D)  $94 million 
A)  $268 million 
B)  $393 million 
C)  $211 million 
D)  $94 million

Question 17

Which of the following statements regarding recapitalizations is false?

Accepted Answer

A)  With a recapitalization, even though leverage reduces the total value of equity, shareholders capture the benefits of the interest tax shield up front. 
B)  The share price rises after the completion of the recapitalization. 
C)  Leveraged recaps were especially popular in the mid- to late-1980s, when many firms found that these transactions could reduce their tax payments. 
D)  When a firm makes a significant change to its capital structure, the transaction is called a recapitalization. 
A)  With a recapitalization, even though leverage reduces the total value of equity, shareholders capture the benefits of the interest tax shield up front. 
B)  The share price rises after the completion of the recapitalization. 
C)  Leveraged recaps were especially popular in the mid- to late-1980s, when many firms found that these transactions could reduce their tax payments. 
D)  When a firm makes a significant change to its capital structure, the transaction is called a recapitalization.

Question 18

Use the information for the question(s) below.
Flagstaff Enterprises is 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 is in the 35% corporate tax bracket.
-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 19

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

Accepted Answer

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

Question 20

Which of the following statements is false?

Accepted Answer

A)  Over the past 43-year period, Canadian corporations issued, on average, $19.9 billion of debt per year compared to $13.3 billion of equity per year. 
B)  Over the past 43 years, the tendency to use debt instead of equity is more pronounced but there are some notable exceptions. 
C)  Over the past 43-year period, Canadian corporations issued, on average, more equity per year than debt per year. 
D)  While firms seem to prefer debt when raising external funds, not all investment is externally funded. 
A)  Over the past 43-year period, Canadian corporations issued, on average, $19.9 billion of debt per year compared to $13.3 billion of equity per year. 
B)  Over the past 43 years, the tendency to use debt instead of equity is more pronounced but there are some notable exceptions. 
C)  Over the past 43-year period, Canadian corporations issued, on average, more equity per year than debt per year. 
D)  While firms seem to prefer debt when raising external funds, not all investment is externally funded.

Exam 18: Debt and Taxes

Which of the following statements is false?

Use the information for the question(s) below. Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%. -If Rosewood had no interest expense,its net income would be closest to:

Use the table for the question(s) below. Consider the following income statement for Kroger Inc. (all figures in $ millions): -The total amount available to pay out to all the investors in Kroger in 2006 is closest to:

Which of the following statements is false?

Which of the following statements is false?

Which of the following statements is false?

Which of the following statements is false?

The Government of Canada,in its 2008 budget,proposed a new account called a ________,which would expand the opportunity for Canadians to have investments with no application of personal taxes.

Which of the following statements is false?

Use the table for the question(s) below. Consider the following income statement for Kroger Inc. (all figures in $ millions): -The interest rate tax shield for Kroger in 2004 is closest to:

Which of the following statements regarding recapitalizations is false?

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

Which of the following statements is false?

The Corporation

Introduction to Financial Statement Analysis

Arbitrage and Financial Decision Making

The Time Value of Money

Interest Rates

Valuing Bonds

Valuing Stocks

Investment Decision Rules

Fundamentals of Capital Budgeting

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behaviour and Capital Market Efficiency

Financial Options

Option Valuation

Real Options

Capital Structure in a Perfect Market

Financial Distress, managerial Incentives, and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modelling: a Case Study

The Mechanics of 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: V_L = V_U + τ_cD The term τ_cD represents