Question 1

Which of the following equations is incorrect?

Accepted Answer

A)  VL = VU +   
B)  VL = VU + τcD 
C)  rwacc =   rE +
  rD -
  rDτc 
D)  rwacc =   rE +
  rD(1 + τc) 
A)  VL = VU +   
B)  VL = VU + τcD 
C)  rwacc =   rE +
  rD -
  rDτc 
D)  rwacc =   rE +
  rD(1 + τc)

Question 2

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 of the tax shield is only 6% even though the loan pays 8%,then the present value of LCMS' interest tax shield is closest to:

Accepted Answer

A)  $24.5 million 
B)  $18.0 million 
C)  $33.0 million 
D)  $20.0 million 
A)  $24.5 million 
B)  $18.0 million 
C)  $33.0 million 
D)  $20.0 million

Question 3

Use the information for the question(s) below.
KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt. KD has had consistently stable earnings, and pays a 15% tax rate. Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
-The value of KD's unlevered equity is closest to:

Accepted Answer

A)  $600 million 
B)  $470 million 
C)  $390 million 
D)  $400 million 
A)  $600 million 
B)  $470 million 
C)  $390 million 
D)  $400 million

Question 4

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 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 5

When securities are ________,the original shareholders of a firm capture the full benefit of the interest tax shield from an increase in leverage.

Accepted Answer

A)  overpriced 
B)  underpriced 
C)  fairly priced 
D)  best priced 
A)  overpriced 
B)  underpriced 
C)  fairly priced 
D)  best priced

Question 6

The value of a firm is the total amount it can raise from ________.

Accepted Answer

A)  all investors 
B)  creditors 
C)  shareholders 
D)  stakeholders 
A)  all investors 
B)  creditors 
C)  shareholders 
D)  stakeholders

Question 7

Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and free cash flow of $27 million. FBNA's marginal corporate tax rate is 40%.
-IF FBNA increases leverage so that its interest expense rises by $1 million,then the amount its net income will change is closest to:

Accepted Answer

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

Question 8

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.
-LCMS' annual interest tax shield is closest to:

Accepted Answer

A)  $2.8 million 
B)  $2.0 million 
C)  $3.6 million 
D)  $5.6 million 
A)  $2.8 million 
B)  $2.0 million 
C)  $3.6 million 
D)  $5.6 million

Question 9

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 10

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 an all equity firm would be closest to:

Accepted Answer

A)  $73 million 
B)  $80 million 
C)  $115 million 
D)  $100 million 
A)  $73 million 
B)  $80 million 
C)  $115 million 
D)  $100 million

Question 11

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 2005 is closest to:

Accepted Answer

A)  $362 million 
B)  $36 million 
C)  $102 million 
D)  $195 million 
A)  $362 million 
B)  $36 million 
C)  $102 million 
D)  $195 million

Question 12

In Canada and many other countries,interest income has historically been taxed ________ dividends or capital gains from equity.

Accepted Answer

A)  equally to 
B)  less heavily than 
C)  more heavily than 
D)  more deliberately than 
A)  equally to 
B)  less heavily than 
C)  more heavily than 
D)  more deliberately than

Question 13

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.
-Raceway Products has a market debt-to-equity ratio of .60,a corporate tax rate of 40%,and pays 8% interest on its debt.The interest tax shield on Raceway's debt lowers its WACC by what amount?

Accepted Answer

Use the formula r_wacc = @#IMG-DLM& r_E + @#IMG-DLM& r_D -

Question 14

After the recapitalization,the value of a share of KD's stock is closest to:

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

Question 15

Which of the following statements is false?

Accepted Answer

A)  The higher the firm's leverage, the more the firm exploits the tax advantage of debt, and the lower its WACC. 
B)  Corporate taxes lower the effective cost of debt financing, which translates into a reduction in the weighted average cost of capital. 
C)  Because the firm's free cash flow is computed without considering the firm's leverage, we account for the benefit of the interest tax shield by calculating the WACC using the before-tax cost of debt. 
D)  The reduction in the WACC increases with the amount of debt financing. 
A)  The higher the firm's leverage, the more the firm exploits the tax advantage of debt, and the lower its WACC. 
B)  Corporate taxes lower the effective cost of debt financing, which translates into a reduction in the weighted average cost of capital. 
C)  Because the firm's free cash flow is computed without considering the firm's leverage, we account for the benefit of the interest tax shield by calculating the WACC using the before-tax cost of debt. 
D)  The reduction in the WACC increases with the amount of debt financing.

Question 16

Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and free cash flow of $27 million. FBNA's marginal corporate tax rate is 40%.
-IF FBNA increases leverage so that its interest expense rises by $1 million,then the amount its free cash flow will change is closest to:

Accepted Answer

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

Question 17

Which of the following statements is false?

Accepted Answer

A)  A biotech firm might be developing drugs with tremendous potential, but it has yet to receive any revenue from these drugs. Such a firm will not have taxable earnings. In that case, a tax-optimal capital structure does not include debt. 
B)  No corporate tax benefit arises from incurring interest payments that regularly exceed EBIT. 
C)  The optimal level of leverage from a tax-saving perspective is a level where interest equals EBIT. 
D)  In general, as a firm's interest expense approaches its expected taxable earnings, the marginal tax advantage of debt increases, limiting the amount of equity the firm should use. 
A)  A biotech firm might be developing drugs with tremendous potential, but it has yet to receive any revenue from these drugs. Such a firm will not have taxable earnings. In that case, a tax-optimal capital structure does not include debt. 
B)  No corporate tax benefit arises from incurring interest payments that regularly exceed EBIT. 
C)  The optimal level of leverage from a tax-saving perspective is a level where interest equals EBIT. 
D)  In general, as a firm's interest expense approaches its expected taxable earnings, the marginal tax advantage of debt increases, limiting the amount of equity the firm should use.

Question 18

Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and free cash flow of $27 million. FBNA's marginal corporate tax rate is 40%.
-FBNA's EBIT is closest to:

Accepted Answer

A)  $43 million 
B)  $40 million 
C)  $45 million 
D)  $60 million 
A)  $43 million 
B)  $40 million 
C)  $45 million 
D)  $60 million

Question 19

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%.
-The total of Rosewood's net income and interest payments is closest to:

Accepted Answer

A)  $270 million 
B)  $355 million 
C)  $290 million 
D)  $450 million 
A)  $270 million 
B)  $355 million 
C)  $290 million 
D)  $450 million

Question 20

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

Accepted Answer

A)  10.5% 
B)  11.0% 
C)  9.0% 
D)  10.0% 
A)  10.5% 
B)  11.0% 
C)  9.0% 
D)  10.0%

Exam 18: Debt and Taxes

Which of the following equations is incorrect?

When securities are ________,the original shareholders of a firm capture the full benefit of the interest tax shield from an increase in leverage.

The value of a firm is the total amount it can raise from ________.

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

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 2005 is closest to:

In Canada and many other countries,interest income has historically been taxed ________ dividends or capital gains from equity.

After the recapitalization,the value of a share of KD's stock is closest to:

Which of the following statements is false?

Which of the following statements is false?

Use the information for the question(s) below. Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and free cash flow of $27 million. FBNA's marginal corporate tax rate is 40%. -FBNA's EBIT is closest to:

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%. -The total of Rosewood's net income and interest payments is closest to:

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

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