Exam 16: Assessing Long-Term Debt, equity, and Capital Structure

Your company doesn't face any taxes and has $300 million in assets,currently financed entirely with equity.Equity is worth $10 per share,and book value of equity is equal to market value of equity.Also,let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year,with the possible values of EBIT and their associated probabilities shown as follows: The firm is considering switching to a 30 percent debt capital structure,and has determined that they would have to pay a 9 percent yield on perpetual debt in either event.What will be the break-even EBIT?

Explain how Irving Fisher's separation principle addresses the question of what will happen to a firm's WACC in M&Ms perfect world as the capital structure changes.

A firm faces a 30 percent tax rate and has $200m in assets,currently financed entirely with equity.Equity is worth $10 per share,and book value of equity is equal to market value of equity.Also,let's assume that the firm's expected EBIT is $10m.The firm is considering switching to a 25 percent debt capital structure,and has determined that they would have to pay a 10 percent yield on perpetual debt.What will be the firm's new ROE if they switch to the proposed capital structure?

Which of the following is a true statement?

Your company doesn't face any taxes and has $750 million in assets,currently financed entirely with equity.Equity is worth $25 per share,and book value of equity is equal to market value of equity.Also,let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year,with the possible values of EBIT and their associated probabilities shown as follows: The firm is considering switching to a 25 percent debt capital structure,and has determined that they would have to pay a 10 percent yield on perpetual debt in either event.What will be the break-even level of EBIT?

Explain why,in a world with both corporate taxes and the chance of bankruptcy,a small firm with volatile EBIT is unlikely to have much debt?

Explain how passive capital structure management works.

Which of the following is incorrect with respect to leverage buyouts (LBOs)?

An all-equity financed firm has $650 in assets and the stock price is $20.If the firm restructures with 40 percent debt which creates interest expense of $17 per year and the firm's tax rate is 40 percent,what is the break-even EBIT?

We use the term leverage to describe the use of debt in the firm' capital structure because:

A situation that arises when a firm's equity is close to worthless,and equity holders will prefer to invest in overly risky projects with a small chance of success rather than simply paying debt holders their regularly schedule payments is referred to as:

Which strategy-active or passive capital structure management-would make the process of changing the firm's capital structure a longer-term proposition? Why?

Which of the following is a true statement regarding Proposition I?

All else the same,firms with stable,predictable income streams will able to:

Your company has a 40 percent tax rate and has $750 million in assets,currently financed entirely with equity.Equity is worth $50 per share,and book value of equity is equal to market value of equity.Also,let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year,with the possible values of EBIT and their associated probabilities shown follows: The firm is considering switching to a 30 percent debt capital structure,and has determined that they would have to pay a 9 percent yield on perpetual debt in either event.What will be the standard deviation in EPS if they switch to the proposed capital structure?

The mix of debt and equity that a firm uses to finance its operations is known as:

Your company doesn't face any taxes and has $750 million in assets,currently financed entirely with equity.Equity is worth $50 per share,and book value of equity is equal to market value of equity.Also,let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year,with the possible values of EBIT and their associated probabilities shown as follows: The firm is considering switching to a 30 percent debt capital structure,and has determined that they would have to pay a 9 percent yield on perpetual debt in either event.What will be the standard deviation in EPS if they switch to the proposed capital structure?

A firm faces a 30 percent tax rate and has $500m in assets,currently financed entirely with equity.Equity is worth $100 per share,and book value of equity is equal to market value of equity.Also,let's assume that the firm's expected EBIT is $60m.The firm is considering switching to a 25 percent debt capital structure,and has determined that they would have to pay a 10 percent yield on perpetual debt.How much will ROE change if they switch to the proposed capital structure?

All else the same,firms facing relatively high tax rates should:

If the U.S.government increased the corporate tax rates: