Question 1

Suppose a firm has $80 million of permanent debt.If the tax rate is 35% and the cost of debt is 8%,what is the value of the interest tax shield each year?

Accepted Answer

A) $2.2 million 
B) $6.4 million 
C) $28 million 
D) $80 million 
E) $350 million 
A) $2.2 million 
B) $6.4 million 
C) $28 million 
D) $80 million 
E) $350 million C

Question 2

Suppose a project financed via an issue of debt requires five annual interest payments of $10 million each year.If the tax rate is 30% and the cost of debt is 6%,what is the value of the interest rate tax shield?

Accepted Answer

A) $11.35 million 
B) $12.21 million 
C) $13.20 million 
D) $12.64 million 
E) $15 million 
A) $11.35 million 
B) $12.21 million 
C) $13.20 million 
D) $12.64 million 
E) $15 million D

Question 3

What are some implications of market imperfections?

Accepted Answer

Market frictions such as corporate taxes affect the firm's value to its investors and hence play a critical role in the firm's choice of capital structure.

Question 4

A firm requires an investment of $100,000,financed with $60,000 of equity and the remainder with debt.If the return on equity is 12%,the cost of debt is 4% and the tax rate is 35%,what is the firm's WACC?

Accepted Answer

A) 6.64% 
B) 7.20% 
C) 7.96% 
D) 8.24% 
E) 8.80% 
A) 6.64% 
B) 7.20% 
C) 7.96% 
D) 8.24% 
E) 8.80%

Question 5

Market timing means that managers may sell ________ when they believe the stock is over-valued and rely on ________ when the stock is under-valued.

Accepted Answer

A) debt,shares 
B) debt,preferred stock 
C) new shares,debt 
D) debt,debt 
E) shares,preferred stock 
A) debt,shares 
B) debt,preferred stock 
C) new shares,debt 
D) debt,debt 
E) shares,preferred stock

Question 6

A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 20% equity and 80% debt.If the firm can borrow at 4%,what is the return on levered equity?

Accepted Answer

A) 25% 
B) 21% 
C) 109% 
D) 125% 
E) 33% 
A) 25% 
B) 21% 
C) 109% 
D) 125% 
E) 33%

Question 7

Investment cash flows are independent of financing choices in a:

Accepted Answer

A) market with frictions. 
B) perfect capital market. 
C) setting with frictions in investment returns. 
D) firm with leverage. 
E) firm with no leverage. 
A) market with frictions. 
B) perfect capital market. 
C) setting with frictions in investment returns. 
D) firm with leverage. 
E) firm with no leverage.

Question 8

Equity-debt holder conflicts are more likely to arise if the risk of financial distress is high.

Accepted Answer

A) True 
 B)False

Question 9

MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets.

Accepted Answer

A) earnings after taxes 
B) earnings after interest 
C) cash flows after taxes 
D) free cash flows 
E) earnings after interest and taxes 
A) earnings after taxes 
B) earnings after interest 
C) cash flows after taxes 
D) free cash flows 
E) earnings after interest and taxes

Question 10

How does the interest paid by a firm affect its value to investors?

Accepted Answer

The interest paid by a firm is tax-deduc

Question 11

Equity in a firm with no debt is called unlevered equity.

Accepted Answer

A) True 
 B)False

Question 12

The presence of financial distress costs can explain why firms choose debt levels that are too low to exploit the interest tax shield.

Accepted Answer

A) True 
 B)False

Question 13

A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm can borrow at 7%,what is the return on levered equity?

Accepted Answer

A) 43% 
B) 25% 
C) 18% 
D) 39% 
E) 7% 
A) 43% 
B) 25% 
C) 18% 
D) 39% 
E) 7%

Question 14

A firm requires an investment of $20,000 and borrows $10,000.If the return on equity is 20%,the tax rate is 30%,and the WACC is 12.8%,what is the firm's cost of debt?

Accepted Answer

A) 5.6% 
B) 8% 
C) 18.7% 
D) 13.2% 
E) 14% 
A) 5.6% 
B) 8% 
C) 18.7% 
D) 13.2% 
E) 14%

Question 15

A firm is currently financed with 40% equity and 60% debt.The firm generates perpetual earnings after taxes and interest payments of $2 million per year.The firm's cost of equity is 12%,its cost of debt is 5%,and it has a tax rate of 40%.What is the value of the levered firm?

Accepted Answer

A) $2 million 
B) $30.3 million 
C) $25.6 million 
D) $46.7 million 
E) $10 million 
A) $2 million 
B) $30.3 million 
C) $25.6 million 
D) $46.7 million 
E) $10 million

Question 16

The pecking order hypothesis states that managers will have a preference to fund investment by using ________,followed by ________,and will issue ________ as a last resort.

Accepted Answer

A) debt,equity,retained earnings 
B) retained earnings,equity,debt 
C) retained earnings,debt,equity 
D) debt,retained earnings,equity 
E) equity,retained earnings,debt 
A) debt,equity,retained earnings 
B) retained earnings,equity,debt 
C) retained earnings,debt,equity 
D) debt,retained earnings,equity 
E) equity,retained earnings,debt

Question 17

The relative proportions of debt,equity,and other securities that a firm has outstanding constitute its:

Accepted Answer

A) capital structure. 
B) leverage. 
C) retained earnings. 
D) paid-out capital. 
E) debt-to-value ratio. 
A) capital structure. 
B) leverage. 
C) retained earnings. 
D) paid-out capital. 
E) debt-to-value ratio.

Question 18

Explain why a reduction in leverage that reduces a firm's return on equity (ROE)does not necessarily make an equity investment in the firm less attractive.

Accepted Answer

A high ROE that may be present when a fi

Question 19

How do capital structure choices differ across industries?

Accepted Answer

The average debt-to-value rati

Question 20

A firm requires an investment of $20,000.The firm's debt cost of capital is 5%,and its return on equity is 12%.If the firm's pre-tax WACC is 7.8%,how much equity did the firm use for its investment?

Accepted Answer

A) $8,000 
B) $10,000 
C) $12,000 
D) $14,000 
E) $20,000 
A) $8,000 
B) $10,000 
C) $12,000 
D) $14,000 
E) $20,000

Exam 16: Capital Structure

Suppose a firm has $80 million of permanent debt.If the tax rate is 35% and the cost of debt is 8%,what is the value of the interest tax shield each year?

Suppose a project financed via an issue of debt requires five annual interest payments of $10 million each year.If the tax rate is 30% and the cost of debt is 6%,what is the value of the interest rate tax shield?

What are some implications of market imperfections?

A firm requires an investment of $100,000,financed with $60,000 of equity and the remainder with debt.If the return on equity is 12%,the cost of debt is 4% and the tax rate is 35%,what is the firm's WACC?

Market timing means that managers may sell ________ when they believe the stock is over-valued and rely on ________ when the stock is under-valued.

A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 20% equity and 80% debt.If the firm can borrow at 4%,what is the return on levered equity?

Investment cash flows are independent of financing choices in a:

Equity-debt holder conflicts are more likely to arise if the risk of financial distress is high.

MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets.

How does the interest paid by a firm affect its value to investors?

Equity in a firm with no debt is called unlevered equity.

The presence of financial distress costs can explain why firms choose debt levels that are too low to exploit the interest tax shield.

A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm can borrow at 7%,what is the return on levered equity?

A firm requires an investment of $20,000 and borrows $10,000.If the return on equity is 20%,the tax rate is 30%,and the WACC is 12.8%,what is the firm's cost of debt?

A firm is currently financed with 40% equity and 60% debt.The firm generates perpetual earnings after taxes and interest payments of $2 million per year.The firm's cost of equity is 12%,its cost of debt is 5%,and it has a tax rate of 40%.What is the value of the levered firm?

The pecking order hypothesis states that managers will have a preference to fund investment by using ________,followed by ________,and will issue ________ as a last resort.

The relative proportions of debt,equity,and other securities that a firm has outstanding constitute its:

Explain why a reduction in leverage that reduces a firm's return on equity (ROE)does not necessarily make an equity investment in the firm less attractive.

How do capital structure choices differ across industries?

A firm requires an investment of $20,000.The firm's debt cost of capital is 5%,and its return on equity is 12%.If the firm's pre-tax WACC is 7.8%,how much equity did the firm use for its investment?

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

The Valuation Principle: the Foundation of Financial Decision Making

The Time Value of Money

Interest Rates

Bonds

Valuing Stocks

Investment Decision Rules

Fundamentals of Capital Budgeting

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

Determining the Cost of Capital

Risk and the Pricing of Options

Raising Equity Capital

Debt Financing

Payout Policy

Financial Modelling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Risk Management

International Corporate Finance

Leasing

Mergers and Acquisitions

Corporate Governance

Filters

Market timing means that managers may sell when they believe the stock is over-valued and rely on when the stock is under-valued.

The pecking order hypothesis states that managers will have a preference to fund investment by using ,followed by ,and will issue as a last resort.