Question 1

The direct costs of bankruptcy are estimated to be far greater,as a percent of assets,than the indirect costs of bankruptcy.

Accepted Answer

A) True 
 B)False

Question 2

What effect does debt have on a firm's weighted average cost of capital?

Accepted Answer

In a world with taxes,debt pro

Question 3

When firms generate sufficient cash to fund their investments and choose not to issue debt or equity,instead relying on retained earnings,this is an example of:

Accepted Answer

A) market timing. 
B) adverse selection. 
C) the pecking order hypothesis. 
D) the agency cost of debt. 
E) the signalling theory of debt. 
A) market timing. 
B) adverse selection. 
C) the pecking order hypothesis. 
D) the agency cost of debt. 
E) the signalling theory of debt.

Question 4

Issuing debt provides incentives for managers to run the firm efficiently because:

Accepted Answer

A) debt increases the funds available to managers to run the firm. 
B) ownership may remain more concentrated,improving monitoring of management. 
C) managers may take actions that benefit shareholders but harm creditors and lower the value of the firm. 
D) shareholders prefer to decline new projects to save cash,even if their NPVs are positive. 
E) managers will be obligated to run the firm in the interests of bondholders. 
A) debt increases the funds available to managers to run the firm. 
B) ownership may remain more concentrated,improving monitoring of management. 
C) managers may take actions that benefit shareholders but harm creditors and lower the value of the firm. 
D) shareholders prefer to decline new projects to save cash,even if their NPVs are positive. 
E) managers will be obligated to run the firm in the interests of bondholders.

Question 5

What considerations should managers have while deciding on their capital structure?

Accepted Answer

Managers should first take a look at the

Question 6

Under perfect capital markets,which of the following statements is regarding capital structure is most accurate?

Accepted Answer

A) As long as the firm's choice of securities does not change the cash flows generated by its assets,the capital structure decision will not change the total value of the firm or the amount of capital it can raise. 
B) If securities are fairly priced,then buying or selling securities has a positive net present value (NPV)and will,therefore,change the value of a firm. 
C) The future repayments that the firm must make on its debt are larger than the amount of the loan it receives up front. 
D) An investor who would like more leverage than the firm has chosen can lend and add leverage to his or her own portfolio. 
E) The firm can increase debt levels to increase firm value. 
A) As long as the firm's choice of securities does not change the cash flows generated by its assets,the capital structure decision will not change the total value of the firm or the amount of capital it can raise. 
B) If securities are fairly priced,then buying or selling securities has a positive net present value (NPV)and will,therefore,change the value of a firm. 
C) The future repayments that the firm must make on its debt are larger than the amount of the loan it receives up front. 
D) An investor who would like more leverage than the firm has chosen can lend and add leverage to his or her own portfolio. 
E) The firm can increase debt levels to increase firm value.

Question 7

Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as With.You have $5000 of your own money to invest and you plan on buying With stock.Using homemade (un)leverage,how much do you need to invest at the risk-free rate so that the payoff of your account will be the same as a $5000 investment in Without stock?

Accepted Answer

A) $5000 
B) $0 
C) $2500 
D) $4000 
E) -$5000 (borrow $5000) 
A) $5000 
B) $0 
C) $2500 
D) $4000 
E) -$5000 (borrow $5000)

Question 8

With perfect capital markets,because different choices of capital structure offer a benefit to investors,they affect the value of the firm.

Accepted Answer

A) True 
 B)False

Question 9

According to MM Proposition I,the stock price for With is closest to:

Accepted Answer

A) $8.00 
B) $24.00 
C) $6.00 
D) $12.00 
E) $18.00 
A) $8.00 
B) $24.00 
C) $6.00 
D) $12.00 
E) $18.00

Question 10

The tradeoff theory suggests:

Accepted Answer

A) the firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress. 
B) with higher costs of financial distress,it is optimal for the firm to choose higher leverage. 
C) differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries. 
D) there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield. 
E) the firm should choose a debt level where the cost of debt is equal to the cost of equity. 
A) the firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress. 
B) with higher costs of financial distress,it is optimal for the firm to choose higher leverage. 
C) differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries. 
D) there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield. 
E) the firm should choose a debt level where the cost of debt is equal to the cost of equity.

Question 11

An unlevered firm currently has a value of $15 million.The firm has a tax rate of 40%.The firm wishes to replace $5 million of its equity with $5 million of permanent debt.By increasing its leverage,the PV of the expected costs of financial distress would rise from 0 to $1 million.What is the value of the levered firm if it goes ahead with this plan?

Accepted Answer

A) $10 million 
B) $14 million 
C) $15 million 
D) $16 million 
E) $20 million 
A) $10 million 
B) $14 million 
C) $15 million 
D) $16 million 
E) $20 million

Question 12

A firm has a market value of assets of $50,000.It borrows $10,000 at 3%.If the unlevered cost of equity is 15%,what is the firm's cost of equity capital?

Accepted Answer

A) 15% 
B) 16% 
C) 17% 
D) 18% 
E) 19% 
A) 15% 
B) 16% 
C) 17% 
D) 18% 
E) 19%

Question 13

An unlevered firm currently has a value of $40 million.The firm has a tax rate of 40%.The firm wishes to replace $10 million of its equity with $10 million of permanent debt.What is the value of the levered firm if it goes ahead with this plan?

Accepted Answer

A) $42 million 
B) $50 million 
C) $40 million 
D) $44 million 
E) $45 million 
A) $42 million 
B) $50 million 
C) $40 million 
D) $44 million 
E) $45 million

Question 14

A firm requires an investment of $30,000 and borrows $20,000 at 7%.If the return on equity is 15% and the tax rate is 30%,what is the firm's WACC?

Accepted Answer

A) 8.27% 
B) 9.13% 
C) 10.4% 
D) 8.91% 
E) 9.67% 
A) 8.27% 
B) 9.13% 
C) 10.4% 
D) 8.91% 
E) 9.67%

Question 15

Assume that in addition to 1.25 billion common shares outstanding,Luther has stock options given to employees valued at $2 billion.The market value of Luther's non-cash assets is closest to:

Accepted Answer

A) $22 billion 
B) $20 billion 
C) $25 billion 
D) $18 billion 
E) $27 billion 
A) $22 billion 
B) $20 billion 
C) $25 billion 
D) $18 billion 
E) $27 billion

Question 16

We discount the cash flows of a levered firm with a different discount rate than the cost of equity of the unlevered firm because:

Accepted Answer

A) leverage decreases the risk of equity of the firm. 
B) leverage changes the unlevered cost of equity. 
C) leverage increases the risk of equity of the firm. 
D) cost of debt decreases in this setting. 
E) default risk increases. 
A) leverage decreases the risk of equity of the firm. 
B) leverage changes the unlevered cost of equity. 
C) leverage increases the risk of equity of the firm. 
D) cost of debt decreases in this setting. 
E) default risk increases.

Question 17

An unlevered firm currently has a value of $100 million.The firm has a tax rate of 30%.The firm wishes to replace $50 million of its equity with $50 million of permanent debt.By increasing its leverage,the PV of the expected costs of financial distress would rise from 0 to $10 million.What is the value of the levered firm if it goes ahead with this plan?

Accepted Answer

A) $105 million 
B) $115 million 
C) $100 million 
D) $125 million 
E) $110 million 
A) $105 million 
B) $115 million 
C) $100 million 
D) $125 million 
E) $110 million

Question 18

A firm requires an investment of $30,000 and borrows $10,000 at 6%.If the tax rate is 30%,and the firm's WACC is 11.4%,what is the firm's cost of equity?

Accepted Answer

A) 15% 
B) 14.1% 
C) 5.4% 
D) 17.4% 
E) 15.6% 
A) 15% 
B) 14.1% 
C) 5.4% 
D) 17.4% 
E) 15.6%

Question 19

In general,the gain to investors from the tax deductibility of interest payments is referred to as the interest rate tax shield.

Accepted Answer

A) True 
 B)False

Question 20

Managers should make use of the interest tax shield if the firm has:

Accepted Answer

A) consistent taxable income. 
B) volatility in taxable income. 
C) consistent dividend payments. 
D) low tax rates. 
E) many tangible assets. 
A) consistent taxable income. 
B) volatility in taxable income. 
C) consistent dividend payments. 
D) low tax rates. 
E) many tangible assets.

Exam 16: Capital Structure

The direct costs of bankruptcy are estimated to be far greater,as a percent of assets,than the indirect costs of bankruptcy.

What effect does debt have on a firm's weighted average cost of capital?

When firms generate sufficient cash to fund their investments and choose not to issue debt or equity,instead relying on retained earnings,this is an example of:

Issuing debt provides incentives for managers to run the firm efficiently because:

What considerations should managers have while deciding on their capital structure?

Under perfect capital markets,which of the following statements is regarding capital structure is most accurate?

With perfect capital markets,because different choices of capital structure offer a benefit to investors,they affect the value of the firm.

According to MM Proposition I,the stock price for With is closest to:

The tradeoff theory suggests:

A firm has a market value of assets of $50,000.It borrows $10,000 at 3%.If the unlevered cost of equity is 15%,what is the firm's cost of equity capital?

An unlevered firm currently has a value of $40 million.The firm has a tax rate of 40%.The firm wishes to replace $10 million of its equity with $10 million of permanent debt.What is the value of the levered firm if it goes ahead with this plan?

A firm requires an investment of $30,000 and borrows $20,000 at 7%.If the return on equity is 15% and the tax rate is 30%,what is the firm's WACC?

Assume that in addition to 1.25 billion common shares outstanding,Luther has stock options given to employees valued at $2 billion.The market value of Luther's non-cash assets is closest to:

We discount the cash flows of a levered firm with a different discount rate than the cost of equity of the unlevered firm because:

A firm requires an investment of $30,000 and borrows $10,000 at 6%.If the tax rate is 30%,and the firm's WACC is 11.4%,what is the firm's cost of equity?

In general,the gain to investors from the tax deductibility of interest payments is referred to as the interest rate tax shield.

Managers should make use of the interest tax shield if the firm has:

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