Question 1

Which of the following is one of the characteristics of perfect capital markets?

Accepted Answer

A) All investors hold the efficient portfolio of assets. 
B) There are no taxes,but there may be transaction costs associated with security trading. 
C) A firm's financing decisions may change the cash flows generated by its investments. 
D) Investors and firms can trade the same set of securities at competitive market prices equal to the present value (PV)of their future cash flows. 
E) No market participants engage in illegal behaviour. 
A) All investors hold the efficient portfolio of assets. 
B) There are no taxes,but there may be transaction costs associated with security trading. 
C) A firm's financing decisions may change the cash flows generated by its investments. 
D) Investors and firms can trade the same set of securities at competitive market prices equal to the present value (PV)of their future cash flows. 
E) No market participants engage in illegal behaviour.

Question 2

The presence of leverage can influence the behaviour of the managers of a firm.

Accepted Answer

A) True 
 B)False

Question 3

With perfect capital markets,what is the market price per share of Luther's stock after the share repurchase?

Accepted Answer

A) $25 
B) $24 
C) $15 
D) $20 
E) $18 
A) $25 
B) $24 
C) $15 
D) $20 
E) $18

Question 4

Even if two firms operate in the same industry,they may prefer different choices of debt-equity ratios.

Accepted Answer

A) True 
 B)False

Question 5

Suppose a firm has $50 million of permanent debt.If the tax rate is 25% and the cost of debt is 7%,what is the value of the interest tax shield each year?

Accepted Answer

A) $3.5 million 
B) $50 million 
C) $0.875 million 
D) $178.6 million 
E) $12.5 million 
A) $3.5 million 
B) $50 million 
C) $0.875 million 
D) $178.6 million 
E) $12.5 million

Question 6

Suppose Blank Company has only one project,as forecast above,and an unlevered cost of equity of 8%.If the company uses no leverage,what is expected return to equity holders?

Accepted Answer

A) 8.0% 
B) 11.6% 
C) 9.33% 
D) 30.0% 
E) 33.3% 
A) 8.0% 
B) 11.6% 
C) 9.33% 
D) 30.0% 
E) 33.3%

Question 7

The tradeoff theory of optimal capital structure weighs the benefits of debt against the costs of:

Accepted Answer

A) financial distress. 
B) interest payments. 
C) dividend reinvestment. 
D) input factors. 
E) equity. 
A) financial distress. 
B) interest payments. 
C) dividend reinvestment. 
D) input factors. 
E) equity.

Question 8

When a firm's investment decisions have different consequences for the value of equity and the value of debt,managers may take actions:

Accepted Answer

A) to increase debt values. 
B) to decrease costs of distress. 
C) that benefit shareholders at the expense of debt holders. 
D) that benefit debt holders at the expense of shareholders. 
E) to reduce fixed costs. 
A) to increase debt values. 
B) to decrease costs of distress. 
C) that benefit shareholders at the expense of debt holders. 
D) that benefit debt holders at the expense of shareholders. 
E) to reduce fixed costs.

Question 9

A firm has a market value of assets of $50,000.It borrows $10,000 at 5%.If the unlevered cost of equity is 15%,what is the firm's cost of equity capital?

Accepted Answer

A) 15% 
B) 17.5% 
C) 18.5% 
D) 19.2% 
E) 20.6% 
A) 15% 
B) 17.5% 
C) 18.5% 
D) 19.2% 
E) 20.6%

Question 10

After the repurchase,how many shares will Luther have outstanding?

Accepted Answer

A) 0.75 billion 
B) 1.0 billion 
C) 1.1 billion 
D) 1.2 billion 
E) 1.25 billion 
A) 0.75 billion 
B) 1.0 billion 
C) 1.1 billion 
D) 1.2 billion 
E) 1.25 billion

Question 11

A new business will generate a one-time cash flow of $20,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm's unlevered equity cost of capital is 10%,what is the levered value of the firm with perfect capital markets?

Accepted Answer

A) $18,182 
B) $20,000 
C) $19,000 
D) $22,000 
E) $18,000 
A) $18,182 
B) $20,000 
C) $19,000 
D) $22,000 
E) $18,000

Question 12

Suppose a project financed via an issue of debt requires six annual interest payments of $20 million each year.If the cost of debt is 8%,and the present value of the interest rate tax shield is $27.74 million,what is the firm's tax rate?

Accepted Answer

A) 25% 
B) 30% 
C) 33% 
D) 35% 
E) 40% 
A) 25% 
B) 30% 
C) 33% 
D) 35% 
E) 40%

Question 13

As the level of debt increases,the tax benefits of debt increase until:

Accepted Answer

A) interest costs exceed dividend payments. 
B) the tax shield benefit exceeds distress costs. 
C) raw material costs exceed dividend payments. 
D) employee costs exceed interest expense. 
E) the firm decides to issue more equity. 
A) interest costs exceed dividend payments. 
B) the tax shield benefit exceeds distress costs. 
C) raw material costs exceed dividend payments. 
D) employee costs exceed interest expense. 
E) the firm decides to issue more equity.

Question 14

What are indirect costs of financial distress?

Accepted Answer

Indirect costs of financial di

Question 15

One of the factors that determines the present value (PV)of financial distress costs is:

Accepted Answer

A) costs of unpaid interest arrears. 
B) loss of dividend payments. 
C) probability of financial distress. 
D) employee compensation. 
E) size of the interest tax shield. 
A) costs of unpaid interest arrears. 
B) loss of dividend payments. 
C) probability of financial distress. 
D) employee compensation. 
E) size of the interest tax shield.

Question 16

A firm requires an investment of $30,000 and borrows $10,000 at 6%.If the return on equity is 15%,what is the firm's pre tax WACC?

Accepted Answer

A) 14% 
B) 13% 
C) 12% 
D) 11% 
E) 10.5% 
A) 14% 
B) 13% 
C) 12% 
D) 11% 
E) 10.5%

Question 17

The market value of Luther's non-cash assets is closest to:

Accepted Answer

A) $20 billion 
B) $19 billion 
C) $25 billion 
D) $24 billion 
E) $30 billion 
A) $20 billion 
B) $19 billion 
C) $25 billion 
D) $24 billion 
E) $30 billion

Question 18

Agency costs arise when:

Accepted Answer

A) there are high labour costs. 
B) input costs are higher than interest costs. 
C) interest costs exceed dividend payments. 
D) conflicts of interest exist between stakeholders. 
E) a firm becomes financially distressed. 
A) there are high labour costs. 
B) input costs are higher than interest costs. 
C) interest costs exceed dividend payments. 
D) conflicts of interest exist between stakeholders. 
E) a firm becomes financially distressed.

Question 19

A firm is currently financed with 50% equity and 50% debt.The firm generates perpetual earnings after taxes and interest rates of $10 million per year.The firm's cost of equity is 14%,its cost of debt is 7%,and it has a tax rate of 30%.What is the value of the levered firm?

Accepted Answer

A) $10 million 
B) $73 million 
C) $105.8 million 
D) $173.5 million 
E) $100 million 
A) $10 million 
B) $73 million 
C) $105.8 million 
D) $173.5 million 
E) $100 million

Question 20

When investors use leverage in their own portfolios to adjust the leverage choice made by the firm,it is referred to as:

Accepted Answer

A) outside debt. 
B) retained earnings. 
C) homemade leverage. 
D) payout ratio. 
E) portfolio rebalancing. 
A) outside debt. 
B) retained earnings. 
C) homemade leverage. 
D) payout ratio. 
E) portfolio rebalancing.

Exam 16: Capital Structure

Which of the following is one of the characteristics of perfect capital markets?

The presence of leverage can influence the behaviour of the managers of a firm.

With perfect capital markets,what is the market price per share of Luther's stock after the share repurchase?

Even if two firms operate in the same industry,they may prefer different choices of debt-equity ratios.

Suppose a firm has $50 million of permanent debt.If the tax rate is 25% and the cost of debt is 7%,what is the value of the interest tax shield each year?

Suppose Blank Company has only one project,as forecast above,and an unlevered cost of equity of 8%.If the company uses no leverage,what is expected return to equity holders?

The tradeoff theory of optimal capital structure weighs the benefits of debt against the costs of:

When a firm's investment decisions have different consequences for the value of equity and the value of debt,managers may take actions:

A firm has a market value of assets of $50,000.It borrows $10,000 at 5%.If the unlevered cost of equity is 15%,what is the firm's cost of equity capital?

After the repurchase,how many shares will Luther have outstanding?

A new business will generate a one-time cash flow of $20,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm's unlevered equity cost of capital is 10%,what is the levered value of the firm with perfect capital markets?

Suppose a project financed via an issue of debt requires six annual interest payments of $20 million each year.If the cost of debt is 8%,and the present value of the interest rate tax shield is $27.74 million,what is the firm's tax rate?

As the level of debt increases,the tax benefits of debt increase until:

What are indirect costs of financial distress?

One of the factors that determines the present value (PV)of financial distress costs is:

A firm requires an investment of $30,000 and borrows $10,000 at 6%.If the return on equity is 15%,what is the firm's pre tax WACC?

The market value of Luther's non-cash assets is closest to:

Agency costs arise when:

A firm is currently financed with 50% equity and 50% debt.The firm generates perpetual earnings after taxes and interest rates of $10 million per year.The firm's cost of equity is 14%,its cost of debt is 7%,and it has a tax rate of 30%.What is the value of the levered firm?

When investors use leverage in their own portfolios to adjust the leverage choice made by the firm,it is referred to as:

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