Question 1

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

Accepted Answer

The interest paid by a firm is tax-deductible and is referred to as interest tax shield. This is the additional amount that a firm would have paid in taxes if it did not have any debt in its capital structure.

Question 2

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

Accepted Answer

A) True 
 B)False  True

Question 3

A firm requires an investment of $30,000 and borrows $15,000 at 7%. If the return on equity is 19%, what is the firm's pretax WACC?

Accepted Answer

A)  13% 
B)  6.5% 
C)  15.6% 
D)  18.2% 
A)  13% 
B)  6.5% 
C)  15.6% 
D)  18.2% A

Question 4

Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share.
-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 
A)  $20 billion 
B)  $19 billion 
C)  $25 billion 
D)  $24 billion

Question 5

Which of the following statements is FALSE?

Accepted Answer

A)  When a firm borrows significant money to repurchase shares or pay a large cash dividend, the transaction is called a leveraged recapitalization. 
B)  MM Proposition I applies to capital structure decisions made at any time during the life of a firm. 
C)  By choosing positive-NPV projects that are worth more than their initial investment, a firm can enhance its value. 
D)  The choice of capital structure does not change the value of a firm if the cost of equity is higher than the cost of debt. 
A)  When a firm borrows significant money to repurchase shares or pay a large cash dividend, the transaction is called a leveraged recapitalization. 
B)  MM Proposition I applies to capital structure decisions made at any time during the life of a firm. 
C)  By choosing positive-NPV projects that are worth more than their initial investment, a firm can enhance its value. 
D)  The choice of capital structure does not change the value of a firm if the cost of equity is higher than the cost of debt.

Question 6

Managers should make use of the interest tax shield if a firm has ________.

Accepted Answer

A)  consistent taxable income 
B)  volatility in taxable income 
C)  consistent dividend payments 
D)  low tax rates 
A)  consistent taxable income 
B)  volatility in taxable income 
C)  consistent dividend payments 
D)  low tax rates

Question 7

Suppose a project financed via an issue of debt requires six annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 8%, what is the value of the interest rate tax shield?

Accepted Answer

A)  $23.30 million 
B)  $29.12 million 
C)  $34.95 million 
D)  $58.25 million 
A)  $23.30 million 
B)  $29.12 million 
C)  $34.95 million 
D)  $58.25 million

Question 8

What are the issues in determining the present value (PV) of financial distress?

Accepted Answer

Calculating the precise present value (P

Question 9

The presence of a large amount of debt can encourage shareholders to take excessive risk because ________.

Accepted Answer

A)  equity holders are risk seeking by nature 
B)  the costs of failure are borne largely by debt holders 
C)  debt holders are risk seeking 
D)  firm value increases with risk taking 
A)  equity holders are risk seeking by nature 
B)  the costs of failure are borne largely by debt holders 
C)  debt holders are risk seeking 
D)  firm value increases with risk taking

Question 10

A firm has a market value of equity of $40,000. It borrows $8000 at 7%. If the unlevered cost of equity is 16%, what is the firm's cost of equity capital?

Accepted Answer

A)  8.9% 
B)  21.4% 
C)  17.8% 
D)  24.9% 
A)  8.9% 
B)  21.4% 
C)  17.8% 
D)  24.9%

Question 11

Consider the following equation for the question(s) below.
  
-The A in the equation above represents ________.

Accepted Answer

A)  the value of the firm's debt 
B)  the market value of the firm's assets 
C)  the value of the firm's equity 
D)  the value of the firm's unlevered equity 
A)  the value of the firm's debt 
B)  the market value of the firm's assets 
C)  the value of the firm's equity 
D)  the value of the firm's unlevered equity

Question 12

A firm requires an investment of $25,000 and will return $36,500 after 1 year. If the firm borrows $20,000 at 7%, what is the return on levered equity?

Accepted Answer

A)  162% 
B)  202% 
C)  242% 
D)  283% 
A)  162% 
B)  202% 
C)  242% 
D)  283%

Question 13

Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share.
-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 
A)  0.75 billion 
B)  1.0 billion 
C)  1.1 billion 
D)  1.2 billion

Question 14

Use the information for the question(s) below.
Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at an interest rate of 5%.
-Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as Firm X. You have $5,000 of your own money to invest and you plan on buying Firm Y stock. Using homemade leverage you borrow enough in your margin account so that the payoff of your margined purchase of Firm Y stock will be the same as a $5,000 investment in Firm X stock. The number of shares of Firm Y stock you purchased is closest to ________.

Accepted Answer

A)  425 
B)  1,650 
C)  2,000 
D)  825 
A)  425 
B)  1,650 
C)  2,000 
D)  825

Question 15

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

Accepted Answer

A) True 
 B)False

Question 16

What role do industries play in the capital structure choice for a firm?

Accepted Answer

Industries are found to have distinct pa

Question 17

One of the factors that determine 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 
A)  costs of unpaid interest arrears 
B)  loss of dividend payments 
C)  probability of financial distress 
D)  employee compensation

Question 18

By adding leverage, the returns on a firm are split between debt holders and equity holders, but equity holder risk increases because ________.

Accepted Answer

A)  interest payments can be rolled over 
B)  dividends are paid first 
C)  debt and equity have equal priority 
D)  interest payments have first priority 
A)  interest payments can be rolled over 
B)  dividends are paid first 
C)  debt and equity have equal priority 
D)  interest payments have first priority

Question 19

According to researchers Modigliani and Miller, with perfect capital markets, the total value of a firm should not depend on its capital structure.

Accepted Answer

A) True 
 B)False

Question 20

A firm requires an investment of $18,000 and will return $25,000 after one year. If the firm borrows $10,000 at 6%, what is the return on levered equity?

Accepted Answer

A)  80% 
B)  64% 
C)  96% 
D)  112% 
A)  80% 
B)  64% 
C)  96% 
D)  112%

Exam 16: Capital Structure

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

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

A firm requires an investment of $30,000 and borrows $15,000 at 7%. If the return on equity is 19%, what is the firm's pretax WACC?

Which of the following statements is FALSE?

Managers should make use of the interest tax shield if a firm has ________.

Suppose a project financed via an issue of debt requires six annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 8%, what is the value of the interest rate tax shield?

What are the issues in determining the present value (PV) of financial distress?

The presence of a large amount of debt can encourage shareholders to take excessive risk because ________.

A firm has a market value of equity of $40,000. It borrows $8000 at 7%. If the unlevered cost of equity is 16%, what is the firm's cost of equity capital?

Consider the following equation for the question(s) below. -The A in the equation above represents ________.

A firm requires an investment of $25,000 and will return $36,500 after 1 year. If the firm borrows $20,000 at 7%, what is the return on levered equity?

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

What role do industries play in the capital structure choice for a firm?

One of the factors that determine the present value (PV) of financial distress costs is ________.

By adding leverage, the returns on a firm are split between debt holders and equity holders, but equity holder risk increases because ________.

According to researchers Modigliani and Miller, with perfect capital markets, the total value of a firm should not depend on its capital structure.

A firm requires an investment of $18,000 and will return $25,000 after one year. If the firm borrows $10,000 at 6%, what is the return on levered equity?

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

Time Value of Money: an Introduction

Time Value of Money: Valuing Cash Flow Streams

Interest Rates

Bonds

Stock Valuation

Investment Decision Rules

Fundamentals of Capital Budgeting

Stock Valuation: a Second Look

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

The Cost of Capital

Raising Equity Capital

Debt Financing

Payout Policy

Financial Modeling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Option Applications and Corporate Finance

Mergers and Acquisitions

International Corporate Finance

Leasing

Insurance and Risk Management

Corporate Governance

Filters