Exam 16: Capital Structure

Suppose a project financed via an issue of debt requires five annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 7%, what is the value of the interest rate tax shield?

Leverage can ________ a firm's expected earnings per share, but does not necessarily increase the share price.

What considerations should managers have while deciding on firms' capital structure?

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. -Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options given to employees valued at $2 billion. After the repurchase how many shares will Luther have outstanding?

A firm requires an investment of $60,000 and borrows $30,000 at 9%. If the return on equity is 22% and the tax rate is 35%, what is the firm's WACC?

Consider the following equation for the question(s) below. -Which of the following statements is TRUE?

What is the capital structure of a firm?

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

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 $5000 of your own money to invest and you plan on buying Firm Y stock. Using homemade leverage, how much do you need to borrow 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?

In a setting where there is no risk that a firm will default, leverage ________ the risk of equity.

Financial managers prefer to choose the same debt level no matter which industry they operate in.

A project will give a one-time cash flow of $22,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is expected return to equity holders? Assume the demand is as expected.

Which of the following does a firm consider in the choice of securities issued?

It is not correct to discount the cash flows of a levered firm with the cost of equity of the unlevered firm because ________.

Consider the following equation for the question(s) below. -Which of the following statements is FALSE?

Consider the following equation for the question(s) below. -Which of the following statements is FALSE assuming a perfect market?

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

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 X stock. Using homemade (un)leverage you invest enough at the risk-free rate so that the payoff of your account will be the same as a $5,000 investment in Firm Y stock. The number of shares of Firm X stock you purchased is closest to ________.

Consider the following equation for the question(s) below. -Which of the following statements is FALSE?