Exam 16: Capital Structure

Suppose a project financed via an issue of debt requires five annual interest payments of $12 million each year. If the tax rate is 35% and the cost of debt is 5%, what is the value of the interest rate tax shield?

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?

A firm has a market value of equity of $30,000. It borrows $7500 at 8%. If the unlevered cost of equity is 16%, what is the firm's cost of equity capital?

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?

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

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

Differences in the magnitude of financial distress costs and volatility of cash flows across industries do not impact the choice of leverage.

Which of the following statements is FALSE?

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

What are direct costs of financial distress?

A firm has a market value of equity of $30,000. It borrows $7500 at 8%. If the unlevered cost of equity is 15%, what is the firm's cost of equity capital?

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

Asymmetric information implies that ________ may have better information about a firm's cash flows than other stakeholders.

A firm requires an investment of $30,000 and borrows $20,000 at 9%. If the return on equity is 15% and the tax rate is 30%, what is the firm's WACC?

Which of the following statements is TRUE?

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

The optimal capital structure depends on ________ such as taxes, distress costs and agency costs.

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

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.