Exam 16: Capital Structure

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, 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 $5,000 investment in Firm Y stock?

What are indirect costs of financial distress?

What is the capital structure of a firm?

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?

Equity-debt holder conflicts are more likely to arise if the risk of financial distress is high.

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?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

What are some implications of market imperfections?

Which of the following statements is FALSE?

Equity in a firm with no debt is called unlevered equity.

Market timing means that managers may sell ________ when they believe the stock is over-valued and rely on ________ when the stock is undervalued.

Managers should consider ________ for external financing when agency costs are significant.

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

With perfect capital markets, what is the market value of Luther's equity after the share repurchase?

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

To reduce agency costs, issuing debt instead of equity provides incentives for managers to run a firm efficiently because ________.

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?

MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets.

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?