Question 1

Jemisen's has expected earnings before interest and taxes of $6,200.Its unlevered cost of capital is 14 percent and its tax rate is 34 percent.The firm has debt with both a book and a face value of $2,500.This debt has a 9 percent coupon and pays interest annually.What is the firm's weighted average cost of capital?

Accepted Answer

A) 12.48 percent 
B) 13.60 percent 
C) 13.87 percent 
D) 14.14 percent 
E) 14.37 percent

Question 2

A firm may file for Chapter 11 bankruptcy:
I.in an attempt to gain a competitive advantage.
II.using a prepack.
III.while allowing the current management to continue running the firm.
IV.only after the firm becomes insolvent.

Accepted Answer

A) I and III only 
B) I and II only 
C) I, II, and IV only 
D) I, II, and III only 
E) I, II, III, and IV

Question 3

M & M Proposition II with taxes:

Accepted Answer

A) has the same general implications as M & M Proposition II without taxes. 
B) states that a firm's capital structure is irrelevant. 
C) supports the argument that business risk is determined by the capital structure decision. 
D) supports the argument that the cost of equity decreases as the debt-equity ratio increases. 
E) concludes that the capital structure decision is irrelevant to the value of a firm.

Question 4

East Side,Inc.has no debt outstanding and a total market value of $136,000.Earnings before interest and taxes,EBIT,are projected to be $12,000 if economic conditions are normal.If there is strong expansion in the economy,then EBIT will be 27 percent higher.If there is a recession,then EBIT will be 55 percent lower.East Side is considering a $54,000 debt issue with a 5 percent interest rate.The proceeds will be used to repurchase shares of stock.There are currently 2,000 shares outstanding.Ignore taxes.If the economy enters a recession,EPS will change by ____ percent as compared to a normal economy,assuming that the firm recapitalizes.

Accepted Answer

A) -70.97 percent 
B) -63.15 percent 
C) -58.08 percent 
D) -42.29 percent 
E) -38.87 percent

Question 5

In each of the theories of capital structure,the cost of equity increases as the amount of debt increases.So why don't financial managers use as little debt as possible to keep the cost of equity down?
 After all,aren't financial managers supposed to maximize the value of a firm?

Accepted Answer

The answer of In each of the theories of capital...

Question 6

L.A.Clothing has expected earnings before interest and taxes of $48,900,an unlevered cost of capital of 14.5 percent,and a tax rate of 34 percent.The company also has $8,000 of debt that carries a 7 percent coupon.The debt is selling at par value.What is the value of this firm?

Accepted Answer

A) $222,579.31 
B) $223,333.33 
C) $224,108.16 
D) $225,299.31 
E) $225,476.91

Question 7

Bruce & Co.expects its EBIT to be $100,000 every year forever.The firm can borrow at 11 percent.Bruce currently has no debt,and its cost of equity is 18 percent.The tax rate is 31 percent.Bruce will borrow $61,000 and use the proceeds to repurchase shares.What will the WACC be after recapitalization?

Accepted Answer

A) 16.30 percent 
B) 16.87 percent 
C) 17.15 percent 
D) 18.29 percent 
E) 18.86 percent

Question 8

The Corner Bakery has a debt-equity ratio of 0.62.The firm's required return on assets is 14.2 percent and its cost of equity is 16.1 percent.What is the pre-tax cost of debt based on M & M Proposition II with no taxes?

Accepted Answer

A) 7.10 percent 
B) 10.68 percent 
C) 11.14 percent 
D) 17.56 percent 
E) 18.40 percent

Question 9

ABC Co.and XYZ Co.are identical firms in all respects except for their capital structure.ABC is all equity financed with $480,000 in stock.XYZ uses both stock and perpetual debt; its stock is worth $240,000 and the interest rate on its debt is 9 percent.Both firms expect EBIT to be $58,400.Ignore taxes.The cost of equity for ABC is _____ percent,and for XYZ it is ______ percent.

Accepted Answer

A) 12.17; 12.68 
B) 12.17; 13.33 
C) 12.17; 15.33 
D) 12.29; 12.68 
E) 12.29; 13.33

Question 10

Bruce & Co.expects its EBIT to be $100,000 every year forever.The firm can borrow at 10 percent.Bruce currently has no debt,and its cost of equity is 20 percent.The tax rate is 34 percent.What will the value of Bruce & Co.be if the firm borrows $54,000 and uses the loan proceeds to repurchase shares?

Accepted Answer

A) $280,130 
B) $346,600 
C) $348,360 
D) $378,900 
E) $381,520

Question 11

The explicit costs,such as legal and administrative expenses,associated with corporate default are classified as _____ costs.

Accepted Answer

A) flotation 
B) issue 
C) direct bankruptcy 
D) indirect bankruptcy 
E) unlevered

Question 12

Which one of the following makes the capital structure of a firm irrelevant?

Accepted Answer

A) taxes 
B) interest tax shield 
C) 100 percent dividend payout ratio 
D) debt-equity ratio that is greater than 0 but less than 1 
E) homemade leverage

Question 13

Down Bedding has an unlevered cost of capital of 14 percent,a cost of debt of 7.8 percent,and a tax rate of 32 percent.What is the target debt-equity ratio if the targeted cost of equity is 15.51 percent?

Accepted Answer

A) .24 
B) .29 
C) .36 
D) .52 
E) .71

Question 14

The concept of homemade leverage is most associated with:

Accepted Answer

A) M & M Proposition I with no tax. 
B) M & M Proposition II with no tax. 
C) M & M Proposition I with tax. 
D) M & M Proposition II with tax. 
E) static theory proposition.

Question 15

Sewer's Paradise is an all equity firm that has 5,000 shares of stock outstanding at a market price of $15 a share.The firm's management has decided to issue $30,000 worth of debt and use the funds to repurchase shares of the outstanding stock.The interest rate on the debt will be 10 percent.What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes.

Accepted Answer

A) $1.46 
B) $1.50 
C) $1.67 
D) $1.88 
E) $1.94

Question 16

Lamont Corp.uses no debt.The weighted average cost of capital is 11 percent.The current market value of the equity is $38 million and there are no taxes.What is EBIT?

Accepted Answer

A) $3,423,000 
B) $3,508,600 
C) $3,781,100 
D) $3,898,700 
E) $4,180,000

Question 17

Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business.The process this firm underwent is known as a:

Accepted Answer

A) merger. 
B) repurchase program. 
C) liquidation. 
D) reorganization. 
E) divestiture.

Question 18

Bob's Warehouse has a pre-tax cost of debt of 8.4 percent and an unlevered cost of capital of 14.6 percent.The firm's tax rate is 37 percent and the cost of equity is 18 percent.What is the firm's debt-equity ratio?

Accepted Answer

A) 0.72 
B) 0.76 
C) 0.79 
D) 0.82 
E) 0.87

Question 19

Which one of the following is a direct bankruptcy cost?

Accepted Answer

A) company CEO's time spent in bankruptcy court 
B) maintaining cash reserves 
C) maintaining a debt-equity ratio that is lower than the optimal ratio 
D) losing a key company employee 
E) paying an outside accountant fees to prepare bankruptcy reports

Question 20

Homemade leverage is:

Accepted Answer

A) the incurrence of debt by a corporation in order to pay dividends to shareholders. 
B) the exclusive use of debt to fund a corporate expansion project. 
C) the borrowing or lending of money by individual shareholders as a means of adjusting their level of financial leverage. 
D) best defined as an increase in a firm's debt-equity ratio. 
E) the term used to describe the capital structure of a levered firm.

Exam 16: Financial Leverage and Capital Structure Policy

A firm may file for Chapter 11 bankruptcy: I.in an attempt to gain a competitive advantage. II.using a prepack. III.while allowing the current management to continue running the firm. IV.only after the firm becomes insolvent.