Question 1

ABC, Inc. has a debt/equity ratio = 1.2. The ﬁrm has a cost of equity of 12% and a cost of debt of 8%. What will the cost of equity be if the target debt/equity ratio increases to 2.0 and the cost of debt
Does not change? Ignore taxes.

Accepted Answer

A)   10.56%
B)   11.12%
C)   13.46%
D)   14.74%
E)   15.45%F) D) and E)
G) B) and C)

Question 2

Ina world without taxes, M&M Proposition I contends that:

Accepted Answer

A)   The cost of equity is dependent upon the debt-ratio of the ﬁrm.
B)   A ﬁrm's cost of equity varies with its cost of debt.
C)   The total value of the ﬁrm remains constant regardless of the debt-equity mixture applied.
D)   A ﬁrm's WACC also determines its cost of equity.
E)   The cost of capital is a linear function with a positive slope.F) A) and B)
G) A) and C)

Question 3

Manchu company had net income of $140,000 and interest expense of $30,000. If the corporate tax rate was 30%, determine its Degree of Financial Leverage (DFL) .

Accepted Answer

A)   1.00
B)   1.05
C)   1.10
D)   1.15
E)   1.20F) A) and B)
G) A) and E)

Question 4

The optimal capital structure of a ﬁrm _____ the marketed claims and _____ the nonmarketed claims against the cash ﬂows of the ﬁrm.

Accepted Answer

A)   minimizes; minimizes
B)   minimizes; maximizes
C)   maximizes; minimizes
D)   maximizes; maximizes
E)   equates; (leave blank) F) None of the above
G) All of the above

Question 5

The interest tax shield is a key reason why:

Accepted Answer

A)   The required rate of return on assets rises when debt is added to the capital structure.
B)   The value of an unlevered ﬁrm is equal to the value of a levered ﬁrm.
C)   The net cost of debt to a ﬁrm is generally less than the cost of equity.
D)   The cost of debt is equal to the cost of equity for a levered ﬁrm.
E)   Firms prefer equity ﬁnancing over debt ﬁnancing.F) B) and E)
G) A) and D)

Question 6

Differentiate between (A) business failure, (B) legal bankruptcy, (C) technical insolvency, and (D)
accounting insolvency.

Accepted Answer

This a straightforward questio...

Question 7

Jefferson Electrical Supply has a cost of equity of 12% and an unlevered cost of capital of 10.5%. The company has $12,000 in debt that is selling at par value. The levered value of the ﬁrm is
$28,000 and the tax rate is 34%. What is the pre-tax cost of debt?

Accepted Answer

A)   6.67%
B)   7.23%
C)   7.47%
D)   7.65%
E)   7.71%F) B) and E)
G) A) and E)

Question 8

Foregone proﬁtable projects due to debt restrictions is an indirect cost of bankruptcy.

Accepted Answer

A) True 
 B)False

Question 9

Which of the following is true about the WACC?

Accepted Answer

A)   The WACC is the appropriate discount rate for all new projects of the ﬁrm.
B)   The optimal capital structure is the one that maximizes the WACC.
C)   The value of the ﬁrm will be maximized when the WACC is minimized.
D)   The WACC is virtually impossible to calculate for a ﬁrm with multiple divisions.
E)   Since discount rates and ﬁrm value move in the same direction, minimizing the WACC will minimize the value of the ﬁrm.F) B) and E)
G) A) and D)

Question 10

Financial risk is wholly dependent upon the ﬁnancial policy of a ﬁrm.

Accepted Answer

A) True 
 B)False

Question 11

Given the following, what is the WACC? EBIT = $2 million; tax rate = 34%; market value and book value of debt = $4 million; unlevered cost of capital = 14%; cost of debt = 9%.

Accepted Answer

A)   11.4%
B)   11.9%
C)   12.2%
D)   12.6%
E)   13.1%F) All of the above
G) None of the above

Question 12

Which of the following is NOT true about bankruptcy and its costs?

Accepted Answer

A)   As the debt/equity ratio falls, the probability that a ﬁrm will be able to meet the promised payments on bonds decreases.
B)   If a ﬁrm is economically bankrupt, then an ensuing legal bankruptcy will likely result in the bondholders receiving less than what they are owed.
C)   The amount of debt a ﬁrm can raise decreases as the probability of bankruptcy increases.
D)   A ﬁrm is economically bankrupt when the value of its assets is less than the value of its debt.
E)   Direct bankruptcy costs are a disincentive to debt ﬁnancing.F) C) and E)
G) B) and E)

Question 13

UNLEV has an expected perpetual EBIT = $4,000. The unlevered cost of capital = 15% and there are 20,000 shares of stock outstanding. The ﬁrm is considering issuing $8,800 in new par bonds to
Add ﬁnancial leverage to the ﬁrm. The proceeds of the debt issue will be used to repurchase equity.
The cost of debt = 10% and the tax rate = 34%. There are no ﬂotation costs.
What is UNLEV's cost of equity after the restructuring?

Accepted Answer

A)   14.8%
B)   17.5%
C)   18.4%
D)   20.0%
E)   22.5%F) B) and C)
G) A) and B)

Question 14

An unlevered ﬁrm has a cost of capital of 14% and earnings before interest and taxes of $150,000. A levered ﬁrm with the same operations and assets has both a book value and a market value of debt
Of $700,000 with a 7% annual coupon. The applicable tax rate is 35%. What is the value of the
Levered ﬁrm?

Accepted Answer

A)   $696,429
B)   $907,679
C)   $941,429
D)   $1,184,929
E)   $1,396,429F) C) and D)
G) A) and E)

Question 15

Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of 8%. The tax rate is 34%. What is the present value of the tax shield?

Accepted Answer

A)   $2,823
B)   $2,887
C)   $4,080
D)   $4,500
E)   $4,633F) C) and D)
G) B) and C)

Question 16

M&M Proposition I with taxes states that the:

Accepted Answer

A)   Debt-equity ratio does not affect the total value of a ﬁrm.
B)   Cost of equity ﬁnancing increases as the debt-equity ratio rises.
C)   Value of a levered ﬁrm is equal to the present value of the interest tax shield plus the value of an unlevered ﬁrm.
D)   Required return on assets is determined by the level of ﬁnancial risk.
E)   Return on equity is dependent upon the marginal tax rate and the debt-equity ratio.F) B) and C)
G) A) and E)

Question 17

Which of the following is the best deﬁnition of homemade leverage?

Accepted Answer

A)   A legal proceeding for liquidating or reorganizing a business. Also, the transfer of some or all of a ﬁrm's assets to its creditors.
B)   The direct and indirect costs associated with going bankrupt or experiencing ﬁnancial distress.
C)   The equity risk that comes from the ﬁnancial policy (i.e., capital structure)  of the ﬁrm.
D)   The use of personal borrowing to change the overall amount of ﬁnancial leverage to which the individual is exposed.
E)   The diﬃculties of running a business that is experiencing ﬁnancial distress.F) A) and C)
G) B) and D)

Question 18

Which one of the following statements is true?

Accepted Answer

A)   The total value of a ﬁrm decreases as debt is initially added to an all equity ﬁrm, if taxes are considered.
B)   The tax shield applies to both debt and equity ﬁnancing.
C)   The ideal capital structure minimizes the total tax liability.
D)   Capital structure does matter when taxes are included.
E)   The general conclusions of M&M Proposition II do not hold when taxes are considered.F) B) and E)
G) A) and B)

Question 19

A ﬁrm that has negative net worth is said to be:

Accepted Answer

A)   Experiencing a business failure.
B)   In legal bankruptcy.
C)   Experiencing technical insolvency.
D)   Experiencing accounting insolvency.
E)   In bankruptcy reorganization.F) C) and D)
G) A) and B)

Question 20

When taxes are factored in, debt ﬁnancing lowers a ﬁrm's weighted average cost of capital.

Accepted Answer

A) True 
 B)False

Exam 16: Financial Leverage and Capital Structure Policy

When taxes are factored in, debt ﬁnancing lowers a ﬁrm's weighted average cost of capital.

Correct Answer
verified

The optimal capital structure of a ﬁrm _ the marketed claims and _ the nonmarketed claims against the cash ﬂows of the ﬁrm.

Correct Answer
verified

Which of the following is the best deﬁnition of homemade leverage?

Correct Answer
verified

Correct Answer
verified

M&M Proposition I with taxes states that the:

Correct Answer
verified

Which one of the following statements is true?

Correct Answer
verified

Which of the following is true about the WACC?

Correct Answer
verified

Differentiate between (A) business failure, (B) legal bankruptcy, (C) technical insolvency, and (D) accounting insolvency.

Correct Answer
verified
This a straightforward questio...
View Answer

A ﬁrm that has negative net worth is said to be:

Correct Answer
verified

Financial risk is wholly dependent upon the ﬁnancial policy of a ﬁrm.

Correct Answer
verified

The interest tax shield is a key reason why:

Correct Answer
verified

Manchu company had net income of $140,000 and interest expense of $30,000. If the corporate tax rate was 30%, determine its Degree of Financial Leverage (DFL) .

Correct Answer
verified

Jefferson Electrical Supply has a cost of equity of 12% and an unlevered cost of capital of 10.5%. The company has $12,000 in debt that is selling at par value. The levered value of the ﬁrm is $28,000 and the tax rate is 34%. What is the pre-tax cost of debt?

Correct Answer
verified

Ina world without taxes, M&M Proposition I contends that:

Correct Answer
verified

Which of the following is NOT true about bankruptcy and its costs?

Correct Answer
verified

Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of 8%. The tax rate is 34%. What is the present value of the tax shield?

Correct Answer
verified

Given the following, what is the WACC? EBIT = $2 million; tax rate = 34%; market value and book value of debt = $4 million; unlevered cost of capital = 14%; cost of debt = 9%.

Correct Answer
verified

Foregone proﬁtable projects due to debt restrictions is an indirect cost of bankruptcy.

Correct Answer
verified

ABC, Inc. has a debt/equity ratio = 1.2. The ﬁrm has a cost of equity of 12% and a cost of debt of 8%. What will the cost of equity be if the target debt/equity ratio increases to 2.0 and the cost of debt Does not change? Ignore taxes.

Correct Answer
verified

Correct Answer
verified

Exam 16: Financial Leverage and Capital Structure Policy

When taxes are factored in, debt ﬁnancing lowers a ﬁrm's weighted average cost of capital.

Correct AnswerverifiedShow Answer

The optimal capital structure of a ﬁrm _____ the marketed claims and _____ the nonmarketed claims against the cash ﬂows of the ﬁrm.

Correct AnswerverifiedShow Answer

Which of the following is the best deﬁnition of homemade leverage?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

M&M Proposition I with taxes states that the:

Correct AnswerverifiedShow Answer

Which one of the following statements is true?

Correct AnswerverifiedShow Answer

Which of the following is true about the WACC?

Correct AnswerverifiedShow Answer

Differentiate between (A) business failure, (B) legal bankruptcy, (C) technical insolvency, and (D) accounting insolvency.

Correct AnswerverifiedThis a straightforward questio...View AnswerShow Answer

A ﬁrm that has negative net worth is said to be:

Correct AnswerverifiedShow Answer

Financial risk is wholly dependent upon the ﬁnancial policy of a ﬁrm.

Correct AnswerverifiedShow Answer

The interest tax shield is a key reason why:

Correct AnswerverifiedShow Answer

Manchu company had net income of $140,000 and interest expense of $30,000. If the corporate tax rate was 30%, determine its Degree of Financial Leverage (DFL) .

Correct AnswerverifiedShow Answer

Jefferson Electrical Supply has a cost of equity of 12% and an unlevered cost of capital of 10.5%. The company has $12,000 in debt that is selling at par value. The levered value of the ﬁrm is $28,000 and the tax rate is 34%. What is the pre-tax cost of debt?

Correct AnswerverifiedShow Answer

Ina world without taxes, M&M Proposition I contends that:

Correct AnswerverifiedShow Answer

Which of the following is NOT true about bankruptcy and its costs?

Correct AnswerverifiedShow Answer

Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of 8%. The tax rate is 34%. What is the present value of the tax shield?

Correct AnswerverifiedShow Answer

Given the following, what is the WACC? EBIT = $2 million; tax rate = 34%; market value and book value of debt = $4 million; unlevered cost of capital = 14%; cost of debt = 9%.

Correct AnswerverifiedShow Answer

Foregone proﬁtable projects due to debt restrictions is an indirect cost of bankruptcy.

Correct AnswerverifiedShow Answer

ABC, Inc. has a debt/equity ratio = 1.2. The ﬁrm has a cost of equity of 12% and a cost of debt of 8%. What will the cost of equity be if the target debt/equity ratio increases to 2.0 and the cost of debt Does not change? Ignore taxes.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct Answer
verified

The optimal capital structure of a ﬁrm _ the marketed claims and _ the nonmarketed claims against the cash ﬂows of the ﬁrm.

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
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Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
This a straightforward questio...
View Answer

Correct Answer
verified

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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