Question 1

Longmont Inc. has a cost of equity of 12% and a pre-tax cost of debt of 6%. The required return on the assets is 10%. What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

Accepted Answer

A)   .45
B)   .50
C)   .55
D)   .60
E)   .65F) B) and C)
G) None of the above

Question 2

Rosita's has a cost of equity of 13.8% and a pre-tax cost of debt of 8.5%. The debt-equity ratio is .60 and the tax rate is .34. What is Rosita's unlevered cost of capital?

Accepted Answer

A)   8.83%
B)   12.30%
C)   13.97%
D)   14.08%
E)   14.60%F) C) and D)
G) A) and B)

Question 3

A firm has a debt-to-equity ratio of .5. Its cost of equity is 22%,and its cost of debt is 16%. If the corporate tax rate is .40,what would the cost of equity be if the debt-to-equity ratio were 0?

Accepted Answer

A)   14.00%
B)   20.61%
C)   21.07%
D)   22.00%
E)   None of these.F) C) and D)
G) A) and B)

Question 4

Discuss Modigliani and Miller's Propositions I and II in a world without taxes. List the basic assumptions,results,and intuition of the model.

Accepted Answer

Modigliani and Miller Proposition I and ...

Question 5

The weighted average cost of capital is invariant to the use of leverage under MM conditions of no taxes. Graph the relationship of the weighted average cost of capital and leverage; be sure to include the cost of equity and debt. Explain why this relationship holds.

Accepted Answer

See graph page 504.
In a world without t...

Question 6

Wild Flowers Express has a debt-equity ratio of .60. The pre-tax cost of debt is 9% while the unlevered cost of capital is 14%. What is the cost of equity if the tax rate is 34%?

Accepted Answer

A)   7.52%
B)   8.78%
C)   15.98%
D)   16.83%
E)   17.30%F) A) and D)
G) A) and E)

Question 7

The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:

Accepted Answer

A)   MM Proposition I with no tax.
B)   MM Proposition II with no tax.
C)   MM Proposition I with tax.
D)   MM Proposition II with tax.
E)   static theory proposition.F) C) and D)
G) A) and D)

Question 8

The proposition that the value of the firm is independent of its capital structure is called:

Accepted Answer

A)   the capital asset pricing model.
B)   MM Proposition I.
C)   MM Proposition II.
D)   the law of one price.
E)   the efficient markets hypothesis.F) None of the above
G) B) and E)

Question 9

The Winter Wear Company has expected earnings before interest and taxes of $2,100,an unlevered cost of capital of 14% and a tax rate of 34%. The company also has $2,800 of debt that carries a 7% coupon. The debt is selling at par value. What is the value of this firm?

Accepted Answer

A)   $9,900
B)   $10,852
C)   $11,748
D)   $12,054
E)   $12,700F) A) and B)
G) B) and E)

Question 10

Consider two firms,U and L,both with $50,000 in assets. Firm U is unlevered,and firm L has $20,000 of debt that pays 8% interest. Firm U has 1,000 shares outstanding,while firm L has 600 shares outstanding. Mike owns 20% of firm L and believes that leverage works in his favor. Steve tells Mike that this is an illusion,and that with the possibility of borrowing on his own account at 8% interest,he can replicate Mike's payout from firm L.
After seeing Steve's analysis,Mike tells Steve that while his analysis looks good on paper,Steve will never be able to borrow at 8%,but would have to pay a more realistic rate of 12%. If Mike is right,what will Steve's payout be?

Accepted Answer

Steve borrows $4,000 at 12% in...

Question 11

If a firm is unlevered and has a cost of equity capital of 12%,what would the cost of equity be if its debt-equity ratio became 2? The expected cost of debt is 8%.

Accepted Answer

A)   14.0%
B)   14.67%
C)   16.0%
D)   20.0%
E)   None of these.F) B) and D)
G) B) and C)

Question 12

In each of the theories of capital structure the cost of equity rises 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,isn't the goal of the firm to maximize share value and minimize shareholder costs?

Accepted Answer

This question requires students to diffe...

Question 13

Anderson's Furniture Outlet has an unlevered cost of capital of 10%,a tax rate of 34%,and expected earnings before interest and taxes of $1,600. The company has $3,000 in bonds outstanding that have an 8% coupon and pay interest annually. The bonds are selling at par value. What is the cost of equity?

Accepted Answer

A)   8.67%
B)   9.34%
C)   9.72%
D)   9.99%
E)   10.46%F) A) and B)
G) A) and E)

Question 14

In an EPS-EBI graphical relationship,the slope of the debt ray is steeper than the equity ray. The debt ray has a lower intercept because:

Accepted Answer

A)   more shares are outstanding for the same level of EBI.
B)   the break-even point is higher with debt.
C)   a fixed interest charge must be paid even at low earnings.
D)   the amount of interest per share has only a positive effect on the intercept.
E)   the higher the interest rate the greater the slopE.F) C) and D)
G) A) and E)

Question 15

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) None of the above
G) A) and B)

Question 16

Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure?
I. A reduction in tax rates
II. A large tax loss carryforward
III. A large depreciation tax deduction
IV. A sizeable increase in taxable income

Accepted Answer

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

Question 17

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

Accepted Answer

A)   homemade leverage.
B)   dividend recapture.
C)   the weighted average cost of capital.
D)   private debt placement.
E)   personal offset.F) C) and D)
G) A) and E)

Question 18

The Modigliani-Miller Proposition I without taxes states:

Accepted Answer

A)   a firm cannot change the total value of its outstanding securities by changing its capital structure proportions.
B)   when new projects are added to the firm the firm value is the sum of the old value plus the new.
C)   managers can make correct corporate decisions that will satisfy all shareholders if they select projects that maximize value.
D)   the determination of value must consider the timing and risk of the cash flows.
E)   None of these.F) A) and B)
G) B) and E)

Question 19

A firm has debt of $5,000,equity of $16,000,a leveraged value of $8,900,a cost of debt of 8%,a cost of equity of 12%,and a tax rate of 34%. What is the firm's weighted average cost of capital?

Accepted Answer

A)   7.29%
B)   7.94%
C)   8.87%
D)   10.40%
E)   11.05%F) A) and B)
G) A) and D)

Question 20

MM Proposition I with taxes supports the theory that:

Accepted Answer

A)   there is a positive linear relationship between the amount of debt in a levered firm and its value.
B)   the value of a firm is inversely related to the amount of leverage used by the firm.
C)   the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield.
D)   a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm.
E)   a firm's weighted average cost of capital increases as the debt-equity ratio of the firm rises.F) B) and D)
G) None of the above

Exam 16: Capital Structure: Basic Concepts

Correct Answer
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Steve borrows $4,000 at 12% in...
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The Winter Wear Company has expected earnings before interest and taxes of $2,100,an unlevered cost of capital of 14% and a tax rate of 34%. The company also has $2,800 of debt that carries a 7% coupon. The debt is selling at par value. What is the value of this firm?

Correct Answer
verified

The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:

Correct Answer
verified

Wild Flowers Express has a debt-equity ratio of .60. The pre-tax cost of debt is 9% while the unlevered cost of capital is 14%. What is the cost of equity if the tax rate is 34%?

Correct Answer
verified

The interest tax shield is a key reason why:

Correct Answer
verified

Discuss Modigliani and Miller's Propositions I and II in a world without taxes. List the basic assumptions,results,and intuition of the model.

Correct Answer
verified
Modigliani and Miller Proposition I and ...
View Answer

In an EPS-EBI graphical relationship,the slope of the debt ray is steeper than the equity ray. The debt ray has a lower intercept because:

Correct Answer
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A firm has a debt-to-equity ratio of .5. Its cost of equity is 22%,and its cost of debt is 16%. If the corporate tax rate is .40,what would the cost of equity be if the debt-to-equity ratio were 0?

Correct Answer
verified

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

Correct Answer
verified

MM Proposition I with taxes supports the theory that:

Correct Answer
verified

The proposition that the value of the firm is independent of its capital structure is called:

Correct Answer
verified

The Modigliani-Miller Proposition I without taxes states:

Correct Answer
verified

The weighted average cost of capital is invariant to the use of leverage under MM conditions of no taxes. Graph the relationship of the weighted average cost of capital and leverage; be sure to include the cost of equity and debt. Explain why this relationship holds.

Correct Answer
verified
See graph page 504.
In a world without t...
View Answer

Correct Answer
verified

Rosita's has a cost of equity of 13.8% and a pre-tax cost of debt of 8.5%. The debt-equity ratio is .60 and the tax rate is .34. What is Rosita's unlevered cost of capital?

Correct Answer
verified

In each of the theories of capital structure the cost of equity rises 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,isn't the goal of the firm to maximize share value and minimize shareholder costs?

Correct Answer
verified
This question requires students to diffe...
View Answer

If a firm is unlevered and has a cost of equity capital of 12%,what would the cost of equity be if its debt-equity ratio became 2? The expected cost of debt is 8%.

Correct Answer
verified

Longmont Inc. has a cost of equity of 12% and a pre-tax cost of debt of 6%. The required return on the assets is 10%. What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

Correct Answer
verified

A firm has debt of $5,000,equity of $16,000,a leveraged value of $8,900,a cost of debt of 8%,a cost of equity of 12%,and a tax rate of 34%. What is the firm's weighted average cost of capital?

Correct Answer
verified

Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure? I. A reduction in tax rates II. A large tax loss carryforward III. A large depreciation tax deduction IV. A sizeable increase in taxable income

Correct Answer
verified

Exam 16: Capital Structure: Basic Concepts

Correct AnswerverifiedSteve borrows $4,000 at 12% in...View AnswerShow Answer

The Winter Wear Company has expected earnings before interest and taxes of $2,100,an unlevered cost of capital of 14% and a tax rate of 34%. The company also has $2,800 of debt that carries a 7% coupon. The debt is selling at par value. What is the value of this firm?

Correct AnswerverifiedShow Answer

The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:

Correct AnswerverifiedShow Answer

Wild Flowers Express has a debt-equity ratio of .60. The pre-tax cost of debt is 9% while the unlevered cost of capital is 14%. What is the cost of equity if the tax rate is 34%?

Correct AnswerverifiedShow Answer

The interest tax shield is a key reason why:

Correct AnswerverifiedShow Answer

Discuss Modigliani and Miller's Propositions I and II in a world without taxes. List the basic assumptions,results,and intuition of the model.

Correct AnswerverifiedModigliani and Miller Proposition I and ...View AnswerShow Answer

In an EPS-EBI graphical relationship,the slope of the debt ray is steeper than the equity ray. The debt ray has a lower intercept because:

Correct AnswerverifiedShow Answer

A firm has a debt-to-equity ratio of .5. Its cost of equity is 22%,and its cost of debt is 16%. If the corporate tax rate is .40,what would the cost of equity be if the debt-to-equity ratio were 0?

Correct AnswerverifiedShow Answer

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

Correct AnswerverifiedShow Answer

MM Proposition I with taxes supports the theory that:

Correct AnswerverifiedShow Answer

The proposition that the value of the firm is independent of its capital structure is called:

Correct AnswerverifiedShow Answer

The Modigliani-Miller Proposition I without taxes states:

Correct AnswerverifiedShow Answer

The weighted average cost of capital is invariant to the use of leverage under MM conditions of no taxes. Graph the relationship of the weighted average cost of capital and leverage; be sure to include the cost of equity and debt. Explain why this relationship holds.

Correct AnswerverifiedSee graph page 504.In a world without t...View AnswerShow Answer

Correct AnswerverifiedShow Answer

Rosita's has a cost of equity of 13.8% and a pre-tax cost of debt of 8.5%. The debt-equity ratio is .60 and the tax rate is .34. What is Rosita's unlevered cost of capital?

Correct AnswerverifiedShow Answer

In each of the theories of capital structure the cost of equity rises 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,isn't the goal of the firm to maximize share value and minimize shareholder costs?

Correct AnswerverifiedThis question requires students to diffe...View AnswerShow Answer

If a firm is unlevered and has a cost of equity capital of 12%,what would the cost of equity be if its debt-equity ratio became 2? The expected cost of debt is 8%.

Correct AnswerverifiedShow Answer

Longmont Inc. has a cost of equity of 12% and a pre-tax cost of debt of 6%. The required return on the assets is 10%. What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

Correct AnswerverifiedShow Answer

A firm has debt of $5,000,equity of $16,000,a leveraged value of $8,900,a cost of debt of 8%,a cost of equity of 12%,and a tax rate of 34%. What is the firm's weighted average cost of capital?

Correct AnswerverifiedShow Answer

Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure? I. A reduction in tax rates II. A large tax loss carryforward III. A large depreciation tax deduction IV. A sizeable increase in taxable income

Correct AnswerverifiedShow Answer

Correct Answer
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Steve borrows $4,000 at 12% in...
View 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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Modigliani and Miller Proposition I and ...
View Answer

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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See graph page 504.
In a world without t...
View Answer

Correct Answer
verified

Correct Answer
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Correct Answer
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This question requires students to diffe...
View Answer

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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