Question 1

Which one of the following conditions exists at the point where a firm maximizes its value?

Accepted Answer

A)   The tax benefit from an additional dollar of debt is zero.
B)   Financial distress costs are equal to zero.
C)   The debt-equity ratio is 1.0.
D)   WACC is minimized.
E)   The cost of equity is minimized.F) None of the above
G) B) and D)

Question 2

Which one of the following statements matches M&M Proposition I?

Accepted Answer

A)   The cost of equity capital has a positive linear relationship with a firm's capital structure.
B)   The dividends paid by a firm determine the firm's value.
C)   The cost of equity capital varies in response to changes in a firm's capital structure.
D)   The value of a firm is independent of the firm's capital structure.
E)   The value of a firm is dependent on the firm's capital structure.F) B) and E)
G) A) and D)

Question 3

Charleston Mills is an all-equity firm with a total market value of $221,000. The firm has 8,000 shares of stock outstanding. Management is considering issuing $50,000 of debt at an interest rate of 7 percent and using the proceeds on a stock repurchase. Ignore taxes. How many shares can the firm repurchase if it issues the debt securities?

Accepted Answer

A)   1,810 shares
B)   1,818 shares
C)   1,847 shares
D)   1,856 shares
E)   1,899 sharesF) B) and E)
G) A) and C)

Question 4

Weston Mines has a cost of equity of 19.8 percent, a pre-tax cost of debt of 9.4 percent, and a return on assets of 17.1 percent. Ignore taxes. What is the debt-equity ratio?

Accepted Answer

A)   0.35
B)   0.41
C)   0.47
D)   0.56
E)   0.62F) None of the above
G) A) and D)

Question 5

The level of financial risk to which a firm is exposed is dependent upon the firm's:

Accepted Answer

A)   tax rate.
B)   debt-equity ratio.
C)   return on assets.
D)   level of earnings before interest and taxes.
E)   operational level of risk.F) C) and D)
G) A) and E)

Question 6

The Water Works has a return on assets of 13.7 percent, a cost of equity of 18.6 percent, and a pre-tax cost of debt of 7.1 percent. What is the debt-equity ratio? Ignore taxes.

Accepted Answer

A)   0.44
B)   0.47
C)   0.61
D)   0.68
E)   0.74F) C) and E)
G) A) and C)

Question 7

M.G. Movers can borrow at 7.5 percent. The firm currently has no debt, and the cost of equity is 16 percent. The current value of the firm is $540,000. What will the value be if the firm borrows $160,000 and uses the proceeds to repurchase shares? The corporate tax rate is 34 percent.

Accepted Answer

A)   $528,000
B)   $540,000
C)   $552,000
D)   $571,000
E)   $594,400F) B) and C)
G) B) and D)

Question 8

M&M Proposition II, without taxes, states that the:

Accepted Answer

A)   capital structure of a firm is highly relevant.
B)   weighted average cost of capital decreases as the debt-equity ratio decreases.
C)   cost of equity increases as a firm increases its debt-equity ratio.
D)   return on equity is equal to the return on assets multiplied by the debt-equity ratio.
E)   return on equity remains constant as the debt-equity ratio increases.F) B) and C)
G) A) and E)

Question 9

Kelner's Nursery has 8,000 bonds outstanding with a face value of $1,000 each. The coupon rate is 6.5 percent and the tax rate is 34 percent. What is the present value of the interest tax shield?

Accepted Answer

A)   $2.72 million
B)   $2.83 million
C)   $3.09 million
D)   $3.13 million
E)   $3.26 millionF) All of the above
G) A) and D)

Question 10

Coaster's has a cost of equity of 15.4 percent, a return on assets of 10.2 percent, and a cost of debt of 7.3 percent. There are no taxes. What is the firm's weighted average cost of capital?

Accepted Answer

A)   7.30 percent
B)   10.20 percent
C)   10.97 percent
D)   15.40 percent
E)   Cannot be determined from the information provided.F) B) and E)
G) A) and E)

Question 11

Uptown Construction is comparing two different capital structures. Plan I would result in 23,000 shares of stock and $320,000 in debt. Plan II would result in 17,000 shares of stock and $260,000 in debt. The interest rate on the debt is 10 percent. Ignoring taxes, EPS will be identical for Plans I and II when EBIT equals which one of the following?

Accepted Answer

A)   $8,550
B)   $9,000
C)   $9,600
D)   $10,400
E)   $10,750F) C) and E)
G) C) and D)

Question 12

Which one of the following is correct based on the static theory of capital structure?

Accepted Answer

A)   A firm receives the greatest benefit from debt financing when its tax rate is relatively low.
B)   A debt-equity ratio of 1 is considered to be the optimal capital structure.
C)   The costs of financial distress decrease the value of a firm.
D)   The more debt a firm assumes, the greater the incentive to acquire even more debt until such time as the firm is financed with 100 percent debt.
E)   At the optimal level of debt a firm also optimizes its tax shield on debt.F) A) and C)
G) A) and B)

Question 13

Which one of the following represents the present value of the interest tax shield?

Accepted Answer

A)   
B)   
C)   
D)   
E)  F) B) and E)
G) D) and E)

Question 14

Which one of the following is the equity risk arising from the daily operations of a firm?

Accepted Answer

A)   Strategic risk
B)   Financial risk
C)   Liquidity risk
D)   Industry risk
E)   Business riskF) A) and E)
G) C) and D)

Exam 13: Leverage and Capital Structure

Which one of the following is the equity risk arising from the daily operations of a firm?

Correct Answer
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Kelner's Nursery has 8,000 bonds outstanding with a face value of $1,000 each. The coupon rate is 6.5 percent and the tax rate is 34 percent. What is the present value of the interest tax shield?

Correct Answer
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Which one of the following conditions exists at the point where a firm maximizes its value?

Correct Answer
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Which one of the following represents the present value of the interest tax shield?

Correct Answer
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Which one of the following is correct based on the static theory of capital structure?

Correct Answer
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Correct Answer
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Weston Mines has a cost of equity of 19.8 percent, a pre-tax cost of debt of 9.4 percent, and a return on assets of 17.1 percent. Ignore taxes. What is the debt-equity ratio?

Correct Answer
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Coaster's has a cost of equity of 15.4 percent, a return on assets of 10.2 percent, and a cost of debt of 7.3 percent. There are no taxes. What is the firm's weighted average cost of capital?

Correct Answer
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Which one of the following statements matches M&M Proposition I?

Correct Answer
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M.G. Movers can borrow at 7.5 percent. The firm currently has no debt, and the cost of equity is 16 percent. The current value of the firm is $540,000. What will the value be if the firm borrows $160,000 and uses the proceeds to repurchase shares? The corporate tax rate is 34 percent.

Correct Answer
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M&M Proposition II, without taxes, states that the:

Correct Answer
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The level of financial risk to which a firm is exposed is dependent upon the firm's:

Correct Answer
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The Water Works has a return on assets of 13.7 percent, a cost of equity of 18.6 percent, and a pre-tax cost of debt of 7.1 percent. What is the debt-equity ratio? Ignore taxes.

Correct Answer
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Correct Answer
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Exam 13: Leverage and Capital Structure

Which one of the following is the equity risk arising from the daily operations of a firm?

Correct AnswerverifiedShow Answer

Kelner's Nursery has 8,000 bonds outstanding with a face value of $1,000 each. The coupon rate is 6.5 percent and the tax rate is 34 percent. What is the present value of the interest tax shield?

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Which one of the following conditions exists at the point where a firm maximizes its value?

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Which one of the following represents the present value of the interest tax shield?

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Which one of the following is correct based on the static theory of capital structure?

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Correct AnswerverifiedShow Answer

Weston Mines has a cost of equity of 19.8 percent, a pre-tax cost of debt of 9.4 percent, and a return on assets of 17.1 percent. Ignore taxes. What is the debt-equity ratio?

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Coaster's has a cost of equity of 15.4 percent, a return on assets of 10.2 percent, and a cost of debt of 7.3 percent. There are no taxes. What is the firm's weighted average cost of capital?

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Which one of the following statements matches M&M Proposition I?

Correct AnswerverifiedShow Answer

M.G. Movers can borrow at 7.5 percent. The firm currently has no debt, and the cost of equity is 16 percent. The current value of the firm is $540,000. What will the value be if the firm borrows $160,000 and uses the proceeds to repurchase shares? The corporate tax rate is 34 percent.

Correct AnswerverifiedShow Answer

M&M Proposition II, without taxes, states that the:

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The level of financial risk to which a firm is exposed is dependent upon the firm's:

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The Water Works has a return on assets of 13.7 percent, a cost of equity of 18.6 percent, and a pre-tax cost of debt of 7.1 percent. What is the debt-equity ratio? Ignore taxes.

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Correct AnswerverifiedShow Answer

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