Question 1

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)  $1.94F) None of the above
G) B) and C)

Question 2

An unlevered firm has a cost of capital of 17.5 percent and earnings before interest and taxes of $327,500. A levered firm with the same operations and assets has both a book value and a face value of debt of $650,000 with a 7.5 percent annual coupon. The applicable tax rate is 38 percent. What is the value of the levered firm?

Accepted Answer

A)  $1,397,212
B)  $1,398,256
C)  $1,402,509
D)  $1,407,286
E)  $1,414,414F) D) and E)
G) A) and D)

Question 3

W.V. Trees, Inc. has a debt-equity ratio of 1.4. Its WACC is 10 percent, and its cost of debt is 9 percent. The corporate tax rate is 33 percent. What is the firm's unlevered cost of equity capital?

Accepted Answer

A)  12.38 percent
B)  12.79 percent
C)  13.68 percent
D)  14.10 percent
E)  14.45 percentF) C) and E)
G) C) and D) A

Question 4

AA Tours is comparing two capital structures to determine how to best finance its operations. The first option consists of all equity financing. The second option is based on a debt-equity ratio of 0.45. What should AA Tours do if its expected earnings before interest and taxes (EBIT)  are less than the break-even level? Assume there are no taxes.

Accepted Answer

A)  select the leverage option because the debt-equity ratio is less than 0.50
B)  select the leverage option since the expected EBIT is less than the break-even level
C)  select the unlevered option since the debt-equity ratio is less than 0.50
D)  select the unlevered option since the expected EBIT is less than the break-even level
E)  cannot be determined from the information providedF) None of the above
G) C) and D)

Question 5

Douglass & Frank has a debt-equity ratio of 0.45. The pre-tax cost of debt is 7.6 percent while the unlevered cost of capital is 13.3 percent. What is the cost of equity if the tax rate is 39 percent?

Accepted Answer

A)  13.79 percent
B)  14.86 percent
C)  15.92 percent
D)  18.40 percent
E)  18.87 percentF) B) and E)
G) A) and E)

Question 6

Which one of the following is the equity risk that is most related to the daily operations of a firm?

Accepted Answer

A)  market risk
B)  systematic risk
C)  extrinsic risk
D)  business risk
E)  financial riskF) All of the above
G) B) and C)

Question 7

Jessica invested in Quantro stock when the firm was unlevered. Since then, Quantro has changed its capital structure and now has a debt-equity ratio of 0.30. To unlever her position, Jessica needs to:

Accepted Answer

A)  borrow some money and purchase additional shares of Quantro stock.
B)  maintain her current equity position as the debt of the firm did not affect her personally.
C)  sell some shares of Quantro stock and hold the proceeds in cash.
D)  sell some shares of Quantro stock and loan out the sale proceeds.
E)  create a personal debt-equity ratio of 0.30.F) B) and D)
G) A) and E)

Question 8

If a firm has the optimal amount of debt, then the:

Accepted Answer

A)  direct financial distress costs must equal the present value of the interest tax shield.
B)  value of the levered firm will exceed the value of the firm if it were unlevered.
C)  value of the firm is minimized.
D)  value of the firm is equal to VL + TC * D.
E)  debt-equity ratio is equal to 1.0.F) D) and E)
G) B) and D)

Question 9

Young's Home Supply has a debt-equity ratio of 0.80. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent. What will the firm's cost of equity be if the debt-equity ratio is revised to 0.75?

Accepted Answer

A)  10.89 percent
B)  11.47 percent
C)  11.70 percent
D)  13.89 percent
E)  14.23 percentF) B) and C)
G) C) and D)

Question 10

The value of a firm is maximized when the:

Accepted Answer

A)  cost of equity is maximized.
B)  tax rate is zero.
C)  levered cost of capital is maximized.
D)  weighted average cost of capital is minimized.
E)  debt-equity ratio is minimized.F) A) and C)
G) C) and D)

Question 11

The absolute priority rule determines:

Accepted Answer

A)  when a firm must be declared officially bankrupt.
B)  how a distressed firm is reorganized.
C)  which judge is assigned to a particular bankruptcy case.
D)  how long a reorganized firm is allowed to remain under bankruptcy protection.
E)  which parties receive payment first in a bankruptcy proceeding.F) B) and E)
G) A) and B) E

Question 12

M&M Proposition I with tax supports the theory that:

Accepted Answer

A)  a firm's weighted average cost of capital decreases as the firm's debt-equity ratio increases.
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 cost of equity increases as the debt-equity ratio of the firm decreases.F) A) and C)
G) A) and B)

Question 13

Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?

Accepted Answer

A)  consumer claim
B)  dividend payment to preferred shareholder
C)  company contribution to the employees' retirement account
D)  payment to an unsecured creditor
E)  payment of employee wagesF) C) and E)
G) A) and E)

Question 14

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 31 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)  $361,740
D)  $378,900
E)  $381,520F) A) and E)
G) A) and D)

Question 15

The Pizza Palace has a cost of equity of 15.3 percent and an unlevered cost of capital of 11.8 percent. The company has $22,000 in debt that is selling at par value. The levered value of the firm is $41,000 and the tax rate is 34 percent. What is the pre-tax cost of debt?

Accepted Answer

A)  4.73 percent
B)  6.18 percent
C)  6.59 percent
D)  7.22 percent
E)  9.92 percentF) A) and B)
G) D) and E)

Question 16

Down Bedding has an unlevered cost of capital of 13 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)  .63
B)  .68
C)  .71
D)  .76
E)  .84F) A) and B)
G) D) and E)

Question 17

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)  unleveredF) A) and C)
G) A) and E)

Question 18

The Jean Outlet is an all equity firm that has 146,000 shares of stock outstanding. The company has decided to borrow the $1.1 million to repurchase 7,500 shares of its stock from the estate of a deceased shareholder. What is the total value of the firm if you ignore taxes?

Accepted Answer

A)  $18,387,702
B)  $18,500,000
C)  $19,666,667
D)  $21,000,000
E)  $21,413,333F) A) and E)
G) B) and C)

Question 19

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

Accepted Answer

A)  permits creditors to file a prepack immediately after a firm files for bankruptcy protection.
B)  prevents creditors from submitting any reorganization plans.
C)  prevents firms from filing for bankruptcy protection more than once.
D)  permits key employee retention plans only if an employee has another job offer.
E)  allows firms to pay bonuses to all key employees to entice those employees to remain in the firm's employ.F) A) and D)
G) C) and D)

Question 20

Stacy owns 38 percent of The Town Centre. She has decided to retire and wants to sell all of her shares in this closely held, all equity firm. The other shareholders have agreed to have the firm borrow $650,000 to purchase her shares of stock. What is the total market value of The Town Centre? Ignore taxes.

Accepted Answer

A)  $1,710,526
B)  $1,748,219
C)  $1,771,089
D)  $1,801,406
E)  $1,808,649F) A) and E)
G) A) and B) A

Exam 16: Financial Leverage and Capital Structure Policy

Correct Answer
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Correct Answer
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W.V. Trees, Inc. has a debt-equity ratio of 1.4. Its WACC is 10 percent, and its cost of debt is 9 percent. The corporate tax rate is 33 percent. What is the firm's unlevered cost of equity capital?

Correct Answer
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A

Correct Answer
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Douglass & Frank has a debt-equity ratio of 0.45. The pre-tax cost of debt is 7.6 percent while the unlevered cost of capital is 13.3 percent. What is the cost of equity if the tax rate is 39 percent?

Correct Answer
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Which one of the following is the equity risk that is most related to the daily operations of a firm?

Correct Answer
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Jessica invested in Quantro stock when the firm was unlevered. Since then, Quantro has changed its capital structure and now has a debt-equity ratio of 0.30. To unlever her position, Jessica needs to:

Correct Answer
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If a firm has the optimal amount of debt, then the:

Correct Answer
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Young's Home Supply has a debt-equity ratio of 0.80. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent. What will the firm's cost of equity be if the debt-equity ratio is revised to 0.75?

Correct Answer
verified

The value of a firm is maximized when the:

Correct Answer
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The absolute priority rule determines:

Correct Answer
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E

M&M Proposition I with tax supports the theory that:

Correct Answer
verified

Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?

Correct Answer
verified

Correct Answer
verified

The Pizza Palace has a cost of equity of 15.3 percent and an unlevered cost of capital of 11.8 percent. The company has $22,000 in debt that is selling at par value. The levered value of the firm is $41,000 and the tax rate is 34 percent. What is the pre-tax cost of debt?

Correct Answer
verified

Down Bedding has an unlevered cost of capital of 13 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?

Correct Answer
verified

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

Correct Answer
verified

The Jean Outlet is an all equity firm that has 146,000 shares of stock outstanding. The company has decided to borrow the $1.1 million to repurchase 7,500 shares of its stock from the estate of a deceased shareholder. What is the total value of the firm if you ignore taxes?

Correct Answer
verified

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

Correct Answer
verified

Correct Answer
verified
A

Exam 16: Financial Leverage and Capital Structure Policy

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

W.V. Trees, Inc. has a debt-equity ratio of 1.4. Its WACC is 10 percent, and its cost of debt is 9 percent. The corporate tax rate is 33 percent. What is the firm's unlevered cost of equity capital?

Correct AnswerverifiedA

Correct AnswerverifiedShow Answer

Douglass & Frank has a debt-equity ratio of 0.45. The pre-tax cost of debt is 7.6 percent while the unlevered cost of capital is 13.3 percent. What is the cost of equity if the tax rate is 39 percent?

Correct AnswerverifiedShow Answer

Which one of the following is the equity risk that is most related to the daily operations of a firm?

Correct AnswerverifiedShow Answer

Jessica invested in Quantro stock when the firm was unlevered. Since then, Quantro has changed its capital structure and now has a debt-equity ratio of 0.30. To unlever her position, Jessica needs to:

Correct AnswerverifiedShow Answer

If a firm has the optimal amount of debt, then the:

Correct AnswerverifiedShow Answer

Young's Home Supply has a debt-equity ratio of 0.80. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent. What will the firm's cost of equity be if the debt-equity ratio is revised to 0.75?

Correct AnswerverifiedShow Answer

The value of a firm is maximized when the:

Correct AnswerverifiedShow Answer

The absolute priority rule determines:

Correct AnswerverifiedE

M&M Proposition I with tax supports the theory that:

Correct AnswerverifiedShow Answer

Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The Pizza Palace has a cost of equity of 15.3 percent and an unlevered cost of capital of 11.8 percent. The company has $22,000 in debt that is selling at par value. The levered value of the firm is $41,000 and the tax rate is 34 percent. What is the pre-tax cost of debt?

Correct AnswerverifiedShow Answer

Down Bedding has an unlevered cost of capital of 13 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?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

The Jean Outlet is an all equity firm that has 146,000 shares of stock outstanding. The company has decided to borrow the $1.1 million to repurchase 7,500 shares of its stock from the estate of a deceased shareholder. What is the total value of the firm if you ignore taxes?

Correct AnswerverifiedShow Answer

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedA

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A

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E

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