Question 1

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 2

The proposition that the cost of equity is a positive linear function of 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) C) and D)
G) D) and E)

Question 3

If a firm is unlevered and has a cost of equity capital of 12%, what would its 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 the above.F) A) and B)
G) C) and D)

Question 4

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 5

A key assumption of MM's Proposition I without taxes is:

Accepted Answer

A)  that financial leverage increases risk.
B)  that individuals can borrow on their own account at rates less than the firm.
C)  that individuals must be able to borrow on their own account at rates equal to the firm.
D)  managers are acting to maximize the value of the firm.
E)  All of the above.F) C) and D)
G) A) and B)

Question 6

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) A) and D)
G) B) and D)

Question 7

Based on MM with taxes and without taxes, how much time should a financial manager spend analyzing the capital structure of his firm? What if the analysis is based on the static theory?

Accepted Answer

Under either MM scenario, the financial ...

Question 8

MM Proposition II is the proposition that:

Accepted Answer

A)  supports the argument that the capital structure of a firm is irrelevant to the value of the firm.
B)  the cost of equity depends on the return on debt, the debt-equity ratio and the tax rate.
C)  a firm's cost of equity capital is a positive linear function of the firm's capital structure.
D)  the cost of equity is equivalent to the required return on the total assets of a firm.
E)  supports the argument that the size of the pie does not depend on how the pie is sliced.F) A) and C)
G) A) and B)

Question 9

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) B) and D)
G) A) and E)

Question 10

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) C) and E)
G) A) and B)

Question 11

Gail's Dance Studio is currently an all equity firm that has 80,000 shares of stock outstanding with a market price of $42 a share.The current cost of equity is 12% and the tax rate is 34%.Gail is considering adding $1 million of debt with a coupon rate of 8% to her capital structure.The debt will be sold at par value.What is the levered value of the equity?

Accepted Answer

A)  $2.4 million
B)  $2.7 million
C)  $3.3 million
D)  $3.7 million
E)  $3.9 millionF) None of the above
G) B) and D)

Question 12

What is the cost of equity for a firm if the corporate tax rate is 40%? The firm has a debt-to-equity ratio of 1.5.If it had no debt, its cost of equity would be 16%.Its current cost of debt is 10%.

Accepted Answer

A)  17.4%
B)  18.4%
C)  19.6%
D)  21.4%
E)  None of the above.F) A) and B)
G) C) and E)

Question 13

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) D) and E)
G) A) and D)

Question 14

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 its 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 the above.F) C) and D)
G) All of the above

Question 15

Discuss Modigliani and Miller's Propositions I and II in a world with taxes.List the basic assumptions, results, and intuition of the model.

Accepted Answer

Modigliani and Miller Proposition I and ...

Question 16

MM Proposition I with no tax supports the argument that:

Accepted Answer

A)  business risk determines the return on assets.
B)  the cost of equity rises as leverage rises.
C)  it is completely irrelevant how a firm arranges its finances.
D)  a firm should borrow money to the point where the tax benefit from debt is equal to the cost of the increased probability of financial distress.
E)  financial risk is determined by the debt-equity ratio.F) None of the above
G) B) and E)

Question 17

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) All of the above
G) None of the above

Question 18

Bertha's Boutique has 2,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 9%.The interest is paid semi-annually.What is the amount of the annual interest tax shield if the tax rate is 34%?

Accepted Answer

A)  $58,500
B)  $60,100
C)  $60,750
D)  $61,200
E)  $62,250F) A) and E)
G) B) and E)

Question 19

The change in firm value in the presence of corporate taxes only is:

Accepted Answer

A)  positive as equityholders face a lower effective tax rate.
B)  positive as equityholders gain the tax shield on the debt interest.
C)  negative because of the increased risk of default and fewer shares outstanding.
D)  negative because of a reduction of equity outstanding.
E)  None of the above.F) C) and D)
G) B) and D)

Question 20

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) C) and E)
G) A) and B)

Exam 16: Capital Structure: Basic Concepts

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

The proposition that the cost of equity is a positive linear function of capital structure is called:

Correct Answer
verified

MM Proposition II is the proposition that:

Correct Answer
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What is the cost of equity for a firm if the corporate tax rate is 40%? The firm has a debt-to-equity ratio of 1.5.If it had no debt, its cost of equity would be 16%.Its current cost of debt is 10%.

Correct Answer
verified

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

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

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

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 its cost of equity be if the debt-to-equity ratio were 0?

Correct Answer
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Bertha's Boutique has 2,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 9%.The interest is paid semi-annually.What is the amount of the annual interest tax shield if the tax rate is 34%?

Correct Answer
verified

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
verified

Based on MM with taxes and without taxes, how much time should a financial manager spend analyzing the capital structure of his firm? What if the analysis is based on the static theory?

Correct Answer
verified
Under either MM scenario, the financial ...
View Answer

The interest tax shield is a key reason why:

Correct Answer
verified

MM Proposition I with taxes supports the theory that:

Correct Answer
verified

A key assumption of MM's Proposition I without taxes is:

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

MM Proposition I with no tax supports the argument that:

Correct Answer
verified

Correct Answer
verified
Steve borrows $4,000 at 12% in...
View Answer

Discuss Modigliani and Miller's Propositions I and II in a world with taxes.List the basic assumptions, results, and intuition of the model.

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

The change in firm value in the presence of corporate taxes only is:

Correct Answer
verified

Correct Answer
verified

Exam 16: Capital Structure: Basic Concepts

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

The proposition that the cost of equity is a positive linear function of capital structure is called:

Correct AnswerverifiedShow Answer

MM Proposition II is the proposition that:

Correct AnswerverifiedShow Answer

What is the cost of equity for a firm if the corporate tax rate is 40%? The firm has a debt-to-equity ratio of 1.5.If it had no debt, its cost of equity would be 16%.Its current cost of debt is 10%.

Correct AnswerverifiedShow Answer

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

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

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

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 its cost of equity be if the debt-to-equity ratio were 0?

Correct AnswerverifiedShow Answer

Bertha's Boutique has 2,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 9%.The interest is paid semi-annually.What is the amount of the annual interest tax shield if the tax rate is 34%?

Correct AnswerverifiedShow 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

Based on MM with taxes and without taxes, how much time should a financial manager spend analyzing the capital structure of his firm? What if the analysis is based on the static theory?

Correct AnswerverifiedUnder either MM scenario, the financial ...View AnswerShow Answer

The interest tax shield is a key reason why:

Correct AnswerverifiedShow Answer

MM Proposition I with taxes supports the theory that:

Correct AnswerverifiedShow Answer

A key assumption of MM's Proposition I without taxes is:

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

MM Proposition I with no tax supports the argument that:

Correct AnswerverifiedShow Answer

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

Discuss Modigliani and Miller's Propositions I and II in a world with taxes.List the basic assumptions, results, and intuition of the model.

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

The change in firm value in the presence of corporate taxes only is:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow 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
verified
This question requires students to diffe...
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
verified
Under either MM scenario, the financial ...
View Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
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Correct Answer
verified

Correct Answer
verified

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

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

Correct Answer
verified

Correct Answer
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