Question 1

A firm requires an investment of $36,000 and borrows $12,000 at 9%. If the return on equity is 20%, what is the firm's pretax WACC?

Accepted Answer

A)  8.2%
B)  19.6%
C)  16.3%
D)  22.9% C

Question 2

Equity in a firm with no debt is called unlevered equity.

Accepted Answer

A) True 
 B)False  True

Question 3

The A in the equation above represents ________.

Accepted Answer

A)  the value of the firm's debt
B)  the market value of the firm's assets
C)  the value of the firm's equity
D)  the value of the firm's unlevered equity

Question 4

Which of the following statements is FALSE?

Accepted Answer

A)  As long as a firm's choice of securities does not change the cash flows generated by its assets, the capital structure decision will not change the total value of the firm or the amount of capital it can raise.
B)  If securities are fairly priced, then buying or selling securities has a net present value (NPV) of zero and, therefore, should not change the value of a firm.
C)  The future repayments that the firm must make on its debt are equal in value to the amount of the loan it receives up front.
D)  An investor who would like more leverage than the firm has chosen can lend and add leverage to his or her own portfolio. D

Question 5

Which of the following statements is FALSE?

Accepted Answer

A)  Investors can alter the leverage choice of a firm to suit their personal tastes either by borrowing and reducing leverage or by holding bonds and adding more leverage.
B)  As per MM proposition II, the cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a premium that is proportional to the debt-equity ratio.
C)  The MM propositions imply that the true role of a firm's financial policy is to deal with financial market imperfections such as taxes and transaction costs.
D)  In practice, we will find that capital structure can have an effect on a firm's value.

Question 6

Leverage can ________ a firm's expected earnings per share, but does not necessarily increase the share price.

Accepted Answer

A)  decrease
B)  dilute
C)  increase
D)  never change

Question 7

What effect does debt have on a firm's weighted average cost of capital?

Accepted Answer

In a world with taxes, interes...

Question 8

Which of the following statements is FALSE?

Accepted Answer

A)  As long as investors can borrow or lend at the same interest rate as a firm, homemade leverage is a perfect substitute for the use of leverage by the firm.
B)  When investors use leverage in their own portfolios to adjust the leverage choice made by a firm, we say that they are using homemade leverage.
C)  The value of a firm is determined by the present value (PV) of the cash flows from its current and future investments.
D)  The investor can re-create the payoffs of unlevered equity by borrowing and using the proceeds to purchase the equity of a firm.

Question 9

A firm requires an investment of $18,000 and will return $25,000 after one year. If the firm borrows $10,000 at 6%, what is the return on levered equity?

Accepted Answer

A)  80%
B)  64%
C)  96%
D)  112%

Question 10

The direct costs of bankruptcy are estimated to be far greater, as a percent of assets, than the indirect costs of bankruptcy.

Accepted Answer

A) True 
 B)False

Question 11

Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options given to employees valued at $2 billion. The market value of Luther's non-cash assets is closest to ________.

Accepted Answer

A)  $22 billion
B)  $20 billion
C)  $25 billion
D)  $18 billion

Question 12

A firm requires an investment of $30,000 and borrows $7500 at 7%. If the return on equity is 18%, what is the firm's pretax WACC?

Accepted Answer

A)  7.6%
B)  18.3%
C)  21.4%
D)  15.3%

Question 13

In general, the gain to investors from the tax deductibility of interest payments is referred to as the interest rate tax shield.

Accepted Answer

A) True 
 B)False

Question 14

It is not correct to discount the cash flows of a levered firm with the cost of equity of the unlevered firm because ________.

Accepted Answer

A)  leverage decreases the risk of equity of the firm
B)  leverage changes the unlevered cost of equity
C)  leverage increases the risk of the equity of the firm
D)  cost of debt decreases in this setting

Question 15

How does the interest paid by a firm affect its value to investors?

Accepted Answer

The interest paid by a firm is tax-deduc...

Question 16

Suppose a project financed via an issue of debt requires six annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 8%, what is the value of the interest rate tax shield?

Accepted Answer

A)  $23.30 million
B)  $29.12 million
C)  $34.95 million
D)  $58.25 million

Question 17

The pecking order hypothesis states that managers will have a preference to fund investment by using ________, followed by ________, and will issue ________ as a last resort.

Accepted Answer

A)  debt, equity, retained earnings
B)  retained earnings, equity, debt
C)  retained earnings, debt, equity
D)  debt, retained earnings, equity

Question 18

Which of the following statements is FALSE?

Accepted Answer

A)  The levered equity return equals the unlevered return plus an extra "kick" due to leverage.
B)  By holding a portfolio of a firm's equity and its debt, we can replicate the cash flows from holding its levered equity.
C)  The cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a premium that is proportional to the market value debt-equity ratio.
D)  If a firm is unlevered, all of the free cash flows generated by its assets are available to be paid out to its equity holders.

Question 19

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is the return to equity holders if demand is weak?

Accepted Answer

A)  8.0%
B)  -37.5%
C)  -58.6%
D)  10.28%

Question 20

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is expected return to equity holders? Assume the demand is as expected.

Accepted Answer

A)  8.0%
B)  11.6%
C)  9.33%
D)  30.0%

Exam 16: Capital Structure

A firm requires an investment of $36,000 and borrows $12,000 at 9%. If the return on equity is 20%, what is the firm's pretax WACC?

Correct AnswerverifiedC

Equity in a firm with no debt is called unlevered equity.

Correct AnswerverifiedTrue

The A in the equation above represents ________.

Correct AnswerverifiedShow Answer

Which of the following statements is FALSE?

Correct AnswerverifiedD

Which of the following statements is FALSE?

Correct AnswerverifiedShow Answer

Leverage can ________ a firm's expected earnings per share, but does not necessarily increase the share price.

Correct AnswerverifiedShow Answer

What effect does debt have on a firm's weighted average cost of capital?

Correct AnswerverifiedIn a world with taxes, interes...View AnswerShow Answer

Which of the following statements is FALSE?

Correct AnswerverifiedShow Answer

A firm requires an investment of $18,000 and will return $25,000 after one year. If the firm borrows $10,000 at 6%, what is the return on levered equity?

Correct AnswerverifiedShow Answer

The direct costs of bankruptcy are estimated to be far greater, as a percent of assets, than the indirect costs of bankruptcy.

Correct AnswerverifiedShow Answer

Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options given to employees valued at $2 billion. The market value of Luther's non-cash assets is closest to ________.

Correct AnswerverifiedShow Answer

A firm requires an investment of $30,000 and borrows $7500 at 7%. If the return on equity is 18%, what is the firm's pretax WACC?

Correct AnswerverifiedShow Answer

In general, the gain to investors from the tax deductibility of interest payments is referred to as the interest rate tax shield.

Correct AnswerverifiedShow Answer

It is not correct to discount the cash flows of a levered firm with the cost of equity of the unlevered firm because ________.

Correct AnswerverifiedShow Answer

How does the interest paid by a firm affect its value to investors?

Correct AnswerverifiedThe interest paid by a firm is tax-deduc...View AnswerShow Answer

Suppose a project financed via an issue of debt requires six annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 8%, what is the value of the interest rate tax shield?

Correct AnswerverifiedShow Answer

The pecking order hypothesis states that managers will have a preference to fund investment by using ________, followed by ________, and will issue ________ as a last resort.

Correct AnswerverifiedShow Answer

Which of the following statements is FALSE?

Correct AnswerverifiedShow Answer

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is the return to equity holders if demand is weak?

Correct AnswerverifiedShow Answer

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is expected return to equity holders? Assume the demand is as expected.

Correct AnswerverifiedShow Answer

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D

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In a world with taxes, interes...
View Answer

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The interest paid by a firm is tax-deduc...
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The pecking order hypothesis states that managers will have a preference to fund investment by using , followed by , and will issue as a last resort.

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