Question 1

Of the following, __________ does NOT necessarily indicate ﬁnancial distress.

Accepted Answer

A)   Business failure.
B)   Legal bankruptcy.
C)   Technical insolvency.
D)   Accounting insolvency.
E)   An involuntary bankruptcy petition.F) A) and C)
G) A) and B)

Question 2

The actual ﬁrm value is equal to the M&M Proposition I with tax value minus the ﬁnancial distress
costs.

Accepted Answer

A) True 
 B)False

Question 3

LKP, Inc. has an unlevered cost of capital of 14%, a cost of debt of 9%, a 34% tax rate, and an EBIT of $60,000. The company has $120,000 in total assets, no accounts payable, and $70,000 in total
Equity. What is the value of LKP, Inc.?

Accepted Answer

A)   $265,857
B)   $271,009
C)   $282,857
D)   $291,009
E)   $299,857F) A) and E)
G) A) and D)

Question 4

According to the static theory of capital structure, value-maximizing ﬁnancial managers will borrow
to the point where the ﬁrm's business risk is just equal to its ﬁnancial risk.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following is the best deﬁnition of static theory of capital structure?

Accepted Answer

A)   The costs that are directly associated with bankruptcy, such as legal and administrative expenses.
B)   The cost of capital of a ﬁrm that has no debt.
C)   Theory that a ﬁrm borrows up to the point where the tax beneﬁt from an extra dollar in debt is exactly equal to the cost that comes from the increased probability of ﬁnancialDistress.
D)   The equity risk that comes from the nature of the ﬁrm's operating activities.
E)   The tax saving attained by a ﬁrm from interest expense.F) C) and D)
G) B) and E)

Question 6

A Calgary ﬁrm with no debt has 200,000 shares outstanding valued at $20 each. Its cost of equity is 12%. The ﬁrm is considering adding $1 million in debt to its capital structure. The coupon rate
Would be 8% and the bonds would sell for par value. The ﬁrm's tax rate is 34%. How much will the
ﬁrm be worth after adding the debt?

Accepted Answer

A)   $4.033 million
B)   $4.180 million
C)   $4.340 million
D)   $4.660 million
E)   $5.000 millionF) A) and E)
G) C) and E)

Question 7

Blackstone, Inc. is currently an all equity ﬁrm that has 65,000 shares of stock outstanding at a market price of $22 a share. The ﬁrm has decided to leverage its operations by issuing $605,000
Of debt at an interest rate of 6.5%. This new debt will be used to repurchase shares of the
Outstanding stock. The restructuring is expected to increase the earnings per share. What is the
Minimum level of earnings before interest and taxes that Blackstone is expecting? Ignore taxes.

Accepted Answer

A)   $92,950
B)   $94,700
C)   $95,250
D)   $95,400
E)   $96,150F) All of the above
G) None of the above

Question 8

UNLEV has an expected perpetual EBIT = $4,000. The unlevered cost of capital = 15% and there are 20,000 shares of stock outstanding. The ﬁrm is considering issuing $8,800 in new par bonds to
Add ﬁnancial leverage to the ﬁrm. The proceeds of the debt issue will be used to repurchase equity.
The cost of debt = 10% and the tax rate = 34%. There are no ﬂotation costs.
If there were no taxes, what would be the value of UNLEV before the restructuring?

Accepted Answer

A)   $15,930
B)   $17,600
C)   $18,519
D)   $26,667
E)   $30,000F) A) and E)
G) A) and D)

Question 9

A ﬁrm has $500 in debt at a cost of 7%, a 34% tax rate, a total ﬁrm value of $1,100, and an unlevered return of 14%. What is the WACC?

Accepted Answer

A)   9.24%
B)   9.74%
C)   9.88%
D)   10.67%
E)   11.84%F) A) and E)
G) A) and D)

Question 10

Provide a deﬁnition of M&M Proposition II.

Accepted Answer

A ﬁrm's cost of equi...

Question 11

The use of personal borrowing to change the overall amount of ﬁnancial leverage to which the 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)   A privileged subscription offer.F) A) and E)
G) C) and D)

Question 12

Which one of the following statements concerning ﬁnancial leverage is correct in a world without taxes?

Accepted Answer

A)   Leverage is beneﬁcial only when EBIT is relatively low.
B)   EPS is decreased when leverage is used and the expected level of EBIT is achieved.
C)   Financial leverage lowers the risk level of a ﬁrm.
D)   The amount of ﬁnancial leverage employed has a major effect on the value of the ﬁrm.
E)   M&M Proposition I states that ﬁnancial leverage is irrelevant to the value of a ﬁrm.F) C) and E)
G) None of the above

Question 13

The optimal capital structure is the mixture of debt and equity which maximizes the value of the ﬁrm
and Minimizes the ﬁrm's weighted average cost of capital.

Accepted Answer

A) True 
 B)False

Question 14

When a ﬁrm defaults on a legal obligation, ___________.

Accepted Answer

A)   It is called a business failure.
B)   The ﬁrm is in legal bankruptcy.
C)   The ﬁrm is in technical insolvency.
D)   The ﬁrm is in accounting insolvency.
E)   The ﬁrm is in violation of protective covenants.F) A) and B)
G) C) and D)

Question 15

Your ﬁrm has a debt-equity ratio of .75. Your pre-tax cost of debt is 8.5% and your required return on assets is 15%. What is your cost of equity if you ignore taxes?

Accepted Answer

A)   11.25%
B)   12.21%
C)   16.67%
D)   19.88%
E)   21.38%F) A) and D)
G) B) and D)

Question 16

Your ﬁrm has a debt-equity ratio of .60. Your pre-tax cost of debt is 9% and your required return on assets is 14%. What is your cost of equity if you ignore taxes?

Accepted Answer

A)   16.4%
B)   16.7%
C)   17.0%
D)   17.3%
E)   17.5%F) A) and C)
G) B) and E)

Question 17

Explain why the optimal capital structure is one that maximizes the value of marketed claims and
minimizes the value of nonmarketed claims.

Accepted Answer

Marketed claims are claims the bondholde...

Question 18

Deitweiler International has an unlevered cost of capital of 10%, a tax rate of 35%, and expected earnings before interest and taxes of $26,500. The company has $40,000 in bonds outstanding
That have a 7% coupon and pay interest annually. The bonds are selling at par value. What is the
Cost of equity?

Accepted Answer

A)   9.87%
B)   9.96%
C)   10.27%
D)   10.53%
E)   11.14%F) B) and E)
G) A) and E)

Question 19

All else the same, the ﬁnancial leverage of a ﬁrm will _________________.

Accepted Answer

A)   Decrease as the debt/equity ratio increases.
B)   Decrease as the ﬁrm's retained earnings account grows.
C)   Increase by the amount of equity it issues in a given year.
D)   Decrease if the ﬁrm has negative net income.
E)   Decrease as the ﬁrm uses debt to fund expansion projects.F) B) and E)
G) C) and D)

Question 20

Due to a prolonged economic downturn, Keely Corporation's EBIT and EPS in the previous year were $225,000 and $1.35. This year EBIT and EPS were $35,000 and $0.70. Given this information,
Calculate the company's DFL.

Accepted Answer

A)   0.47
B)   0.50
C)   0.57
D)   0.60
E)   0.67F) D) and E)
G) C) and D)

Exam 16: Financial Leverage and Capital Structure Policy

Your ﬁrm has a debt-equity ratio of .60. Your pre-tax cost of debt is 9% and your required return on assets is 14%. What is your cost of equity if you ignore taxes?

Correct Answer
verified

Explain why the optimal capital structure is one that maximizes the value of marketed claims and minimizes the value of nonmarketed claims.

Correct Answer
verified
Marketed claims are claims the bondholde...
View Answer

Your ﬁrm has a debt-equity ratio of .75. Your pre-tax cost of debt is 8.5% and your required return on assets is 15%. What is your cost of equity if you ignore taxes?

Correct Answer
verified

When a ﬁrm defaults on a legal obligation, ___________.

Correct Answer
verified

The actual ﬁrm value is equal to the M&M Proposition I with tax value minus the ﬁnancial distress costs.

Correct Answer
verified

Provide a deﬁnition of M&M Proposition II.

Correct Answer
verified
A ﬁrm's cost of equi...
View Answer

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

Correct Answer
verified

Due to a prolonged economic downturn, Keely Corporation's EBIT and EPS in the previous year were $225,000 and $1.35. This year EBIT and EPS were $35,000 and $0.70. Given this information, Calculate the company's DFL.

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Which of the following is the best deﬁnition of static theory of capital structure?

Correct Answer
verified

A ﬁrm has $500 in debt at a cost of 7%, a 34% tax rate, a total ﬁrm value of $1,100, and an unlevered return of 14%. What is the WACC?

Correct Answer
verified

All else the same, the ﬁnancial leverage of a ﬁrm will _________________.

Correct Answer
verified

Which one of the following statements concerning ﬁnancial leverage is correct in a world without taxes?

Correct Answer
verified

Correct Answer
verified

According to the static theory of capital structure, value-maximizing ﬁnancial managers will borrow to the point where the ﬁrm's business risk is just equal to its ﬁnancial risk.

Correct Answer
verified

Correct Answer
verified

LKP, Inc. has an unlevered cost of capital of 14%, a cost of debt of 9%, a 34% tax rate, and an EBIT of $60,000. The company has $120,000 in total assets, no accounts payable, and $70,000 in total Equity. What is the value of LKP, Inc.?

Correct Answer
verified

Of the following, __________ does NOT necessarily indicate ﬁnancial distress.

Correct Answer
verified

The optimal capital structure is the mixture of debt and equity which maximizes the value of the ﬁrm and Minimizes the ﬁrm's weighted average cost of capital.

Correct Answer
verified

Exam 16: Financial Leverage and Capital Structure Policy

Your ﬁrm has a debt-equity ratio of .60. Your pre-tax cost of debt is 9% and your required return on assets is 14%. What is your cost of equity if you ignore taxes?

Correct AnswerverifiedShow Answer

Explain why the optimal capital structure is one that maximizes the value of marketed claims and minimizes the value of nonmarketed claims.

Correct AnswerverifiedMarketed claims are claims the bondholde...View AnswerShow Answer

Your ﬁrm has a debt-equity ratio of .75. Your pre-tax cost of debt is 8.5% and your required return on assets is 15%. What is your cost of equity if you ignore taxes?

Correct AnswerverifiedShow Answer

When a ﬁrm defaults on a legal obligation, ___________.

Correct AnswerverifiedShow Answer

The actual ﬁrm value is equal to the M&M Proposition I with tax value minus the ﬁnancial distress costs.

Correct AnswerverifiedShow Answer

Provide a deﬁnition of M&M Proposition II.

Correct AnswerverifiedA ﬁrm's cost of equi...View AnswerShow Answer

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

Correct AnswerverifiedShow Answer

Due to a prolonged economic downturn, Keely Corporation's EBIT and EPS in the previous year were $225,000 and $1.35. This year EBIT and EPS were $35,000 and $0.70. Given this information, Calculate the company's DFL.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following is the best deﬁnition of static theory of capital structure?

Correct AnswerverifiedShow Answer

A ﬁrm has $500 in debt at a cost of 7%, a 34% tax rate, a total ﬁrm value of $1,100, and an unlevered return of 14%. What is the WACC?

Correct AnswerverifiedShow Answer

All else the same, the ﬁnancial leverage of a ﬁrm will _________________.

Correct AnswerverifiedShow Answer

Which one of the following statements concerning ﬁnancial leverage is correct in a world without taxes?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

According to the static theory of capital structure, value-maximizing ﬁnancial managers will borrow to the point where the ﬁrm's business risk is just equal to its ﬁnancial risk.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

LKP, Inc. has an unlevered cost of capital of 14%, a cost of debt of 9%, a 34% tax rate, and an EBIT of $60,000. The company has $120,000 in total assets, no accounts payable, and $70,000 in total Equity. What is the value of LKP, Inc.?

Correct AnswerverifiedShow Answer

Of the following, __________ does NOT necessarily indicate ﬁnancial distress.

Correct AnswerverifiedShow Answer

The optimal capital structure is the mixture of debt and equity which maximizes the value of the ﬁrm and Minimizes the ﬁrm's weighted average cost of capital.

Correct AnswerverifiedShow Answer

Correct Answer
verified

Correct Answer
verified
Marketed claims are claims the bondholde...
View Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
A ﬁrm's cost of equi...
View Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified