Corporate Finance Quizzes (post midterm)

Samuel Corp. provides the following information: EBIT = $286.50 Tax (TC ) = 35% Debt = $810 RU = 15% What is the value of the firm?

$1,241.53 (VU=(EBIT × (1 − TC)) / RU)

Lollipop Corp. provides the following information: EBIT = $286.50 Tax (TC )= 35% Debt= $810 Cost of debt capital = 10% RU = 15% What is the value of the firm?

$1,525.03 (VL = VU + Tc × D)

If a firm permanently borrows $50 million at an interest rate of 10 percent, what is the present value of the interest tax shield? Assume a 21 percent marginal corporate tax rate.

$10.5 mil ((0.21)(50) = $10.5 m)

The asset beta of a levered firm is 1.1. The beta of debt is 0.3. If the debt equity ratio is 0.5, what is the equity beta? (Assume no taxes.)

1.5 (bE = 1.1 + 0.5(1.1 − 0.3) = 1.5.)

Health and Wealth Company is financed entirely by common stock that is priced to offer a 15 percent expected return. If the company repurchases 25 percent of the common stock and substitutes an equal value of debt yielding 6 percent, what is the expected return on the common stock after refinancing? (Ignore taxes.)

18% (rE = rA + (D/E)(rA − rD))

The beta of an all-equity firm is 1.2. Suppose the firm changes its capital structure to 50 percent debt and 50 percent equity using 8 percent debt financing. What is the equity beta of the levered firm? The beta of debt is 0.2. (Assume no taxes.)

2.2 (βE = 1.2 + (0.5/0.5)(1.2 − 0.2) = 2.2.)

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20 percent expected return. If the company repurchases 50 percent of the stock and substitutes an equal value of debt yielding 8 percent, what is the expected return on its common stock after refinancing?

32% (RE = 0.2 + (0.5/0.5)(0.20 − 0.08) = 0.32)

Samuel Corp. provides the following information: EBIT = $386.50 Tax (TC ) = 35% Debt = $810 RU = 15% What is the value of Samuel's equity?

864.83 (E= Vu-D)

The effect of financial leverage depends on the company's _____________.

EBIT

The pecking order theory of capital structure implies that: I) high-risk firms will end up borrowing more; II) firms prefer internal finance; III) firms prefer debt to equity when external financing is required I only II only II and III only III only

c

When financial distress is a possibility, the value of a levered firm is a function of: I) value of the firm if all-equity-financed; II) present value of tax shield; III) present value of costs of financial distress; IV) present value of omitted dividend payments Multiple Choice I only I + II I + II − III I + II - III − IV

c

Capital structure is irrelevant if I) capital markets are efficient; II) each investor can borrow/lend on the same terms as the firm; III) there are no tax benefits to debt a. I only b. II only c. III only d. I, II, and III

d

The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because: I) debt is more risky than equity; II) bankruptcy and its attendant costs are a disadvantage to debt; III) the payment of personal taxes may offset the tax benefit of debt I only II only III only II and III only

d

What signal is sent to the market when a firm decides to issue new stock to raise capital? Bond markets are overpriced. Bond markets are underpriced. Stock price is too low. Stock price is too high.

d

_________ tax rate is the amount of tax payable on the next dollar earned.

marginal

The equation for M & M Proposition I, without taxes, is best shown as:

VL=VU

Modigliani and Miller's Proposition I states that Multiple Choice the market value of any firm is independent of its capital structure. the market value of a firm's debt is independent of its capital structure. the market value of a firm's common stock is independent of its capital structure. None of these options.

a

The equation for M & M Proposition I, with taxes, is best shown as: VL = VU + Tc × D VL = VU × Tc × D VL = VU VL = VU / TD VL + TD = VU

a

Which of the following entities likely has the highest cost of financial distress? Multiple Choice A pharmaceuticals development company A downtown bayfront hotel A yacht leasing company A real estate investment trust

a

For a levered firm where bA = beta of assets and bD = beta of debt, the equity beta (bE) equals a. bE = bA b. bE = bA + (D/E) × [bA - bD] c. bE = bA + (D/(D + E)) × [bA − bD] d. None of these options.

b

In order to calculate the tax shields provided by debt, the tax rate used is the Multiple Choice average corporate tax rate. marginal corporate tax rate. average of shareholders' equity tax rates. average of bondholders' personal tax rates.

b

The capital structure of the firm can be defined as I) the firm's mix of different debt securities; II) the firm's mix of different securities used to finance assets; III) the market imperfection that the firm's managers can exploit a. I only b. II only c. III only d. I, II, and III

b

Assuming that bonds are sold at a fair price, the benefits from the interest tax shield go to the Multiple Choice managers of the firm. bondholders of the firm. stockholders of the firm. lawyers of the firm.

c