fi 410 test 2

Suppose a project financed via an issue of debt requires five annual interest payments of $12 million each year. If the tax rate is 35% and the cost of debt is 5%, what is the value of the interest rate tax shield?

$18.18 million

A project will give a one-time cash flow of $22,000 after one year. If the project risk requires a rate of 11%, what is the levered value of the firm with perfect capital markets?

$19,819.82

A firm requires an investment of $20,000 and will return $26,500 after one year. If the firm borrows $6,000 at 7% what is the return on levered equity?

43%

Which of the following statements is FALSE? A) If we can identify a comparison firm whose assets have the same risk as the project being evaluated, and if the comparison firm is levered, then we can use its cost of debt as the cost of capital for the project B) We can calculate the cost of capital of a firm's assets by computing the weighted average of the firm's equity and debt cost of capital, which we refer to as the firm's weight average cost of capital C) the portfolio of a firm's equity and debt replicates the returns we would earn if the firm were unlevered D) When evaluating any potential investment project, we must use a discount rate that is appropriate given the risk of the project's free cash flow

A

Which of the following statements is FALSE? 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

A

Which of the following statements is FALSE? A) The Law of One Price implies that leverage will affect the total value of a firm under perfect capital market conditions B) In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the firms assets C) With perfect capital markets, leverage merely changes the allocation of cash flows between debt and equity, without altering the total cash flows of a firm D) in a perfect capital market, the total value of a firm is equal to the market value of the total cash flows generated by its assets and is not affected by its choice of capital structure

A

Which of the following statements is FALSE? A) When a firm borrows money to repurchase shares that account for a specific percentage of its outstanding shares, the transaction is called a leveraged recapitalization B) MM Proposition I applies to capital structure decisions made at any time during the life of a firm C) by choosing positive-NPV projects that are worth more than their initial investment, a firm can enhance its value D) The choice of capital structure does not change the value of a firm if the cost of equity is higher than the cost of debt

A

Which of the following statements is false? A) the relative proportions of debt, equity, and other securities that a firm has outstanding constitute its capital structure B) the most common choices are financing through equity alone and financing through a combination of debt and equity C) a project's net present value (NPV) represents the value to the new investors of a firm created by the project D) when corporations raise funds from outside investors, they must choose which type of security to issue

C

Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at an interest rate of 5%. Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as Firm X. you have $5,000 of your own oney to invest and you plan on buying Firm X stock. Using homemade un(leverage), how much do you need to invest at the risk-free rate so that the payoff on your account will be the same as a $5,000 investment in Firm Y stock

$2,500

Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share. The market value of Luther's non-cash assets is closest to:

$20 billion

A project will give a one-time cash flow of $22,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?

$20,000

A firm will give a one-time cash flow of $24,000 after one year. If the project risk requires a rate of return of 10%, what is the levered value of the firm with perfect capital markets?

$21,818.18

Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share. Assume that in addition to the 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:

$22 billion

Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share. With perfect capital markets, what is the market price per share of Luther's stock after the share repurchase?

$25

Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share. With perfect capital markets, what is the market value of Luther's equity after the share repurchase?

$25 billion

Suppose a project financed via an issue of debt requires five annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 7%, what is the value of the interest rate tax shield

$25.83 million

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?

$29.12 million

Blank Company Cash Flow Forecast: Weak Demand-- Cash Flow= $25,000 Expected Demand-- Cash Flow= $35,000 Strong Demand-- Cash Flow= $45,000 Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. What is the value of the company if the demanded is as expected?

$32,407.40

Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at an interest rate of 5%. Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as firm x. you have $5,000 of your own money to invest and you plan on buying firm y stock. using homemade leverage, how much do you need to borrow in your margin account so that the payoff of your margined purchase of firm y stock will be the same as a $5,000 investment in Firm X stock?

$5,000

Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at an interest rate of 5%. According to MM Proposition I, the stock price for firm x is closest to:

$6

Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share. After this repurchase, how many shares will Luther have outstanding?

1 billion

Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at an interest rate of 5%. Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as firm x. you have $5,000 of your own money to invest and you plan on buying firm y stock. Using homemade leverage you borrow enough in your margin account so that the payoff of your margined purchase of Firm Y stock will be the same as a $5,000 investment in Firm X stock. The number of shares of Firm Y stock you purchased is closes to:

1,650

Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors and has already announced the stock repurchase plan. Currently Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share. Assume that in addition to the 1.25 billion common shares outstanding, Luther has stock options given to employees valued at $2 billion. After the repurchase, how many shares will Luther have outstanding?

1.15 billion

Blank Company Cash Flow Forecast: Weak Demand-- Cash Flow= $25,000 Expected Demand-- Cash Flow= $35,000 Strong Demand-- Cash Flow= $45,000 Suppose Blank Company only has 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?

10.28%

A firm requires an investment of $60,000 and borrows $20,000 at 8%. If the return on equity is 14% and the tax rate is 30%, what is the firm's WACC?

11.2%

A firm requires an investment of $30,000 and borrows $15,000 at 7%. If the return on equity is 19%, what is the firm's pretax WACC?

13%

A firm requires an investment of $60,000 and borrows $30,000 at 9%. If the return on equity is 22% and the tax rate is 35%, what is the firm's WACC?

13.9%

A firm requires an investment of $30,000 and borrows $7,500 at 7%. If the return on equity 18%, what is the firm's pretax WACC?

15.3%

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?

16.3%

A firm has a market value of equity of $30,000. It borrows $7,500 at 8%. If the unlevered cost of equity is 15%, what is the firm's cost of equity capital?

16.75%

A firm has a market value of equity of $40,000. It borrows $8,000 at 7%. If the unlevered cost of equity is 16%, what is the firms cost of equity capital?

17.8%

A firm has a market value of equity of $30,000. It borrows $7,500 at 8%. If the unlevered cost of equity is 16%, what is the firms cost of equity capital?

18%

A firm requires an investment of $25,000 and will return $36,500 after one year. If the firm borrows $20,000 at 7%, what is the return on levered equity?

202%

Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at an interest rate of 5%. Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as Firm X. you have $5,000 of your own oney to invest and you plan on buying Firm X stock. Using homemade un(leverage) you invest enough at the risk-free rate so that the payoff of your account will be the same as a $5,00 investment in Firm Y stock. The number of shares of the Firm X stock you purchased is closest to:

417

Blank Company Cash Flow Forecast: Weak Demand-- Cash Flow= $25,000 Expected Demand-- Cash Flow= $35,000 Strong Demand-- Cash Flow= $45,000 Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company uses no leverage, what is the expected return to equity holders?

8%

Blank Company Cash Flow Forecast: Weak Demand-- Cash Flow= $25,000 Expected Demand-- Cash Flow= $35,000 Strong Demand-- Cash Flow= $45,000 Suppose Blank Company only has 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 the demand is strong?

8.95%

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?

80%

A firm requires an investment of $30,000 and borrows $20,000 and 9%. If the return on equity is 15% and the tax rate is 30%, what is the firm's WACC?

9.2%

Blank Company Cash Flow Forecast: Weak Demand-- Cash Flow= $25,000 Expected Demand-- Cash Flow= $35,000 Strong Demand-- Cash Flow= $45,000 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.

9.33%

Aside from direct costs of bankruptcy, a firm may also incur other indirect costs such as ___________ A) loss of customers and loss of suppliers B) loss of interest receipts C) loss of dividend receipts D) increase in raw material costs

A

Consider the equation: E+D=U=A The E in the equation represents: A) the value of the firm's equity B) the value of the firm's debt C) the value of the firm's unlevered equity D) the market value of the firm's assets

A

Equity in a firm with debt is called ______ A) levered equity B) risk-free equity C) unlevered equity D) preferred equity

A

In a setting where there is no risk that a firm will default, leverage _______ the risk of equity A) increases B) decreases C) does not change D) cannot say for sure

A

Managerial entrenchment means that managers ________ and run the firm for their own best interests. A) may face little threat of being fired B) are overseen by equity holders C) are overseen by debt holders D) are well compensated

A

Managers should make use of the interest tax shield if a firm has __________. A) consistent taxable income B) volatility in taxable income C) consistent dividend payments D) low tax rates

A

The Tradeoff Theory suggests that __________. A) a firm should choose a debt level where the tax savings from increasing leverage are just offset by the increase probability of incurring the costs of financial distress B) with higher costs of financial distress, it is optimal for a firm to choose higher leverage C) differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries D) there is no rational explanation for why firms choose debt levels that are too low to fully exploit the tax shield

A

The probability of financial distress depends on the __________ A) likelihood that a firm will be unable to meet its debt commitments B) chance that a firm's raw material costs will increase C) likelihood of dividend payments D) likelihood of asset growth

A

The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its ________. A) capital structure B) dividend expense C) retained earnings D) paid out capital

A

The tradeoff theory of optimal capital structure weighs the benefits of debt against the costs of __________ A) financial distress B) interest payments C) dividend reinvestment D) input factors

A

The use of leverage as a way to signal ________ information to investors is known as the signaling theory of debt. A) good B) bad C) random D) none of the above

A

Which of the following is NOT one of Modigliani and Miller's set of conditions referred to as perfect capital markets? A) All investors hold the efficient portfolio of assets B) There are no taxes, transaction costs, or issuance costs associated with security trading C) A firm's financing decisions neither change the cash flows generated by its investments, not do they reveal new information about them D) Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows

A

Which of the following statements is TRUE? A) Holding cash has the opposite effect of leverage on risk and return B) We use the market value of a firm's net debt when computing its WACC and unlevered beta to measure the cost of capital and market risk of the firm's busines assets C) Since the WACC does not change with the use of leverage, the value of a firm's free cash flow evaluated using the WACC does not change, and so the enterprise value of the firm does not depend on its financing choices D) Even if a firm's capital structure is more complex, the WACC is calculated by computing the weighted average cost of only the firm's debt and equity

A

As the level of debt increases the tax benefits of debt increase until _______ A) interest costs exceed dividend payments B) tax shield benefit exceeds distress costs C) raw material costs exceed dividend payments D) employee costs exceed interest expense

B

Consider the equation: E+D=U=A The A in the equation represents: 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

B

Equity in a firm with no debt is called _____ A) levered equity B) unlevered equity C) risk-free equity D) preferred equity

B

Firms in industries such as real estate tend to have _______ distress costs because of a large proportion of tangible assets A) high B) low C) unexpected D) varying

B

In general, issuing equity may not dilute the ownership of existing shareholders if ________. A) the value of new shares is equal to the value of debt B)the new shares are sold at a fair price C) the firm has no debt financing D) the firm uses debt conservatively

B

Investment cash flows are independent of financing choices in a ____________ A) market with frictions B) perfect capital market C) setting with frictions in investment returns D) firm with leverage

B

The presence of a large amount of debt can encourage shareholders to take excessive risk because _________ A) equity holders are risk seeking by nature B) the costs of failure are borne largely by debt holders C) debt holders are risk seeking D) firm value increases with risk taking

B

To reduce agency costs, issuing debt instead of equity provides incentives for managers to run a firm efficiently because _______ A) debt increases the funds available to managers to run the firm B) ownership of managers may remain more concentrated C) managers may take actions that benefit shareholders but harm creditors and lower the value of the firm D) shareholders prefer to decline new projects to save cash, even if their NPVs are positive

B

Which of the following statements is FALSE? A) While debt itself may be cheap, it increases the risk and therefore the cost of capital of the firm's equity B) Although debt does not have a lower cost of capital than equity, we can consider this cost in isolation. C) We can use MM Proposition I to derive an explicit relationship between leverage and the equity cost of capital D) the total market value of the firm's securities is equal to the market value of its assets, whether the firm is unlevered or levered

B

Which of the following statements is FALSE? A) with no debt, the WACC is equal to the unlevered equity cost of capital B) With perfect capital markets, a firm's WACC is dependent on its capital structure and it equal to the equity cost of capital only if the firm is unlevered C) As the firm borrows at the low cost of capital for debt, its equity cost of capital rises, but the net effect is that the firm's WACC is unchanged D) as debt has a lower cost of capital than equity, higher leverage lowers a firm's WACC

B

Which of the following statements is FALSE? 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

B

X=[E/(E+D)]rE+[D/(E+D)]rD can be used to calculate all of the following EXCEPT: A) the cost of capital for a firm's assets B) the levered cost of preferred equity C) The unlevered cost of equity D) the weighted average cost of capital

B

A bankruptcy process is complex, time-consuming, and costly. The costs of bankruptcy include _________ A) dividend payments B) raw material costs C) costs of hiring legal experts, appraisers, and auctioneers D) taxes

C

A firm's ______ ratio is the fraction of the firm's total value that corresponds to debt A) debt-to-equity B) equity-to-debt C) debt-to-value D) liability

C

Asymmetric information implies that ________ may have better information about a firm's cash flows than other stakeholders. A) debt holders B) suppliers C) managers D) creditors

C

Consider the equation: E+D=U=A The U in the equation represents: A) the value of the firm's equity B) the market value of the firm's assets C) the value of the firm's unlevered equity D) the value of the firm's debt

C

It is not correct to discount the cash flows of a levered firm with the cost of equity of the unlevered firm because _________ A) leverage decreases the risk of equity in 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

C

Leverage can _______ a firm's expected earnings per share, but does not necessarily increase the share price. A) decrease B) dilute C) increase D) never change

C

Marketing timing mean that managers may sell _________ when they believe the stock is over-valued and rely on _______ when the stock is undervalued A) debt, shares B) debt, preferred stock C) new shares, debt D) debt, debt

C

One of the factors that determine the present value (PV) of financial distress costs is _________ A) costs of unpaid interest arrears B) loss of dividend payments C) probability of financial distress D) employee compensation

C

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

C

When a firm's investment decisions have different consequences for the value of equity and the value of debt, managers may take actions __________. A) to increase debt values B) to decrease costs of distress C) that benefit shareholders at the expense of debt holders D) to reduce fixed costs

C

When investors use leverage in their own portfolios to adjust the leverage choice made by the firm, it is referred to as __________ A) outside debt B) retained earnings C) homemade leverage D) payout ratio

C

Which of the following equations would NOT be appropriate to use in a firm with risky debt? A) rE=rU+(D/E) x (rU-rD) B) rU=rD+(D/E) x (rU-rD) C) rE= rU+(D/E) x rU D) rU=[E/(E+D)]rE + [D/(E+D)]rD

C

Agency costs arise when _________ A) there are high labor costs B) input costs are higher than interest costs C) interest costs exceed dividend payments D) conflicts of interest exist between stakeholders

D

By adding leverage, the returns on a firm are split between debt holders and equity holders, but equity holder risk increases because _______ A) interest payments can be rolled over B) dividends are paid first C) debt and equity have equal priority D) interest payments have first priority

D

MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets A) earnings after taxes B) earnings after interest C) cash flows after taxes D) free cash flows

D

The financial manager makes a choice of the amount and source of capital based on how the choice will impact the _______ A) revenue B) face value of bonds C) depreciation D) firm value

D

Under-investment problems refers to the problem that equity holders prefer not to invest in positive-NPV projects in highly levered firms because _________. A) future investments are contingent on debt financing B) projects are contingent on equity financing C) gains are evenly shared between all stakeholders D) most of the gains from the investment accrue to debt holders

D

Which of the following does a firm consider in the choice of securities issued? A) the tax consequences of the chosen security B) the transactions costs of the chosen security C) whether the chosen security will have a fair price in the market D) all of the above

D

Which of the following statements is FALSE assuming a perfect market? A) The unlevered beta measures the market risk of a firm's business activities, ignoring any additional risks due to leverage B) If a firm holds $1 in cash and has $1 of risk-free debt, then the interest earned on the cash will equal the interest paid on the debt. The cash flows from each source cancel each other, just as if the firm held no cash and no debt C) The unlevered beta measures the market risk of a firm without leverage, which is equivalent to the beta of the firm's assets D) As the amount of debt decreases, the debt becomes riskier because there is a chance the firm will default

D

Which of the following statements is FALSE? 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

Which of the following statements is FALSE? 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 the 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

D