Advanced Financial Management Exam 2

Brick House Markets has a tax rate of 21 percent and taxable income of $308,211. What is the value of the interest tax shield if the interest expense is $59,700?

$12,537

Southern Foods has a $13 million bond issue outstanding with a coupon rate of 7.15 percent and a yield to maturity of 7.39 percent. What is the present value of the tax shield if the tax rate is 24 percent?

$3,120,000

Mississippi Mud Products would like to issue new equity shares if its cost of equity declines to 9.5 percent. The company pays a constant annual dividend of $4.80 per share. What does the market price of the stock need to be for the firm to issue the new shares?

$50.53

Chick 'N Fish is considering two different capital structures. The first option is an all-equity firm with 22,500 shares of stock. The second option consists of 18,750 shares of stock plus $120,000 of debt at an interest rate of 7.8 percent. Ignore taxes. What is the break-even level of earnings before interest and taxes (EBIT) between these two options?

$56,150

Destruction Builders has 10,000 shares of stock outstanding and no debt. The new CFO is considering issuing $65,000 of debt and using the proceeds to retire 750 shares of stock. The coupon rate on the debt is 7.2 percent. What is the break-even level of earnings before interest and taxes between these two capital structure options?

$62,400

Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $19.6 million. The bonds mature in 6.5 years and pay semiannual interest payments of $35 each. What is the firm's pretax cost of debt?

7.39%

Fire Hydrant Pet Supply just paid its first annual dividend of $.75 a share. The firm plans to increase the dividend by 2.9 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $16.90 per share?

7.47%

Three years ago, the Fairchildress Company issued 20-year, 7.75 percent semiannual coupon bonds at par. Today, the bonds are quoted at 102.6. What is this firm's pretax cost of debt?

7.48%

Which one of the following statements concerning financial leverage is correct?

Financial leverage magnifies both profits and losses.

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Financial risk

Which one of the following terms applies to the costs incurred by a firm that is trying to avoid filing for bankruptcy?

Indirect bankruptcy costs

Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship?

Interest tax shield

Which one of the following terms refers to the termination of a firm as a going concern?

Liquidation

Which one of the following states that a firm's cost of equity capital is a positive linear function of the firm's capital structure?

M&M Proposition II without taxes

Farmer's Supply is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate to evaluate this proposed expansion. Which one of the following terms describes this evaluation approach?

Pure play approach

Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?

Risk level of the project

Which one of the following represents the present value of the interest tax shield?

Tc × D

Which one of the following statements is the core principle of M&M Proposition I, without taxes?

The capital structure of a firm is totally irrelevant.

Which one of the following is an implication of M&M Proposition II without taxes?

The risk of equity is affected by both financial and operating leverage.

Which one of the following statements matches M&M Proposition I without taxes?

The value of a firm is independent of the firm's capital structure.

Which one of the following represents the minimum rate of return a firm must earn on its assets if it is to maintain the current value of its securities?

Weighted average cost of capital

When evaluating a project, the dividend growth model:

is relatively simple to use.

Commercial Construction Builders has a beta of 1.34, a dividend growth rate of 2.1 percent for the foreseeable future, a stock price of $15 per share, and an expected annual dividend of $.45 per share next year. The market rate of return is 12.8 percent, and the risk-free rate is 4.2 percent. What is the firm's average cost of equity?

10.41%

Musical Charts just paid an annual dividend of $1.84 per share. This dividend is expected to increase by 2.1 percent annually. Currently, the firm has a beta of 1.12 and a stock price of $31 a share. The risk-free rate is 4.3 percent, and the market rate of return is 12.3 percent. What is the cost of equity capital for this firm?

10.71%

The preferred stock of Dolphin Pools pays an annual dividend of $5.20 a share and sells for $48 a share. The tax rate is 21 percent. What is the firm's cost of preferred stock?

10.83%

The market rate of return is 12.65 percent, and the risk-free rate is 3.1 percent. Galaxy Company has 15 percent more systematic risk than the overall market and has a dividend growth rate of 3.75 percent. The firm's stock is currently selling for $53 a share and has a dividend yield of 4.53 percent. What is the firm's average cost of equity?

11.18%

The Woodworker has a pretax cost of debt of 6.25 percent and a return on assets of 15.5 percent. The debt-equity ratio is .41. Ignore taxes. What is the cost of equity?

19.29%

Traditional Bank has an issue of preferred stock with an annual dividend of $7.50 that just sold for $62 a share. What is the bank's cost of preferred stock?

12.10%

Country Cook's cost of equity is 16.2 percent and its aftertax cost of debt is 5.8 percent. What is the firm's weighted average cost of capital if its debt-equity ratio is .42 and the tax rate is 21 percent?

13.12%

The common stock of Serenity Homescapes has a beta of 1.21 and a standard deviation of 17.8 percent. The market rate of return is 13.5 percent, and the risk-free rate is 3.2 percent. What is the cost of equity for this firm?

15.66%

Which one of the following best defines legal bankruptcy?

A legal proceeding for liquidating or reorganizing a business

Which one of the following is the equity risk arising from the daily operations of a firm?

Business risk

Which one of the following statements concerning financial leverage is correct?

Changes in the capital structure of a firm will generally change the firm's earnings per share.

The results of the dividend growth model:

are sensitive to the rate of dividend growth.

Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of return that he and the other lenders require is referred to as the:

cost of debt

Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC?

cost of equity

M&M Proposition II, without taxes, states that the:

cost of equity increases as a firm increases its debt-equity ratio.

The weighted average cost of capital is defined as the weighted average of a firm's:

cost of equity, cost of preferred stock, and its aftertax cost of debt.

The level of financial risk to which a firm is exposed is dependent on the firm's:

debt-equity ratio.

Kate is the CFO of a major firm and has the job of assigning discount rates to each project under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases and a lower rate as the risk level declines. Kate is applying the _________blank approach.

subjective