FIN 4424 Quiz 7

When a firm has no debt, then such a firm is known as a(n)

unlevered firm and an all-equity firm.

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 30 percent marginal corporate tax rate.

$15 million

If a firm permanently borrows $100 million at an interest rate of 8 percent, what is the present value of the interest tax shield? (Assume that the marginal corporate tax rate is 30 percent.)

$30 million

For every dollar of operating income paid out as equity income, the shareholder realizes

(1 - TpE) (1 - TC).

If an investor buys a portion (X) of the equity of a levered firm, then his/her payoff is

(X) × (profits - interest)

If an investor buys a portion (X) of an unlevered firm's equity, then his/her payoff is

(X) × (profits).

Assume the following data for U&P Company: Debt (D) = $100 million; Equity (E) = $300 million; rD = 6%; rE = 12%; and TC = 30%. Calculate the after-tax weighted average cost of capital (WACC):

10.05 percent

A firm has a debt-to-equity ratio of 1. If it had no debt, its cost of equity would be 12 percent. Its cost of debt is 9 percent. What is its cost of equity if there are no taxes?

15 percent

A firm's return on assets is 12 percent and the cost of the firm's debt is 7 percent. Given a 0.7 debt-equity-ratio, what is the levered cost of equity? Assume that there are no taxes.

15.5 percent

Given are the following data: Cost of debt = rD = 6%; Cost of equity = rE = 12.1%; Marginal tax rate = 35%; and the firm has 50 percent debt and 50 percent equity. Calculate the after-tax weighted average cost of capital (WACC).

8 percent WACC = (0.5)(1 - 0.35) (6) + (0.5)(12.1) = 8%.

The M&M Company is financed by $4 million (market value) in debt and $6 million (market value) in equity. The cost of debt is 5 percent and the cost of equity is 10 percent. Calculate the weighted average cost of capital. (Assume no taxes.)

8 percent Weighted average cost of capital (WACC) = (4/10)(5) + (6/10)(10) = 2 + 6 = 8%.

Which of the following is not a potential result from financial distress?

Due to interest tax shields, the firm's effective tax rate is very low.

What signal is sent to the market when a firm decides to issue new stock to raise capital?

Stock price is too high.

A corporate bond that can be exchanged for a fixed number of shares of stock is called a

convertible bond.

The cost of capital for a firm, rWACC, in a tax-free environment is

equal to the market value weighted average of the return on equity and the return on debt; equal to rA, the rate of return for that business risk class; and equal to the overall rate of return required on the levered firm.

When securities are sold by a firm, this is termed a(n):

primary issue.

The following functions, provided by financial intermediaries, enable the smooth functioning of the economy:

processing of payments, borrowing and lending, and pooling risks.

A grant of authority allowing someone else to vote shares of stock that you own is called

proxy voting.

MM Proposition II states that

the expected return on equity is positively related to leverage, the required return on equity is a linear function of the firm's debt to equity ratio, and the risk to equity increases with leverage.

Compared to normal bondholders, convertible bondholders have a greater interest in seeing the firm's stock price increase.

True