Essentials of Corporate Finance ch13

Forbidden Fruit Extracts expects its earnings before interest and taxes to be $287,600 a year forever. Currently, the firm has no debt. The cost of equity is 15.4 percent and the tax rate is 34 percent. The company is in the process of issuing $3 million of bonds at par that carry an annual coupon rate of 7.6 percent. What is the unlevered value of the firm? A $1,107,405 B $1,232,571 C $1,331,971 D $969,325 E $1,371,429

B

Tree Farms currently has 48,000 shares of stock outstanding and no debt. The price per share is $22.50. The firm is considering borrowing funds at 8.5 percent interest and using the proceeds to repurchase 1,750 shares of stock. Ignore taxes. How much is the firm borrowing? A $40,000 B $39,375 C $32,500 D $42,500 E $32,750

B

Which one of the following is the equity risk arising from the daily operations of a firm? A Liquidity risk B Business risk C Industry risk D Strategic risk E Financial risk

B

Which one of the following statements concerning financial leverage is correct? A Financial leverage refers to the use of common stock. B Financial leverage magnifies both profits and losses. C Financial leverage increases profits and decreases losses. D Increasing financial leverage will always decrease the earnings per share. E Financial leverage has no effect on a firm's return on equity.

B

In the process of liquidation, some types of claims receive preference over other claims. Which one of the following determines which type of claim is paid first? A Accounting insolvency definition B Securities and Exchange Commission C Absolute priority rule D Technical insolvency definition E Chapter 7 of the Federal Bankruptcy Reform Act of 1978

C

Northwestern Lumber Products currently has 12,400 shares of stock outstanding and no debt. Patricia, the financial manager, is considering issuing $160,000 of debt at an interest rate of 6.95 percent and using the proceeds to repurchase shares. Given this, how many shares of stock will be outstanding once the debt is issued if the break-even level of EBIT between these two capital structure options is $48,000? Ignore taxes. A 3,025 shares B 3,051 shares C 2,873 shares D 2,667 shares E 2,558 shares

C

Which one of the following is the equity risk arising from the capital structure selected by a firm? A Liquidity risk B Business risk C Financial risk D Industry risk E Strategic risk

C

Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt? A M&M Proposition I, with taxes B M&M Proposition I, without taxes C Static theory of capital structure D M&M Proposition II, with taxes E Homemade leverage proposition

C

Brick House Markets has a tax rate of 34 percent and taxable income of $308,211. What is the value of the interest tax shield if the interest expense is $39,700? A $13,498 B $14,887 C $16,023 D $15,595 E $15,010

A

The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as: A homemade leverage. B financial risk management. C M&M Proposition I. D capital restructuring. E M&M Proposition II.

A

Which one of the following statements matches M&M Proposition I without taxes? A The value of a firm is independent of the firm's capital structure. B The dividends paid by a firm determine the firm's value. C The cost of equity capital has a positive linear relationship with a firm's capital structure. D The value of a firm is dependent on the firm's capital structure. E The cost of equity capital varies in response to changes in a firm's capital structure.

A

Assume both corporate taxes and financial distress costs apply to a firm. Given this, the static theory of capital structure illustrates that: A the value of a firm rises as both the interest rate on debt and the tax rate rise. B the maximum value of a firm is obtained when a firm is financed solely with debt. C the value of a firm rises as the interest rate on debt rises. D a firm's value and its weighted average cost of capital are inversely related. E a firm's value and its tax rate are inversely related.

D

Delta Mowers has a debt-equity ratio of .6. Its WACC is 11.8 percent, and its cost of debt is 7.7 percent. There is no corporate tax. What is the firm's cost of equity capital? A 14.80 percent B 13.83 percent C 12.60 percent D 14.26 percent E 14.29 percent

D

Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $628,000. The current cost of equity is 17.6 percent and the tax rate is 35percent. The company is in the process of issuing $4.3 million of 8.3 percent annual coupon bonds at par. What is the levered value of the firm? A $2,713,185 B $3,541,085 C $3,385,695 D $3,824,318 E $3,422,225

D

The level of financial risk to which a firm is exposed is dependent on the firm's: A tax rate. B level of earnings before interest and taxes. C operational level of risk. D debt-equity ratio. E return on assets.

D

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? AM&M Proposition I with taxes B Static theory of capital structure C Homemade leverage theory D M&M Proposition II without taxes E M&M Proposition I without taxes

D

You are comparing two possible capital structures for a firm. The first option is an all-equity firm. The second option involves the use of $3.8 million of debt. The break-even point between these two financing options occurs when the earnings before interest and taxes (EBIT) are $428,000. Given this, you know that leverage is beneficial to the firm: A only if the debt is decreased by $428,000. B only when EBIT is $428,000. C whenever EBIT is less than $428,000. D whenever EBIT exceeds $428,000. E only if the debt is increased by $428,000.

D

Bird Houses is an all-equity firm with a total market value of $388,980 and18,000 shares of stock outstanding. Management is considering issuing $68,000 of debt at an interest rate of 6.5 percent and using the proceeds on a stock repurchase. Ignore taxes. How many shares will the firm repurchase if it issues the debt securities? (Round the number of shares repurchased down to the nearest whole share.) A 3,167 shares B 3,021 shares C 3,116 shares D 3,207 shares E 3,146 shares

E

The Piano Movers can borrow at 7.8 percent. The firm currently has no debt, and the cost of equity is 15 percent. The current value of the firm is $680,000. What will the value be if the firm borrows $140,000 and uses the proceeds to repurchase shares? The corporate tax rate is 35 percent. A $540,000 B $571,000 C $750,000 D $820,000 E $729,000

E

Which one of the following is minimized when the value of a firm is maximized? A Taxes B Bankruptcy costs C Debt D Return on equity E WACC

E