FIN 701 Chapter 6 Part 1

Paradise Travels is an all-equity firm that has 9,000 shares of stock outstanding at a market price of $27 a share. The firm's management has decided to issue $25,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 7.3 percent. What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes.

$1.97

D. L. Tuckers has $57,000 of debt outstanding that is selling at par and has a coupon rate of 7.15 percent. The tax rate is 21 percent. What is the present value of the tax shield?

$11,970

Georga's Restaurants has 7,000 bonds outstanding with a face value of $1,000 each, a market price of $982, and a coupon rate of 6.95 percent. The interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 23 percent?

$111,895

Lamont corp. is debt free and has a weighted average cost of capital at 12.7 percent. The current market value of the equity is $2.3 million and there are no taxes. According to M&M proposition I, what will be the value of the company if it changes to a debt-equity ration of .85?

$2,300,000

Financial risk is?

Dependant upon a company's capital structure.

The explicit costs, such as legal and administrative expenses, associated wiht corporate default are classified as_______Costs.

Direct bankruptsy

Which of the following is a marketed claim against the cash flows of a company?

Dividend payment to shareholders.

The business risk of a company:

Has a positive relationship with the companys cost of equity.

Westover mills reduced its taxes last year by $210 by increasing interest expense by $1000. Which one of the following terms is used to describe this tax savivng?

Interest Tax Shield

The Optimal capital structure has been achieved when the

debt-equity ratio results in the lowest possible weighted average cost of capital.

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs.

indirect bankruptcy

The optimal capital structure of a copmpany:

maximizes the value of that company's marketed claims.

A firm should select the capital structure that?

maximizes the value of the firm

Holly's is currently an all-equity firm that has 7,200 shares of stock outstanding at a market price of $41 a share. The firm has decided to leverage its operations by issuing $60,000 of debt at an inteest rate of 7.6 percent. This new debt will be used to repurchase shares of the outstandin stock. The restructuring is expected to increase the earnings per share. What is the minimum level of earnings before interest and taxes that the firm is expecting? Ignore taxes.

$22,435

L.A. Clothing has expected earnings before interest and taxes of $63,300, an unlevered cost of capital of 14.7 percent, and a tax rate of 23 percent. The company also has $11,000 of debt that carries a 7 percent coupon. The debt is selling at par value. What is the value of this firm?

$334,101

The June Bug has a $565,000 bond issue outstanding. These bonds have a coupon rate of6.65 percent, pay interest semiannually, and sell at 98.7 percent of face value. The tax rate is 21%. What is the amount of the annual interest tax shield?

$7,890

Katlin Markets is debating a levered and an unlevered capital structure. The all-equity capital structure would consist of 60,000 shares of stock. The debt and equity option would consist of 45,000 shares of stock plus $250,000 of debt with an interest rate of 7.25 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes.

$72,500

Roy's welding has a cost of equity of 14.1 percent and a ppretax cost of debt of 7.7 percent. The required return on assets is 13.2 percent. What is the debt-equity ratio based on the M&M II with no taxes?

.164

Mountain Groves has an unlevered cost of capital of 13.2 percent, a cost of debt of 8.3 percent, and a tax rate of 21 percent. What is the target debt-equity ratio if the targeted cost of equity is 14.5 percent?

.34

Jamison's has expected earnings before interest and taxes of $11,900. Its unlevered cost of capital is 12.8 percent and its tax rate is 21 percent. The company has debt with both a book and a face value of $12,500. This debt has a coupon rate of 7.6 percent and pays interest annually. What is the weighted average cost of capital?

12.36 percent

Ignoring taxes, Pewter & Glass has a weighted average cost of capital of 10.82 percent. The company can borrow at 7.4 percent. What is the cost of equity if the debt-equity ration is .68.

13.15%

Johnson Tire Distributors has debt with both a face and a market value of $35,000. This debt has a coupon rate of 6.6 percent and pays interest annually. The expected earnings before interest and taxes are $8,300, the tax rate is 21 percent, and the unlevered cost of capital is 10.9 percent. What is the cost of equity?

14.56 percent

Douglass & Frank has a debt-equity ratio of .61. The pre-tax cost of debt is 7.8 percent while the unlevered cost of capital is 12.6 percent. What is the cost of equity if the tax rate is 21 percent?

14.91 Percent

Winter's Toyland has a debt-equity ratio of 0.57. The pre-tax cost of debt is 8.2 percent and the required return on assets is 14.7 percent. What is the cost of equity if you ignore taxes?

18.41 percent

Which one of the following is the equity risk that is most related to the daily operations of a firm?

Business Risk

You have computed the break-even point between a levered and unlevered capitalstructure. Ignore taxes, At the break even level, the:

Company is earning just enough to pay for the cost of the debt.

Which one of the following states that the value of a compnay is unrelated to the companys capital structure?

M&M Proposition I, no tax

Assume you are reviewing a graph that plots earnings per share (EPS) against earnings before interest and taxes (EBIT). The steeper the slope of the ploted line the:

The greater the sensitivity of EPS to change in EBIT.

The interest tax shield is a key reason why;

The net cost of debt is generally less than the cost of equity.

Which one of the following statements is correct in relation to M&M Proposition II, without taxes?

The required return on assets is equal to the weighted average cost of capital.

The proposition that a company borrows up to the point where the marginal benefit of the inteest tax shield derived from increased debt is just equal to the marginal expense of the resultin increase in financial distress costs is called?

The static theory of capital structure.

The Value of a firm is maximized when the:

Weighted average cost of capital is minimized.

M&M proposition I with tax implies that the:

Weigted Average cost of capital decreases as the debt-equity ration increases