fin exam 3: ch 16

The June Bug has a $565000 bond issue outstanding. These bonds have a coupon rate of 6.65 percent pay interest semiannually and sell at 98.7 percent of face value. The tax rate is 21 percent. What is the amount of the annual interest tax shield? Select one: $7573 $6907 $8333 $7890 $8250

Annual interest tax shield = $565000(.0665)(.21) Annual interest tax shield = $7890 The correct answer is: $7890

Georga's Restaurants has 7000 bonds outstanding with a face value of $1000 each a market price of $980 and a coupon rate of 6.95 percent. The interest is paid semiannually. What is the amount of the annual interest tax shield if the tax rate is 23 percent? Select one: $111895 $113323 $107750 $110420 $113006

Annual interest tax shield = 7000($1000)(.0695)(.23) Annual interest tax shield = $111895 The correct answer is: $111895

The present value of the interest tax shield is expressed as: Select one: TCD/RA. VU + TCD. TCDRA. [EBIT(TCD)]/RA. TCD.

The correct answer is: TCD.

Bruce & Co. expects its EBIT to be $165000 every year forever. The company currently has no debt but can borrow at 8.6 percent while its cost of equity is 14.7 percent. The tax rate is 21 percent. The company is planning to borrow $55000 and use the loan proceeds to repurchase shares. What will be the WACC after recapitalization? Select one: 14.57 percent 15.07 percent 14.51 percent 14.11 percent 14.58 percent

VU = $165000(1 − .21)/.147 VU = $886735 VL = $886735 + .21($55000) VL = $898285 VE = $898285 − 55000 VE = $843285 RE = .147 + (.147 − .086)($55000/$843285)(1 − .21) RE = .1501 or 15.01% WACC = ($843285/$898285)(.1501) + ($55000/$898285)(.086)(1 − .21) WACC = .1451 or 14.51% The correct answer is: 14.51 percent

Jamison's has expected earnings before interest and taxes of $11900. 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 $12500. This debt has a coupon rate of 7.6 percent and pays interest annually. What is the weighted average cost of capital? Select one: 12.48 percent 12.36 percent 12.87 percent 11.38 percent 12.09 percent

VU = [$11900(1 − .21)]/.128 VU = $73445 VL = $73445 + .21($12500) VL = $76070 VE = $76070 − 12500 VE = $63570 RE = .128 + (.128 − .076)($12500/$63570)(1 − .21) RE = .1361 WACC = ($63570/$76070)(.1361) + ($12500/$76070)(.076)(1 − .21) WACC = .1236 or 12.36% The correct answer is: 12.36 percent

An unlevered company has a cost of capital of 14.6 percent and earnings before interest and taxes of $240090. A levered company with the same operations and assets has a face value of debt of $85000 with a coupon rate of 7.5 percent that sells at par. The applicable tax rate is 22 percent. What is the value of the levered company? Select one: a. $1085338 b. $1398257 c. $1402509 d. $1301373 e. $1001010

VU = [$240090(1 − .22)]/.146 VU = $1282673 VL = $1282673 + .22($85000) VL = $1301373 The correct answer is: $1301373

Lamey Co. has an unlevered cost of capital of 12.3 percent a total tax rate of 25 percent and expected earnings before interest and taxes of $32840. The company has $60000 in bonds outstanding that sell at par and have a coupon rate of 7.2 percent. What is the cost of equity? Select one: 13.78 percent 13.36 percent 13.94 percent 14.07 percent 14.29 percent

VU = [$32840(1 − .25)]/.123 VU = $200244 VL = $200244 + .25($60000) VL = $215244 VE = $215244 − 60000 VE = $155244 RE = .123 + (.123 − .072)($60000/$155244)(1 − .25) RE = .1378 or 13.78% The correct answer is: 13.78 percent

KN Stitches has debt of $26000 a leveraged value of $78400 a pretax cost of debt of 7.05 percent a cost of equity of 15.3 percent and a tax rate of 21 percent. What is the weighted average cost of capital? Select one: 11.47 percent 12.12 percent 11.69 percent 12.07 percent 12.02 percent

WACC = [($78400 − 26000)/$78400](.153) + ($26000/$78400)(.0705)(1 − .21) WACC = .1207 or 12.07% The correct answer is: 12.07 percent

A firm should select the capital structure that: Select one: produces the highest cost of capital. maximizes the value of the firm. minimizes taxes. is fully unlevered. equates the value of debt with the value of equity.

The correct answer is: maximizes the value of the firm.

Southwest Sands currently has 22000 shares of stock outstanding. It is considering issuing $128000 of debt at an interest rate of 7.5 percent. The break-even level of EBIT between these two capital structure options is $74000. How many shares of stock will be repurchased if the company undergoes recapitalization? Ignore taxes. Select one: 2711.35 shares 2854.05 shares 2242.47 shares 3091.89 shares 2446.33 shares

$74000/22000 = [$74000 − 128000(.075)]/X X = 19145.95 shares Shares repurchased = 22000 − 19145.95 Shares repurchased = 2854.05 shares The correct answer is: 2854.05 shares

ABC and XYZ are identical firms in all respects except for their capital structures. ABC is all-equity financed with $530000 in stock. XYZ has the same total value but uses both stock and perpetual debt... its stock is worth $310000 and the interest rate on its debt is 7.9 percent. Both firms expect EBIT to be $62222. Ignore taxes. The cost of equity for ABC is _____ percent and for XYZ it is ______ percent. Select one: 11.74... 9.82 11.74... 12.48 11.74... 14.47 12.09... 9.82 12.09... 12.48

ABC: RE = RA = $62222/$530000 (use ROA formula which is NI/Total Assets) RE = .1174 or 11.74% XYZ: RE = .1174 + (.1174 − .079)[($530000 − 310000)/$310000] RE = .1447 or 14.47% The correct answer is: 11.74... 14.47

Katlin Markets is debating between a levered and an unlevered capital structure. The all-equity capital structure would consist of 60000 shares of stock. The debt and equity option would consist of 45000 shares of stock plus $250000 of debt with an interest rate of 7.35 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes. Select one: $50500 $73500 $81400 $66667 $72500

EBIT/60000 = [EBIT − $250000(.0735)]/45000 EBIT = $73500 The correct answer is: $73500

Ornaments Inc. is an all-equity firm with a total market value of $542000 and 20700 shares of stock outstanding. Management believes the earnings before interest and taxes (EBIT) will be $76400 if the economy is normal. If there is a recession EBIT will be 20 percent lower and if there is a boom EBIT will be 30 percent higher. The tax rate is 35 percent. What is the EPS in a recession? Select one: $1.92 $1.68 $2.40 $3.12 $2.88

EPS = [$76400(1 − .20) − $76400(1 − .20)(.35)]/20700] EPS = $1.92 The correct answer is: $1.92

D. L. Tuckers has $57000 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? Select one: $11647 $12791 $13106 $12200 $11970

PV tax shield = .21($57000) PV tax shield = $11970 The correct answer is: $11970

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 ratio is .58? Select one: 12.8% 13.15% 11.09% 15.85% 12.49%

RE = .1082 + (.1082 − .074)(.58) RE = .1280 or 12.8% The correct answer is: 12.8%

The Corner Bakery has a debt-equity ratio of .53. The required return on assets is 13.5 percent and its cost of equity is 15.08 percent. What is the pretax cost of debt based on M&M Proposition II with no taxes? Select one: 8.78 percent 10.52 percent 9.16 percent 7.56 percent 8.40 percent

RE = .1508 = .135 + (.135 − RD)(.53) RD = .1052 or 10.52% The correct answer is: 10.52 percent

The Greenbriar is an all-equity firm with a total market value of $599000 and 23800 shares of stock outstanding. Management is considering issuing $217000 of debt at an interest rate of 10 percent and using the proceeds on a stock repurchase. Ignore taxes. How many shares will the firm repurchase if it issues the debt securities? Select one: 10231 shares 9379 shares 59900 shares 8441 shares 8622 shares

Shares repurchased = $217000/($599000/23800) 8622 shares The correct answer is: 8622 shares

Which form of financing do companies prefer to use last according to the pecking-order theory? Select one: Regular debt Convertible debt Common stock Preferred stock Internal funds

The correct answer is: Common stock

Which one of the following makes the capital structure of a company irrelevant? Select one: Taxes Interest tax shield 100 percent dividend payout ratio Debt-equity ratio that is greater than 0 but less than 1 Homemade leverage

The correct answer is: Homemade leverage

Westover Mills reduced its taxes last year by $210 by increasing its interest expense by $1000. Which one of the following terms is used to describe this tax savings? Select one: Interest tax shield Interest credit Homemade leverage shield Current tax yield Tax-loss interest

The correct answer is: Interest tax shield

Which one of the following states that the value of a company is unrelated to the company's capital structure? Select one: Homemade leverage M&M Proposition I no tax M&M Proposition II no tax Pecking-order theory Static theory of capital structure

The correct answer is: M&M Proposition I no tax

The concept of homemade leverage is most associated with: Select one: M&M Proposition I with no tax. M&M Proposition II with no tax. M&M Proposition I with tax. M&M Proposition II with tax. the static theory proposition.

The correct answer is: M&M Proposition I with no tax.

Which one of the following statements is correct in relation to M&M Proposition II without taxes? Select one: The cost of equity remains constant as the debt-equity ratio increases. The cost of equity is inversely related to the debt-equity ratio. The required return on assets is equal to the weighted average cost of capital. Financial risk determines the return on assets. Financial risk is unaffected by the debt-equity ratio.

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

You have computed the break-even point between a levered and an unlevered capital structure. Ignore taxes. At the break-even level the: Select one: company is earning just enough to pay for the cost of the debt. company's earnings before interest and taxes are equal to zero. earnings per share for the levered option are exactly double those of the unlevered option. advantages of leverage exceed the disadvantages of leverage. company has a debt-equity ratio of .50.

The correct answer is: company is earning just enough to pay for the cost of the debt.

The optimal capital structure has been achieved when the: Select one: debt-equity ratio is equal to 1. weight of equity is equal to the weight of debt. cost of equity is maximized given a pretax cost of debt. debt-equity ratio is such that the cost of debt exceeds the cost of equity. debt-equity ratio results in the lowest possible weighted average cost of capital.

The correct answer is: debt-equity ratio results in the lowest possible weighted average cost of capital.

M&M Proposition II with taxes: Select one: has the same general implications as M&M Proposition II without taxes. states that capital structure is irrelevant to shareholders. supports the argument that business risk is determined by the capital structure decision. supports the argument that the cost of equity decreases as the debt-equity ratio increases. concludes that the capital structure decision is irrelevant to the value of a firm.

The correct answer is: has the same general implications as M&M Proposition II without taxes.

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs. Select one: flotation direct bankruptcy indirect bankruptcy financial solvency capital structure

The correct answer is: indirect bankruptcy

The basic lesson of M&M theory is that the value of a company is dependent upon: Select one: the company's capital structure. the total cash flows of that company. minimizing the marketed claims. the amount of the company's marketed claims. size of the stockholders' claims.

The correct answer is: the total cash flows of that company.

M&M Proposition I with taxes is based on the concept that: Select one: the optimal capital structure is the one that is totally financed with equity. capital structure is irrelevant because investors and companies have differing tax rates. WACC is unaffected by a change in the company's capital structure. the value of a taxable company increases as the level of debt increases. the cost of equity increases as the debt-equity ratio increases.

The correct answer is: the value of a taxable company increases as the level of debt increases.

If a company has the optimal amount of debt then the: Select one: direct financial distress costs must equal the present value of the interest tax shield. value of the levered company will exceed the value of the unlevered company. company has no financial distress costs. Value of the firm is equal to VL + TCD. debt-equity ratio is equal to 1.

The correct answer is: value of the levered company will exceed the value of the unlevered company.

Hanover Tech is currently an all-equity company that has 145000 shares of stock outstanding with a market price of $22 a share. The current cost of equity is 13.9 percent and the tax rate is 21 percent. The company is considering adding $1.5 million of debt with a coupon rate of 7.5 percent to its capital structure. The debt will be sold at par value. What is the levered value of the equity? Select one: $2.209 million $2.005 million $2.312 million $2.012 million $2.108 million

VL = 145000($22) + .21($1500000) VL = $3505000 VE = $3505000 − 1500000 VE = $2005000 or $2.005 million The correct answer is: $2.005 million

Lamont Corp. is debt-free and has a weighted average cost of capital of 12.7 percent. The current market value of the equity is $2.8 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 ratio of .85? Select one: $18110236 $1955000 $2800000 $2705882 $2300000

VL = VE = $2800000 The correct answer is: $2800000

SLG Corp. is an all-equity firm with a weighted average cost of capital of 10.02 percent. The current market value of the equity is $13.4 million and the total tax rate is 22 percent. What is EBIT? Select one: $1966667 $2021194 $1721385 $2095385 $1943182

VU = $13400000 = EBIT(1 − .22)/.1002 EBIT = $1721385 The correct answer is: $1721385

L.A. Clothing has expected earnings before interest and taxes of $63300 an unlevered cost of capital of 14.7 percent and a combined tax rate of 23 percent. The company also has $11000 of debt that carries a coupon rate of 7 percent. The debt is selling at par value. What is the value of this company? Select one: $342579 $273333 $284108 $334101 $305476

VU = [$63300(1 − .23)]/.147 VU = $331571 VL = $331571 + .23($11000) VL = $334101 The correct answer is: $334101

Home Decor has a pretax cost of debt is 6.8 percent and a tax rate of 22 percent. What is the cost of equity if the debt-equity ratio is .65? WACC is 12.05% Select one: 16.89 percent 17.07 percent 14.70 percent 15.69 percent 16.44 percent

WACC = (1/1.65)RE + (.65/1.65)(.068)(1 − .22) RE = .1644 or 16.44% The correct answer is: 16.44 percent