Question 1

The interest tax shield has no value for a firm when the debt-equity ratio is exactly equal to 1.

Accepted Answer

A) True 
 B)False

Question 2

The optimal capital structure has been achieved when the:

Accepted Answer

A)   Debt-equity ratio is equal to 1.
B)   Weight of equity is equal to the weight of debt.
C)   Cost of equity is maximized given a pre-tax cost of debt.
D)   Debt-equity ratio is such that the cost of debt exceeds the cost of equity.
E)   Debt-equity ratio selected results in the lowest possible weighed average cost of capital.

Question 3

When taxes are factored in, debt financing increases the value of a firm.

Accepted Answer

A) True 
 B)False

Question 4

Which of the following is true regarding bankruptcy?

Accepted Answer

A)   Liquidation frequently is converted into a reorganization.
B)   In a prepack, creditors agree to a reorganization plan prior to the bankruptcy filing.
C)   Firms cannot file bankruptcy to escape long-term leases on closed stores.
D)   Creditors of the firm may not initiate bankruptcy proceedings.
E)   A party other than the current firm management must take control of the firm before it comes out of bankruptcy.

Question 5

Which of the following statements regarding leverage is false?

Accepted Answer

A)   The ultimate effect of leverage depends on the firm's EBIT.
B)   If things go poorly for the firm, increased leverage provides greater returns to shareholders (as measured by ROE and EPS) .
C)   As a firm levers up, shareholders are exposed to greater risk.
D)   The benefits of leverage will not be as great in a firm with substantial accumulated losses or other types of tax shields compared to a firm without many tax shields.
E)   Beyond a certain point, the costs of financial distress outweigh the benefits of leverage.

Question 6

According to the absolute priority rule, the correct order of distribution in liquidation is:
Administrative expenses of the bankruptcy, Employee wages, Government taxes Unsecured creditors.

Accepted Answer

A) True 
 B)False

Question 7

In a(n)  ______________ a business is liquidated, usually at a loss for the creditors.

Accepted Answer

A)   Violation of protective covenants.
B)   Legal bankruptcy.
C)   Technical insolvency.
D)   Accounting insolvency.
E)   Business failure.

Question 8

Wild Flowers Express has a debt-equity ratio of.60. The pre-tax cost of debt is 9% while the unlevered cost of capital is 14%. What is the cost of equity if the tax rate is 34%?

Accepted Answer

A)   7.52%
B)   8.78%
C)   15.98%
D)   16.83%
E)   17.30%

Question 9

A firm has 30,000 shares of stock outstanding, $450,000 in debt at a 9% rate, an EBIT of $112,000, and a tax rate of 0%. What is the EPS?

Accepted Answer

A)   $2.38
B)   $2.51
C)   $2.87
D)   $3.36
E)   $3.73

Question 10

A large depreciation tax deduction will tend to diminish the benefit of the interest tax shield.

Accepted Answer

A) True 
 B)False

Question 11

Which of the following is the best definition of direct bankruptcy costs?

Accepted Answer

A)   The costs that are directly associated with bankruptcy, such as legal and administrative expenses.
B)   The cost of capital of a firm that has no debt.
C)   Theory that a firm borrows up to the point where the tax benefit from an extra dollar in debt is exactly equal to the cost that comes from the increased probability of financial distress.
D)   The equity risk that comes from the nature of the firm's operating activities.
E)   The tax saving attained by a firm from interest expense.

Question 12

Martha White's Fabrics is currently an all equity firm that has 15,000 shares of stock outstanding at a market price of $12.50 a share. Company management has decided to issue $50,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 9%. What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes.

Accepted Answer

A)   $1.005
B)   $1.125
C)   $1.175
D)   $1.200
E)   $1.250

Question 13

Lucky Day Campgrounds has expected earnings before interest and taxes of $6,200, an unlevered cost of capital of 12%, and a tax rate of 35%. The company also has $24,000 of debt that carries an 8% coupon. The debt is selling at par value. What is the value of this firm?

Accepted Answer

A)   $32,609
B)   $34,811
C)   $37,141
D)   $39,617
E)   $41,983

Question 14

According to __________, a firm's cost of equity increases with greater debt financing, while the WACC first decreases and then increases.

Accepted Answer

A)   M&M Proposition I with taxes.
B)   M&M Proposition I without taxes.
C)   The static theory of capital structure.
D)   M&M Proposition II without taxes.
E)   M&M Proposition II with taxes.

Question 15

Roger's Trucking is currently an all equity firm that has 24,000 shares of stock outstanding at a market price of $50 a share. The firm has decided to leverage its operations by issuing $280,000 of debt at an interest rate of 8%. This new debt will be used to repurchase shares of the outstanding stock. The restructuring is expected to increase the earnings per share. What is the minimum level of earnings before interest and taxes that Roger's is expecting? Ignore taxes.

Accepted Answer

A)   $72,500
B)   $77,778
C)   $86,667
D)   $96,000
E)   $101,333

Question 16

Which of the following is the best definition of unlevered cost of capital (RU) ?

Accepted Answer

A)   The costs that are directly associated with bankruptcy, such as legal and administrative expenses.
B)   The cost of capital of a firm that has no debt.
C)   Theory that a firm borrows up to the point where the tax benefit from an extra dollar in debt is exactly equal to the cost that comes from the increased probability of financial distress.
D)   The equity risk that comes from the nature of the firm's operating activities.
E)   The tax saving attained by a firm from interest expense.

Question 17

You are a secured creditor in a bankruptcy liquidation. Listed below, in chronological order, are the steps in the bankruptcy proceeding. Just prior to which step would you expect to have to document the strength of your claim on the firm's assets?

Accepted Answer

A)   The corporation files a bankruptcy petition.
B)   A trustee in bankruptcy is elected.
C)   Assets are liquidated and bankruptcy administration costs are paid.
D)   The proceeds are distributed among creditors.
E)   Residual payments are made to shareholders.

Question 18

The legal proceeding for liquidating or reorganizing a firm operating in default is called a:

Accepted Answer

A)   Tender offer.
B)   Bankruptcy.
C)   Merger.
D)   Takeover.
E)   Proxy fight.

Question 19

Swedish Imports is an unlevered firm with an after-tax net income of $79,000. The unlevered cost of capital is 12% and the tax rate is 35%. What is the value of this firm?

Accepted Answer

A)   $427,916
B)   $514,250
C)   $579,333
D)   $611,407
E)   $658,333

Question 20

Which of the following is the best definition of financial distress costs?

Accepted Answer

A)   A legal proceeding for liquidating or reorganizing a business. Also, the transfer of some or all of a firm's assets to its creditors.
B)   The direct and indirect costs associated with going bankrupt or experiencing financial distress.
C)   The equity risk that comes from the financial policy (i.e., capital structure)  of the firm.
D)   The use of personal borrowing to change the overall amount of financial leverage to which the individual is exposed.
E)   The difficulties of running a business that is experiencing financial distress.

Exam 16: Financial Leverage and Capital Structure Policy

Which of the following is true regarding bankruptcy?

Correct Answer
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You are a secured creditor in a bankruptcy liquidation. Listed below, in chronological order, are the steps in the bankruptcy proceeding. Just prior to which step would you expect to have to document the strength of your claim on the firm's assets?

Correct Answer
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Swedish Imports is an unlevered firm with an after-tax net income of $79,000. The unlevered cost of capital is 12% and the tax rate is 35%. What is the value of this firm?

Correct Answer
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Which of the following is the best definition of unlevered cost of capital (RU) ?

Correct Answer
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Which of the following statements regarding leverage is false?

Correct Answer
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Correct Answer
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When taxes are factored in, debt financing increases the value of a firm.

Correct Answer
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Wild Flowers Express has a debt-equity ratio of.60. The pre-tax cost of debt is 9% while the unlevered cost of capital is 14%. What is the cost of equity if the tax rate is 34%?

Correct Answer
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A large depreciation tax deduction will tend to diminish the benefit of the interest tax shield.

Correct Answer
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Lucky Day Campgrounds has expected earnings before interest and taxes of $6,200, an unlevered cost of capital of 12%, and a tax rate of 35%. The company also has $24,000 of debt that carries an 8% coupon. The debt is selling at par value. What is the value of this firm?

Correct Answer
verified

The interest tax shield has no value for a firm when the debt-equity ratio is exactly equal to 1.

Correct Answer
verified

The legal proceeding for liquidating or reorganizing a firm operating in default is called a:

Correct Answer
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The optimal capital structure has been achieved when the:

Correct Answer
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A firm has 30,000 shares of stock outstanding, $450,000 in debt at a 9% rate, an EBIT of $112,000, and a tax rate of 0%. What is the EPS?

Correct Answer
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Which of the following is the best definition of financial distress costs?

Correct Answer
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Correct Answer
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Which of the following is the best definition of direct bankruptcy costs?

Correct Answer
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According to the absolute priority rule, the correct order of distribution in liquidation is: Administrative expenses of the bankruptcy, Employee wages, Government taxes Unsecured creditors.

Correct Answer
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In a(n) ______________ a business is liquidated, usually at a loss for the creditors.

Correct Answer
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According to __________, a firm's cost of equity increases with greater debt financing, while the WACC first decreases and then increases.

Correct Answer
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Exam 16: Financial Leverage and Capital Structure Policy

Which of the following is true regarding bankruptcy?

Correct AnswerverifiedShow Answer

You are a secured creditor in a bankruptcy liquidation. Listed below, in chronological order, are the steps in the bankruptcy proceeding. Just prior to which step would you expect to have to document the strength of your claim on the firm's assets?

Correct AnswerverifiedShow Answer

Swedish Imports is an unlevered firm with an after-tax net income of $79,000. The unlevered cost of capital is 12% and the tax rate is 35%. What is the value of this firm?

Correct AnswerverifiedShow Answer

Which of the following is the best definition of unlevered cost of capital (RU) ?

Correct AnswerverifiedShow Answer

Which of the following statements regarding leverage is false?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

When taxes are factored in, debt financing increases the value of a firm.

Correct AnswerverifiedShow Answer

Wild Flowers Express has a debt-equity ratio of.60. The pre-tax cost of debt is 9% while the unlevered cost of capital is 14%. What is the cost of equity if the tax rate is 34%?

Correct AnswerverifiedShow Answer

A large depreciation tax deduction will tend to diminish the benefit of the interest tax shield.

Correct AnswerverifiedShow Answer

Lucky Day Campgrounds has expected earnings before interest and taxes of $6,200, an unlevered cost of capital of 12%, and a tax rate of 35%. The company also has $24,000 of debt that carries an 8% coupon. The debt is selling at par value. What is the value of this firm?

Correct AnswerverifiedShow Answer

The interest tax shield has no value for a firm when the debt-equity ratio is exactly equal to 1.

Correct AnswerverifiedShow Answer

The legal proceeding for liquidating or reorganizing a firm operating in default is called a:

Correct AnswerverifiedShow Answer

The optimal capital structure has been achieved when the:

Correct AnswerverifiedShow Answer

A firm has 30,000 shares of stock outstanding, $450,000 in debt at a 9% rate, an EBIT of $112,000, and a tax rate of 0%. What is the EPS?

Correct AnswerverifiedShow Answer

Which of the following is the best definition of financial distress costs?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following is the best definition of direct bankruptcy costs?

Correct AnswerverifiedShow Answer

According to the absolute priority rule, the correct order of distribution in liquidation is: Administrative expenses of the bankruptcy, Employee wages, Government taxes Unsecured creditors.

Correct AnswerverifiedShow Answer

In a(n) ______________ a business is liquidated, usually at a loss for the creditors.

Correct AnswerverifiedShow Answer

According to __________, a firm's cost of equity increases with greater debt financing, while the WACC first decreases and then increases.

Correct AnswerverifiedShow Answer

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