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Exam 12: Capital Structure Decisions

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Question 21

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If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal.

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Question 22

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The benefit of an interest tax shield is captured by the equity holders, not the debt-holders.

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Question 23

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If the value of a levered firm is $5 million, what is the value of the same firm with all-equity financing?

Which of the following statements is correct, other things held constant?

Financial risk refers to the extra risk shareholders bear as a result of using debt as compared with the risk they would bear if no debt were used.

Which of the following statements is correct?

Senbet Ventures is considering starting a new company to produce stereos. The sales price would be set at 1.5 times the variable cost per unit; the VC/unit is estimated to be $2.50; and fixed costs are estimated at $120,000. What sales volume would be required in order to break even, i.e., to have an EBIT of zero for the stereo business?

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

Firms having positive prospects try to raise new equity capital by selling new stocks.

Elephant Books sells paperback books for $7 each. The variable cost per book is $5. At current annual sales of 200,000 books, the publisher is just breaking even. It is estimated that if the authors' royalties are reduced, the variable cost per book will drop by $1. Assume authors' royalties are reduced and sales remain constant; how much more money can the publisher put into advertising (a fixed cost) and still break even?

A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.

An increase in the debt ratio will generally have no effect on which of the following items?

The trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

Vafeas Inc.'s capital structure consists of 80% debt and 20% common equity, and it has a beta of 1.60, and its tax rate of 35%. However, the CFO thinks the company has too much debt, and he is considering moving to a capital structure with 40% debt and 60% equity. The risk-free rate is 5.0% and the market risk premium is 6.0%. By how much would the capital structure shift change the firm's cost of equity?

Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.

Which of the following statements is correct?

If a firm utilizes debt financing, an X% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than X.

Given that corporate tax rate is 34%, personal tax rate on interest income is 10%, and personal tax rate on equity income is 50%, how much value will leverage add to the unlevered firm per dollar of debt?

A group of venture investors is considering putting money into Lemma Books, which wants to produce a new reader for electronic books. The variable cost per unit is estimated at $250, the sales price would be set at twice the VC/unit, fixed costs are estimated at $750,000, and the investors will put up the funds if the project is likely to have an operating income of $500,000 or more. What sales volume would be required in order to meet this profit goal?

Which of the following statements best describes WACC?