Question 1

Which one of the following is the equity risk arising from the daily operations of a firm?

Accepted Answer

A)  liquidity risk
B)  financial risk
C)  strategic risk
D)  business risk
E)  industry riskF) A) and E)
G) D) and E)

Question 2

Barrier Reef Island Resorts has no debt.Its current total value is $58 million.What will the company's value be if it sells $21 million in debt securities and has a tax rate of 30 per cent,assuming that the proceeds will be used to purchase equity?

Accepted Answer

A)  $51 700 000
B)  $60 300 000
C)  $62 300 000
D)  $64 300 000
E)  $65 140 000F) A) and B)
G) A) and C)

Question 3

Eastcoast Transport Ltd can borrow at 7.5 per cent.The firm currently has no debt,and the cost of equity is 16 per cent.The current value of the firm is $540 000.What will the value be if the firm borrows $160 000 and uses the proceeds to repurchase shares? The corporate tax rate is 34 per cent.

Accepted Answer

A)  $528 000
B)  $552 000
C)  $571 000
D)  $540 000
E)  $594 400F) D) and E)
G) A) and D)

Question 4

Which one of the following terms refers to the termination of a firm as a going concern?

Accepted Answer

A)  accounting insolvency
B)  liquidation
C)  technical insolvency
D)  legal bankruptcy
E)  reorganisationF) None of the above
G) A) and B)

Question 5

A firm's optimal capital structure:

Accepted Answer

A)  is the debt-equity ratio that results in the lowest possible weighted average cost of capital
B)  exists when the debt-equity ratio is 0.50
C)  is found by locating the mix of debt and equity which causes the earnings per share to equal exactly $1
D)  is the debt-equity ratio that exists at the point where the firm's weighted after-tax cost of debt is minimised
E)  is generally a mix of 40 per cent debt and 60 per cent equityF) A) and B)
G) None of the above

Question 6

Which of the following statements correctly relate to M&M Proposition I,with taxes?
I.Debt decreases the value of a firm.
II.The levered value of a firm exceeds the firm's unlevered value.
III.The weighted average cost of capital (WACC) is constant.
IV.The optimal capital structure is zero debt.

Accepted Answer

A)  II only
B)  I,III,and IV only
C)  I and IV only
D)  I only
E)  II and III onlyF) A) and E)
G) A) and D)

Question 7

Manly Manufacturing is comparing two different capital structures.Plan I would result in 23 000 shares and $320 000 in debt.Plan II would result in 17 000 shares and $260 000 in debt.The interest rate on the debt is 10 per cent.Ignoring taxes,EPS will be identical for Plans I and II when EBIT equals which one of the following?

Accepted Answer

A)  $9000
B)  $10 750
C)  $8550
D)  $10 400
E)  $9600F) A) and C)
G) A) and B)

Question 8

Day 'n Nite currently has 25 000 shares of stock outstanding and no debt.The price per share is $20.The firm is considering borrowing funds at 8 per cent interest and using the proceeds to repurchase 5000 shares of stock.Ignore taxes.How much is the firm borrowing?

Accepted Answer

A)  $180 000
B)  $140 000
C)  $100 000
D)  $165 000
E)  $185 000F) B) and D)
G) A) and E)

Question 9

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Accepted Answer

A)  industry risk
B)  strategic risk
C)  business risk
D)  financial risk
E)  liquidity riskF) A) and D)
G) B) and E)

Question 10

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?

Accepted Answer

A)  M&M Proposition I,with taxes
B)  M&M Proposition II,with taxes
C)  M&M Proposition I,without taxes
D)  static theory of capital structure
E)  homemade leverage propositionF) C) and E)
G) D) and E)

Question 11

If we observe capital structures across the industries in Australia,what industry typically has the highest debt-equity ratios,excluding banks?

Accepted Answer

A)  property trusts
B)  capital goods
C)  gold mining
D)  food and staples retailing
E)  utilitiesF) A) and D)
G) C) and E)

Question 12

Assume that you are comparing two firms which are identical,with one exception.Firm A is an all-equity firm and firm B has a debt-equity ratio of 0.60.All else equal,firm A will:

Accepted Answer

A)  generate a higher EBIT,but lower net income than firm B
B)  generate a lower EBIT,but higher net income than firm B
C)  always have higher EPS than firm B,since it has no interest expense
D)  have lower EPS than firm B when the level of earnings before interest and taxes (EBIT) is relatively high
E)  have lower EPS than firm B when the level of EBIT is relatively lowF) A) and B)
G) A) and C)

Question 13

Which one of the following represents the present value of the interest tax shield?

Accepted Answer

A)  D / Tc
B)  D ´(1 - Tc) 
C)  D/(1 - Tc) 
D)  D - D(Tc) 
E)  TC ´DF) A) and D)
G) A) and C)

Question 14

The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as:

Accepted Answer

A)  homemade leverage
B)  capital restructuring
C)  M&M Proposition II
D)  financial risk management
E)  M&M Proposition IF) A) and B)
G) B) and E)

Question 15

Which one of the following statements matches M&M Proposition I?

Accepted Answer

A)  The value of a firm is independent of the firm's capital structure.
B)  The cost of equity capital has a positive linear relationship with a firm's capital structure.
C)  The value of a firm is dependent on the firm's capital structure.
D)  The cost of equity capital varies in response to changes in a firm's capital structure.
E)  The dividends paid by a firm determine the firm's value.F) A) and E)
G) All of the above

Question 16

Which of the following will increase the value of a levered firm according to M&M Proposition I,with taxes?
I.decrease in the amount of the debt
II.increase in the value of the unlevered firm
III.decrease in the tax rate
IV.increase in the interest rate on the debt

Accepted Answer

A)  II and IV only
B)  I and IV only
C)  II,III,and IV only
D)  II and III only
E)  II onlyF) C) and D)
G) B) and C)

Question 17

Bankruptcy is best defined as:

Accepted Answer

A)  the termination of a going concern
B)  the failure of a firm to meet its financial obligations in a timely manner
C)  a legal proceeding for liquidating or reorganising a business
D)  a legal process for revising the capital structure of a firm
E)  the process of closing a business due to the inability to meet financial obligationsF) C) and D)
G) D) and E)

Question 18

Blue & Co.is an all-equity firm with a total market value of $230 000.The firm has 25 000 shares outstanding.Management is considering issuing $100 000 of debt at an interest rate of 7 per cent and using the proceeds to repurchase shares.Management estimates that the economy will be fairly normal and thus the firm's earnings before interest and taxes (EBIT) will be $60 000.Ignore taxes.What are the anticipated earnings per share (EPS) if the debt is issued?

Accepted Answer

A)  $3.20
B)  $3.54
C)  $3.75
D)  $3.46
E)  $3.82F) C) and E)
G) C) and D)

Question 19

Southern Fried Foods has a $12 million bond issue outstanding with a coupon rate of 6.75 per cent and a yield-to-maturity of 7.27 per cent.What is the present value of the tax shield if the tax rate is 35 per cent?

Accepted Answer

A)  $283 500
B)  $3 053 400
C)  $3 560 000
D)  $305 340
E)  $4 200 000F) A) and B)
G) B) and D)

Question 20

Paying interest reduces the taxes owed by a firm.Which one of the following terms applies to this relationship?

Accepted Answer

A)  financial risk
B)  M&M Proposition I
C)  interest tax shield
D)  static theory of interest rates
E)  homemade leverageF) C) and D)
G) All of the above

Exam 13: Leverage and Capital Structure

Which one of the following is the equity risk arising from the daily operations of a firm?

Correct Answer
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A firm's optimal capital structure:

Correct Answer
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Assume that you are comparing two firms which are identical,with one exception.Firm A is an all-equity firm and firm B has a debt-equity ratio of 0.60.All else equal,firm A will:

Correct Answer
verified

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Correct Answer
verified

Bankruptcy is best defined as:

Correct Answer
verified

Correct Answer
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Barrier Reef Island Resorts has no debt.Its current total value is $58 million.What will the company's value be if it sells $21 million in debt securities and has a tax rate of 30 per cent,assuming that the proceeds will be used to purchase equity?

Correct Answer
verified

Day 'n Nite currently has 25 000 shares of stock outstanding and no debt.The price per share is $20.The firm is considering borrowing funds at 8 per cent interest and using the proceeds to repurchase 5000 shares of stock.Ignore taxes.How much is the firm borrowing?

Correct Answer
verified

Correct Answer
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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?

Correct Answer
verified

Which of the following will increase the value of a levered firm according to M&M Proposition I,with taxes? I.decrease in the amount of the debt II.increase in the value of the unlevered firm III.decrease in the tax rate IV.increase in the interest rate on the debt

Correct Answer
verified

If we observe capital structures across the industries in Australia,what industry typically has the highest debt-equity ratios,excluding banks?

Correct Answer
verified

Which one of the following represents the present value of the interest tax shield?

Correct Answer
verified

Which one of the following terms refers to the termination of a firm as a going concern?

Correct Answer
verified

Eastcoast Transport Ltd can borrow at 7.5 per cent.The firm currently has no debt,and the cost of equity is 16 per cent.The current value of the firm is $540 000.What will the value be if the firm borrows $160 000 and uses the proceeds to repurchase shares? The corporate tax rate is 34 per cent.

Correct Answer
verified

Which one of the following statements matches M&M Proposition I?

Correct Answer
verified

Which of the following statements correctly relate to M&M Proposition I,with taxes? I.Debt decreases the value of a firm. II.The levered value of a firm exceeds the firm's unlevered value. III.The weighted average cost of capital (WACC) is constant. IV.The optimal capital structure is zero debt.

Correct Answer
verified

Southern Fried Foods has a $12 million bond issue outstanding with a coupon rate of 6.75 per cent and a yield-to-maturity of 7.27 per cent.What is the present value of the tax shield if the tax rate is 35 per cent?

Correct Answer
verified

The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as:

Correct Answer
verified

Paying interest reduces the taxes owed by a firm.Which one of the following terms applies to this relationship?

Correct Answer
verified

Exam 13: Leverage and Capital Structure

Which one of the following is the equity risk arising from the daily operations of a firm?

Correct AnswerverifiedShow Answer

A firm's optimal capital structure:

Correct AnswerverifiedShow Answer

Assume that you are comparing two firms which are identical,with one exception.Firm A is an all-equity firm and firm B has a debt-equity ratio of 0.60.All else equal,firm A will:

Correct AnswerverifiedShow Answer

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Correct AnswerverifiedShow Answer

Bankruptcy is best defined as:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Barrier Reef Island Resorts has no debt.Its current total value is $58 million.What will the company's value be if it sells $21 million in debt securities and has a tax rate of 30 per cent,assuming that the proceeds will be used to purchase equity?

Correct AnswerverifiedShow Answer

Day 'n Nite currently has 25 000 shares of stock outstanding and no debt.The price per share is $20.The firm is considering borrowing funds at 8 per cent interest and using the proceeds to repurchase 5000 shares of stock.Ignore taxes.How much is the firm borrowing?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

Which of the following will increase the value of a levered firm according to M&M Proposition I,with taxes? I.decrease in the amount of the debt II.increase in the value of the unlevered firm III.decrease in the tax rate IV.increase in the interest rate on the debt

Correct AnswerverifiedShow Answer

If we observe capital structures across the industries in Australia,what industry typically has the highest debt-equity ratios,excluding banks?

Correct AnswerverifiedShow Answer

Which one of the following represents the present value of the interest tax shield?

Correct AnswerverifiedShow Answer

Which one of the following terms refers to the termination of a firm as a going concern?

Correct AnswerverifiedShow Answer

Eastcoast Transport Ltd can borrow at 7.5 per cent.The firm currently has no debt,and the cost of equity is 16 per cent.The current value of the firm is $540 000.What will the value be if the firm borrows $160 000 and uses the proceeds to repurchase shares? The corporate tax rate is 34 per cent.

Correct AnswerverifiedShow Answer

Which one of the following statements matches M&M Proposition I?

Correct AnswerverifiedShow Answer

Which of the following statements correctly relate to M&M Proposition I,with taxes? I.Debt decreases the value of a firm. II.The levered value of a firm exceeds the firm's unlevered value. III.The weighted average cost of capital (WACC) is constant. IV.The optimal capital structure is zero debt.

Correct AnswerverifiedShow Answer

Southern Fried Foods has a $12 million bond issue outstanding with a coupon rate of 6.75 per cent and a yield-to-maturity of 7.27 per cent.What is the present value of the tax shield if the tax rate is 35 per cent?

Correct AnswerverifiedShow Answer

The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as:

Correct AnswerverifiedShow Answer

Paying interest reduces the taxes owed by a firm.Which one of the following terms applies to this relationship?

Correct AnswerverifiedShow Answer

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