Question 1

The unlevered cost of capital is _________________.

Accepted Answer

A)   The cost of capital for a ﬁrm with no equity in its capital structure.
B)   The cost of capital for a ﬁrm with no debt in its capital structure.
C)   The interest tax shield times pretax net income.
D)   The cost of preferred stock for a ﬁrm with equal parts debt and common stock in its capital structure.
E)   Equal to the proﬁt margin for a ﬁrm with some debt in its capital structure.F) B) and E)
G) B) and C)

Question 2

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 3

As ﬁnancial risk increases so too does the cost of equity.

Accepted Answer

A) True 
 B)False

Question 4

Which of the following is the best deﬁnition of M&M Proposition I?

Accepted Answer

A)   The tax saving attained by a ﬁrm from interest expense.
B)   Termination of the ﬁrm as a going concern.
C)   The value of the ﬁrm is independent of its capital structure.
D)   A ﬁrm's cost of equity capital is a positive linear function of its capital structure.
E)   Financial restructuring of a failing ﬁrm to attempt to continue operations as a going concern.F) All of the above
G) B) and D)

Question 5

Which of the following is the best deﬁnition of interest tax shield?

Accepted Answer

A)   The tax saving attained by a ﬁrm from interest expense.
B)   Termination of the ﬁrm as a going concern.
C)   The value of the ﬁrm is independent of its capital structure.
D)   A ﬁrm's cost of equity capital is a positive linear function of its capital structure.
E)   Financial restructuring of a failing ﬁrm to attempt to continue operations as a going concern.F) B) and D)
G) C) and E)

Question 6

M&M Proposition II with no tax states that a ﬁrm's cost of equity is dependent upon the required
rate of return on the ﬁrm's assets.

Accepted Answer

A) True 
 B)False

Question 7

A ﬁrm has a tax rate of 35%, an unlevered rate of return of 14%, total debt of $1,000, and an EBIT of $300.00. What is the unlevered value of the ﬁrm?

Accepted Answer

A)   $27
B)   $393
C)   $1,027
D)   $1,393
E)   $2,143F) B) and E)
G) A) and B)

Question 8

There are no taxes. EBIT is expected to be $2.5 million, but could be as high as $3.5 million if an economic expansion occurs, or as low as $2 million if a recession occurs. All values are market
Values.
How many shares are outstanding under the proposed capital structure?

Accepted Answer

A)   100,000
B)   200,000
C)   300,000
D)   400,000
E)   500,000F) A) and E)
G) A) and D)

Question 9

According to _________, the value of the ﬁrm is independent of its capital structure.

Accepted Answer

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

Question 10

The equity risk derived from the ﬁrm's operating activities is called ____________ risk.

Accepted Answer

A)   market
B)   systematic
C)   extrinsic
D)   business
E)   ﬁnancialF) B) and E)
G) A) and D)

Question 11

The procedure for liquidating a corporation is outlined in:

Accepted Answer

A)   The Bankruptcy and Insolvency Act.
B)   The BNA Act.
C)   The Canadian Constitution.
D)   The Corporation Liquidation Act.
E)   The Small Business Reform Act.F) A) and C)
G) B) and D)

Question 12

A Mississauga ﬁrm has debt of $18,000, equity of $42,000, a cost of debt of 7.5%, a cost of equity of 11.6%, and a tax rate of 34%. What is the ﬁrm's weighted average cost of capital?

Accepted Answer

A)   9.03%
B)   9.11%
C)   9.38%
D)   9.46%
E)   9.61%F) A) and D)
G) B) and C)

Question 13

Which of the following is the best deﬁnition of bankruptcy?

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.F) B) and E)
G) B) and D)

Question 14

There are no taxes. EBIT is expected to be $2.5 million, but could be as high as $3.5 million if an economic expansion occurs, or as low as $2 million if a recession occurs. All values are market
Values.
What is EPS during an expansion for the proposed capital structure?

Accepted Answer

A)   $4.17
B)   $5.00
C)   $5.83
D)   $6.00
E)   $7.55F) C) and E)
G) D) and E)

Question 15

China Importers has $267,000 of debt outstanding that is selling at par and has a coupon rate of 9.5%. The tax rate is 35%. What is the present value of the tax shield?

Accepted Answer

A)   $8,878
B)   $16,487
C)   $93,450
D)   $148,020
E)   $173,550F) A) and D)
G) C) and D)

Question 16

What are the advantages for a ﬁrm using a pre-packaged bankruptcy? Disadvantages?

Accepted Answer

A prepack allows a ﬁrm to minimize its s...

Question 17

UNLEV has an expected perpetual EBIT = $4,000. The unlevered cost of capital = 15% and there are 20,000 shares of stock outstanding. The ﬁrm is considering issuing $8,800 in new par bonds to
Add ﬁnancial leverage to the ﬁrm. The proceeds of the debt issue will be used to repurchase equity.
The cost of debt = 10% and the tax rate = 34%. There are no ﬂotation costs.
Including the effect of taxes, what is the value of UNLEV before the restructuring?

Accepted Answer

A)   $15,930
B)   $17,600
C)   $18,519
D)   $26,667
E)   $30,000F) A) and E)
G) A) and D)

Question 18

The fact that individual investors can alter the amount of ﬁnancial leverage to which they are exposed is referred to as:

Accepted Answer

A)   Capital structure targeting.
B)   Adjusting the business risk.
C)   The static theory of capital structure.
D)   Homemade leverage.
E)   M&M Proposition II.F) C) and D)
G) A) and D)

Question 19

Which of the following is NOT accurate regarding ﬁnancial leverage?

Accepted Answer

A)   Whenever a ﬁrm's debt increases faster than its equity, ﬁnancial leverage increases.
B)   Leverage is most beneﬁcial when EBIT is relatively high.
C)   Investors can undo the effects of the ﬁrm's capital structure by using homemade leverage.
D)   Increasing ﬁnancial leverage will always increase the EPS for stockholders.
E)   The level of ﬁnancial leverage that produces the highest ﬁrm value is the one most beneﬁcial to stockholders.F) A) and B)
G) C) and D)

Question 20

The concept of homemade leverage is most associated with:

Accepted Answer

A)   M&M Proposition I with no tax.
B)   M&M Proposition II with no tax.
C)   M&M Proposition I with tax.
D)   M&M Proposition II with tax.
E)   Static theory proposition.F) None of the above
G) A) and E)

Exam 16: Financial Leverage and Capital Structure Policy

As ﬁnancial risk increases so too does the cost of equity.

Correct Answer
verified

Which of the following is NOT accurate regarding ﬁnancial leverage?

Correct Answer
verified

There are no taxes. EBIT is expected to be $2.5 million, but could be as high as $3.5 million if an economic expansion occurs, or as low as $2 million if a recession occurs. All values are market Values. What is EPS during an expansion for the proposed capital structure?

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

Which of the following is the best deﬁnition of interest tax shield?

Correct Answer
verified

Which of the following is the best deﬁnition of M&M Proposition I?

Correct Answer
verified

M&M Proposition II with no tax states that a ﬁrm's cost of equity is dependent upon the required rate of return on the ﬁrm's assets.

Correct Answer
verified

The equity risk derived from the ﬁrm's operating activities is called ____________ risk.

Correct Answer
verified

A ﬁrm has a tax rate of 35%, an unlevered rate of return of 14%, total debt of $1,000, and an EBIT of $300.00. What is the unlevered value of the ﬁrm?

Correct Answer
verified

The unlevered cost of capital is _________________.

Correct Answer
verified

According to _________, the value of the ﬁrm is independent of its capital structure.

Correct Answer
verified

China Importers has $267,000 of debt outstanding that is selling at par and has a coupon rate of 9.5%. The tax rate is 35%. What is the present value of the tax shield?

Correct Answer
verified

There are no taxes. EBIT is expected to be $2.5 million, but could be as high as $3.5 million if an economic expansion occurs, or as low as $2 million if a recession occurs. All values are market Values. How many shares are outstanding under the proposed capital structure?

Correct Answer
verified

The concept of homemade leverage is most associated with:

Correct Answer
verified

A Mississauga ﬁrm has debt of $18,000, equity of $42,000, a cost of debt of 7.5%, a cost of equity of 11.6%, and a tax rate of 34%. What is the ﬁrm's weighted average cost of capital?

Correct Answer
verified

Which of the following is the best deﬁnition of bankruptcy?

Correct Answer
verified

The fact that individual investors can alter the amount of ﬁnancial leverage to which they are exposed is referred to as:

Correct Answer
verified

What are the advantages for a ﬁrm using a pre-packaged bankruptcy? Disadvantages?

Correct Answer
verified
A prepack allows a ﬁrm to minimize its s...
View Answer

Correct Answer
verified

The procedure for liquidating a corporation is outlined in:

Correct Answer
verified

Exam 16: Financial Leverage and Capital Structure Policy

As ﬁnancial risk increases so too does the cost of equity.

Correct AnswerverifiedShow Answer

Which of the following is NOT accurate regarding ﬁnancial leverage?

Correct AnswerverifiedShow Answer

There are no taxes. EBIT is expected to be $2.5 million, but could be as high as $3.5 million if an economic expansion occurs, or as low as $2 million if a recession occurs. All values are market Values. What is EPS during an expansion for the proposed capital structure?

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

Which of the following is the best deﬁnition of interest tax shield?

Correct AnswerverifiedShow Answer

Which of the following is the best deﬁnition of M&M Proposition I?

Correct AnswerverifiedShow Answer

M&M Proposition II with no tax states that a ﬁrm's cost of equity is dependent upon the required rate of return on the ﬁrm's assets.

Correct AnswerverifiedShow Answer

The equity risk derived from the ﬁrm's operating activities is called ____________ risk.

Correct AnswerverifiedShow Answer

A ﬁrm has a tax rate of 35%, an unlevered rate of return of 14%, total debt of $1,000, and an EBIT of $300.00. What is the unlevered value of the ﬁrm?

Correct AnswerverifiedShow Answer

The unlevered cost of capital is _________________.

Correct AnswerverifiedShow Answer

According to _________, the value of the ﬁrm is independent of its capital structure.

Correct AnswerverifiedShow Answer

China Importers has $267,000 of debt outstanding that is selling at par and has a coupon rate of 9.5%. The tax rate is 35%. What is the present value of the tax shield?

Correct AnswerverifiedShow Answer

There are no taxes. EBIT is expected to be $2.5 million, but could be as high as $3.5 million if an economic expansion occurs, or as low as $2 million if a recession occurs. All values are market Values. How many shares are outstanding under the proposed capital structure?

Correct AnswerverifiedShow Answer

The concept of homemade leverage is most associated with:

Correct AnswerverifiedShow Answer

A Mississauga ﬁrm has debt of $18,000, equity of $42,000, a cost of debt of 7.5%, a cost of equity of 11.6%, and a tax rate of 34%. What is the ﬁrm's weighted average cost of capital?

Correct AnswerverifiedShow Answer

Which of the following is the best deﬁnition of bankruptcy?

Correct AnswerverifiedShow Answer

The fact that individual investors can alter the amount of ﬁnancial leverage to which they are exposed is referred to as:

Correct AnswerverifiedShow Answer

What are the advantages for a ﬁrm using a pre-packaged bankruptcy? Disadvantages?

Correct AnswerverifiedA prepack allows a ﬁrm to minimize its s...View AnswerShow Answer

Correct AnswerverifiedShow Answer

The procedure for liquidating a corporation is outlined in:

Correct AnswerverifiedShow Answer

Correct Answer
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Correct Answer
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A prepack allows a ﬁrm to minimize its s...
View Answer

Correct Answer
verified

Correct Answer
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