Question 1

Holly's is currently an all equity firm that has 9,000 shares of stock outstanding at a market price of $45 a share.The firm has decided to leverage its operations by issuing $120,000 of debt at an interest rate of 9.5 percent.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 the firm is expecting? Ignore taxes.

Accepted Answer

A)  $38,475
B)  $40,516
C)  $42,000
D)  $44,141
E)  $45,020F) B) and E)
G) A) and B)

Question 2

North Side, Inc.has no debt outstanding and a total market value of $175,000.Earnings before interest and taxes, EBIT, are projected to be $16,000 if economic conditions are normal.If there is strong expansion in the economy, then EBIT will be 30 percent higher.If there is a recession, then EBIT will be 70 percent lower.North Side is considering a $70,000 debt issue with a 7 percent interest rate.The proceeds will be used to repurchase shares of stock.There are currently 2,500 shares outstanding.North Side has a tax rate of 34 percent.If the economy expands strongly, EPS will change by ____ percent as compared to a normal economy, assuming that the firm recapitalizes.

Accepted Answer

A)  38.80 percent
B)  41.26 percent
C)  43.24 percent
D)  50.45 percent
E)  53.92 percentF) A) and E)
G) A) and D) C

Question 3

AA Tours is comparing two capital structures to determine how to best finance its operations.The first option consists of all equity financing.The second option is based on a debt-equity ratio of 0.45.What should AA Tours do if its expected earnings before interest and taxes (EBIT)  are less than the break-even level? Assume there are no taxes.

Accepted Answer

A)  select the leverage option because the debt-equity ratio is less than 0.50
B)  select the leverage option since the expected EBIT is less than the break-even level
C)  select the unlevered option since the debt-equity ratio is less than 0.50
D)  select the unlevered option since the expected EBIT is less than the break-even level
E)  cannot be determined from the information providedF) A) and E)
G) A) and B)

Question 4

M & M Proposition II is the proposition that:

Accepted Answer

A)  the capital structure of a firm has no effect on the firm's value.
B)  the cost of equity depends on the return on debt, the debt-equity ratio, and the tax rate.
C)  a firm's cost of equity is a linear function with a slope equal to (RA - R
D)  .
D)  the cost of equity is equivalent to the required rate of return on a firm's assets.
E)  the size of the pie does not depend on how the pie is sliced.F) All of the above
G) B) and C) C

Question 5

Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business.The process this firm underwent is known as a:

Accepted Answer

A)  merger.
B)  repurchase program.
C)  liquidation.
D)  reorganization.
E)  divestiture.F) C) and D)
G) D) and E)

Question 6

Bankruptcy:

Accepted Answer

A)  creates value for a firm.
B)  transfers value from shareholders to bondholders.
C)  technically occurs when total equity equals total debt.
D)  costs are limited to legal and administrative fees.
E)  is an inexpensive means of reorganizing a firm.F) All of the above
G) A) and E)

Question 7

The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as _____ costs.

Accepted Answer

A)  flotation
B)  issue
C)  direct bankruptcy
D)  indirect bankruptcy
E)  unleveredF) B) and C)
G) None of the above

Question 8

The interest tax shield has no value when a firm has a:
I.tax rate of zero.
II.debt-equity ratio of 1.
III.zero debt.
IV.zero leverage.

Accepted Answer

A)  I and III only
B)  II and IV only
C)  I, III, and IV only
D)  II, III, and IV only
E)  I, II, and IV onlyF) All of the above
G) B) and D)

Question 9

D.L.Tuckers has $21,000 of debt outstanding that is selling at par and has a coupon rate of 7.5 percent.The tax rate is 32 percent.What is the present value of the tax shield?

Accepted Answer

A)  $504
B)  $615
C)  $644
D)  $6,200
E)  $6,720F) A) and D)
G) C) and E)

Question 10

Which one of the following is the legal proceeding under which an insolvent firm can be reorganized?

Accepted Answer

A)  restructure process
B)  bankruptcy
C)  forced merger
D)  legal takeover
E)  rights offerF) A) and E)
G) B) and D)

Question 11

The Corner Bakery has a debt-equity ratio of 0.62.The firm's required return on assets is 14.2 percent and its cost of equity is 16.1 percent.What is the pre-tax cost of debt based on M & M Proposition II with no taxes?

Accepted Answer

A)  7.10 percent
B)  10.68 percent
C)  11.14 percent
D)  17.56 percent
E)  18.40 percentF) B) and E)
G) A) and D)

Question 12

East Side, Inc.has no debt outstanding and a total market value of $136,000.Earnings before interest and taxes, EBIT, are projected to be $12,000 if economic conditions are normal.If there is strong expansion in the economy, then EBIT will be 27 percent higher.If there is a recession, then EBIT will be 55 percent lower.East Side is considering a $54,000 debt issue with a 5 percent interest rate.The proceeds will be used to repurchase shares of stock.There are currently 2,000 shares outstanding.Ignore taxes.If the economy enters a recession, EPS will change by ____ percent as compared to a normal economy, assuming that the firm recapitalizes.

Accepted Answer

A)  -70.97 percent
B)  -63.15 percent
C)  -58.08 percent
D)  -42.29 percent
E)  -38.87 percentF) B) and D)
G) A) and B)

Question 13

Jessica invested in Quantro stock when the firm was unlevered.Since then, Quantro has changed its capital structure and now has a debt-equity ratio of 0.30.To unlever her position, Jessica needs to:

Accepted Answer

A)  borrow some money and purchase additional shares of Quantro stock.
B)  maintain her current equity position as the debt of the firm did not affect her personally.
C)  sell some shares of Quantro stock and hold the proceeds in cash.
D)  sell some shares of Quantro stock and loan out the sale proceeds.
E)  create a personal debt-equity ratio of 0.30.F) B) and E)
G) C) and E)

Question 14

The value of a firm is maximized when the:

Accepted Answer

A)  cost of equity is maximized.
B)  tax rate is zero.
C)  levered cost of capital is maximized.
D)  weighted average cost of capital is minimized.
E)  debt-equity ratio is minimized.F) B) and C)
G) A) and E)

Question 15

M & M Proposition I with no tax supports the argument that:

Accepted Answer

A)  business risk determines the return on assets.
B)  the cost of equity rises as leverage rises.
C)  the debt-equity ratio of a firm is completely irrelevant.
D)  a firm should borrow money to the point where the tax benefit from debt is equal to the cost of the increased probability of financial distress.
E)  homemade leverage is irrelevant.F) C) and D)
G) A) and C)

Question 16

Which one of the following states that the value of a firm is unrelated to the firm's capital structure?

Accepted Answer

A)  Capital Asset Pricing Model
B)  M & M Proposition I
C)  M & M Proposition II
D)  Law of One Price
E)  Efficient Markets HypothesisF) C) and D)
G) C) and E)

Question 17

Young's Home Supply has a debt-equity ratio of 0.80.The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent.What will the firm's cost of equity be if the debt-equity ratio is revised to 0.70?

Accepted Answer

A)  10.89 percent
B)  11.47 percent
C)  11.70 percent
D)  13.89 percent
E)  13.97 percentF) B) and D)
G) B) and C) E

Question 18

Johnson Tire Distributors has debt with both a face and a market value of $12,000.This debt has a coupon rate of 6 percent and pays interest annually.The expected earnings before interest and taxes are $2,100, the tax rate is 30 percent, and the unlevered cost of capital is 11.7 percent.What is the firm's cost of equity?

Accepted Answer

A)  22.46 percent
B)  22.87 percent
C)  23.20 percent
D)  23.59 percent
E)  25.14 percentF) C) and E)
G) None of the above

Question 19

Which one of the following is the equity risk that is most related to the daily operations of a firm?

Accepted Answer

A)  market risk
B)  systematic risk
C)  extrinsic risk
D)  business risk
E)  financial riskF) A) and B)
G) A) and C)

Question 20

Based on M & M Proposition II with taxes, the weighted average cost of capital:

Accepted Answer

A)  is equal to the aftertax cost of debt.
B)  has a linear relationship with the cost of equity capital.
C)  is unaffected by the tax rate.
D)  decreases as the debt-equity ratio increases.
E)  is equal to RU × (1 - T
C)  .F) A) and D)
G) B) and C)

Exam 16: Dividends and Payout Policy

Correct Answer
verified

Correct Answer
verified
C

Correct Answer
verified

M & M Proposition II is the proposition that:

Correct Answer
verified
C

Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business.The process this firm underwent is known as a:

Correct Answer
verified

Bankruptcy:

Correct Answer
verified

The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as _____ costs.

Correct Answer
verified

The interest tax shield has no value when a firm has a: I.tax rate of zero. II.debt-equity ratio of 1. III.zero debt. IV.zero leverage.

Correct Answer
verified

D.L.Tuckers has $21,000 of debt outstanding that is selling at par and has a coupon rate of 7.5 percent.The tax rate is 32 percent.What is the present value of the tax shield?

Correct Answer
verified

Which one of the following is the legal proceeding under which an insolvent firm can be reorganized?

Correct Answer
verified

The Corner Bakery has a debt-equity ratio of 0.62.The firm's required return on assets is 14.2 percent and its cost of equity is 16.1 percent.What is the pre-tax cost of debt based on M & M Proposition II with no taxes?

Correct Answer
verified

Correct Answer
verified

Jessica invested in Quantro stock when the firm was unlevered.Since then, Quantro has changed its capital structure and now has a debt-equity ratio of 0.30.To unlever her position, Jessica needs to:

Correct Answer
verified

The value of a firm is maximized when the:

Correct Answer
verified

M & M Proposition I with no tax supports the argument that:

Correct Answer
verified

Which one of the following states that the value of a firm is unrelated to the firm's capital structure?

Correct Answer
verified

Young's Home Supply has a debt-equity ratio of 0.80.The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent.What will the firm's cost of equity be if the debt-equity ratio is revised to 0.70?

Correct Answer
verified
E

Correct Answer
verified

Which one of the following is the equity risk that is most related to the daily operations of a firm?

Correct Answer
verified

Based on M & M Proposition II with taxes, the weighted average cost of capital:

Correct Answer
verified

Exam 16: Dividends and Payout Policy

Correct AnswerverifiedShow Answer

Correct AnswerverifiedC

Correct AnswerverifiedShow Answer

M & M Proposition II is the proposition that:

Correct AnswerverifiedC

Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business.The process this firm underwent is known as a:

Correct AnswerverifiedShow Answer

Bankruptcy:

Correct AnswerverifiedShow Answer

The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as _____ costs.

Correct AnswerverifiedShow Answer

The interest tax shield has no value when a firm has a: I.tax rate of zero. II.debt-equity ratio of 1. III.zero debt. IV.zero leverage.

Correct AnswerverifiedShow Answer

D.L.Tuckers has $21,000 of debt outstanding that is selling at par and has a coupon rate of 7.5 percent.The tax rate is 32 percent.What is the present value of the tax shield?

Correct AnswerverifiedShow Answer

Which one of the following is the legal proceeding under which an insolvent firm can be reorganized?

Correct AnswerverifiedShow Answer

The Corner Bakery has a debt-equity ratio of 0.62.The firm's required return on assets is 14.2 percent and its cost of equity is 16.1 percent.What is the pre-tax cost of debt based on M & M Proposition II with no taxes?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Jessica invested in Quantro stock when the firm was unlevered.Since then, Quantro has changed its capital structure and now has a debt-equity ratio of 0.30.To unlever her position, Jessica needs to:

Correct AnswerverifiedShow Answer

The value of a firm is maximized when the:

Correct AnswerverifiedShow Answer

M & M Proposition I with no tax supports the argument that:

Correct AnswerverifiedShow Answer

Which one of the following states that the value of a firm is unrelated to the firm's capital structure?

Correct AnswerverifiedShow Answer

Young's Home Supply has a debt-equity ratio of 0.80.The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent.What will the firm's cost of equity be if the debt-equity ratio is revised to 0.70?

Correct AnswerverifiedE

Correct AnswerverifiedShow Answer

Which one of the following is the equity risk that is most related to the daily operations of a firm?

Correct AnswerverifiedShow Answer

Based on M & M Proposition II with taxes, the weighted average cost of capital:

Correct AnswerverifiedShow Answer

Correct Answer
verified

Correct Answer
verified
C

Correct Answer
verified

Correct Answer
verified
C

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
E

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified