Chapter 17 Quiz A Student Name _________________________

Student ID ____________

________ 1. leverage is increased?

Which one of the following supports the statement that the cost of equity rises when a. M&M Proposition I without taxes b. M&M Proposition I with taxes c. M&M Proposition II without taxes d. static theory

________

2.

The static theory advocates borrowing to the point where: a. the pre-tax cost of debt is equal to the cost of equity. b. the cost of equity is equal to the interest tax shield. c. the tax benefit from debt is equal to the cost of the increased probability of financial d. the interest tax shield is maximized.

distress.

________ firm.

3.

The debt-equity ratio determines the amount of _____ risk that is associated with a a. business b. systematic c. financial d. unsystematic

________

4.

Which one of the following is indicative of an optimal capital structure? a. maximum tax shield b. minimum debt-equity ratio c. maximum cost of capital d. maximum firm value If an individual stockholder wants to offset the leverage position of an issuing firm, he a. increase their holdings in that stock by borrowing money. b. increase their holdings in that stock by reducing their cash reserves. c. reduce their holdings in that stock and borrow money. d. reduce their holdings in that stock and lend out money.

_______ or she should:

5.

________ 6. have an 8 percent What is the amount of

Your firm has 10,000 bonds outstanding with a face value of $1,000 each. These bonds coupon and pay interest semiannually. The current market quote on these bonds is 98. the annual interest tax shield on these bonds if the tax rate is 34 percent? a. $272,000 b. $314,815 c. $528,000 d. $800,000

________ 7. and the unlevered cost of

Big Bills Yachts has a debt-equity ratio of .75. The pre-tax cost of debt is 8 percent capital is 13 percent. What is the cost of equity if the tax rate is 35 percent? a. 13.00 percent b. 15.44 percent c. 16.37 percent d. 17.33 percent

________ 8. cost of equity is 13 the firms weighted

Sallys has debt of $12,000 and equity of $18,00 0. The cost of debt is 8 percent and the percent. The leveraged value of the firm is $10,600 and the tax rate is 34 percent. What is

average cost of capital? a. 9.91 percent b. 10.03 percent ________ 9. is a combination of

c. 10.26 percent

d. 11.00 percent

You are considering two different capital structures. The first is all equity. The second

debt and equity. The all equity option would consist of 15,000 shares of stock. The debt-equity option would consist of 8,500 shares of stock plus $120,000 of debt with an interest rate of 8 percent. What is the breakeven level of earnings before interest and taxes between these two options? Ignore taxes. a. $22,153.85 b. $23,909.18 c. $24,006.16 d. $24,244.19 ________ 10. company is currently repurchased 100,000 shares of the outstanding stock. What is the value of J&J, Inc. if you ignore taxes? a. $450,000 b. $750,000 c. $900,000 d. $1,050,000 Answers J&J, Inc. is an all equity firm that has 250,000 shares of stock outstanding. The negotiating a $300,000 loan at 7 percent interest. The loan proceeds will be used to

Chapter 17 Quiz A 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. c c c d d a b a a

Annual interest tax shield = 10,000 $1,000 .08 .34 = $272,000 R = .13 + (.13 .08) .75 (1 .35) = .15438 = 15.44 percent [18k (12k + 18k) .13] + [12k (12k + 18k) .08 (1 .34)] = .09912 = 9.91 percent EBIT 15,000 = [EBIT ($120,000 .08)] 8,500; EBIT = $22,153.85 b Price per share = $300,000 100,000 = $3; Value of firm = (250,000 100,000) $3 + $300,000 = $750,000
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Chapter 17 Quiz B Student Name _________________________

Student ID ____________

________ 1. firm arranges its

Which one of the following supports the statement that it is totally irrelevant how a financing? a. M&M Proposition I without taxes b. M&M Proposition I with taxes c. M&M Proposition II without taxes d. M&M Proposition II with taxes

________

2. liquidation.

Chapter _____ of the Federal Bankruptcy Reform Act of 1978 deals with straight a. 3 b. 7 c. 11 d. 13

________

3.

_____ risk determines the required return on assets. a. Business b. Total c. Financial d. Unsystematic Which one of the following is indicative of an optimal capital structure? a. maximum tax shield b. maximum debt-equity ratio c. minimum cost of capital d. minimum firm value Homemade leverage refers to the: a. ability of individual investors to borrow and lend money on their own. b. ability of a firm to self-determine the amount of leverage they prefer in their capital c. amount of debt a small firm arranges with their local bank. d. ratio of cash holdings of an individual as compared to their equity holdings.

________

4.

_______

5.

structure.

________ an 8 percent

6.

Your firm has bonds outstanding with a total face value of $180,000. These bonds have coupon and pay interest semiannually. The current market quote on these bonds is 98.

What is the amount of the annual interest tax shield on these bonds if the tax rate is 34 percent? a. $4,896 b. $5,167 c. $7,650 d. $14,400 ________ 7. the unlevered cost of Big Eds Yachts has a debt-equity ratio of .80. The pre-tax cost of debt is 8 percent and capital is 14 percent. What is the cost of equity if the tax rate is 35 percent? a. 13.00 percent b. 15.44 percent c. 16.37 percent d. 17.12 percent ________ 8. cost of equity is 13 the firms weighted average cost of capital? a. 9.91 percent b. 10.03 percent c. 10.26 percent d. 11.05 percent Fredas has debt of $7,000 and equity of $21,000. The cost of debt is 8 percent and the percent. The leveraged value of the firm is $10,600 and the tax rate is 35 percent. What is

________ 9. is a combination of

You are considering two different capital structures. The first is all equity. The second

debt and equity. The all equity option would consist of 20,000 shares of stock. The debt-equity option would consist of 7,500 shares of stock plus $150,000 of debt with an interest rate of 8 percent. What is the breakeven level of earnings before interest and taxes between these two options? Ignore taxes. a. $19,200 b. $22,000 c. $24,500 d. $26,000 ________ 10. company is currently repurchased 15,000 shares of the outstanding stock. What is the value of K&K, Inc. if you ignore taxes? a. $5 million b. $6 million c. $6.4 million d. $6.5 million K&K, Inc. is an all equity firm that has 150,000 shares of stock outstanding. The negotiating a $600,000 loan at 7 percent interest. The loan proceeds will be used to

Chapter 17 Quiz B 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. a b a c a a d d a

Answers

Annual interest tax shield = $180,000 .08 .34 = $4,896 R = .14 + (.14 .08) .80 (1 .35) = .1712 = 17.12 percent [21k (7k + 21K) .13] + [7k (7k + 21k) .08 (1 .35)] = .1105 = 11.05 percent EBIT 20,000 = [EBIT ($150,000 .08)] 7,500; EBIT = $19,200 b Price per share = $600,000 15,000 = $40; Value of firm = (150,000 15,000) $40 + $600,000 = $6 million
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Chapter 17 Quiz C Student Name _________________________

Student ID ____________

________ 1. an unlevered firm plus:

According to M&M I with taxes, the value of a leveraged firm is equal to the value of a. [EBIT (1 T )]. b. [EBIT (1 T )] R . c. (T D). d. (T D).
C C U C C

________

2.

_____ occurs when a firm is unable to meet its financial obligations. a. Bankruptcy b. Accounting insolvency c. Technical insolvency d. Business failure. Which one of the following statements is correct? a. The higher the tax rate, the less incentive a firm has to borrow money. b. M&M theory basically supports the statement that the value of a firm depends on the the firm. c. Financial risk determines the required return on assets. d. M&M II without taxes supports the statement that the cost of equity rises when the use increases.

________

3.

capital structure of

of leverage ________ 4.

Which one of the following is indicative of an optimal capital structure? a. maximum tax shield b. maximum debt-equity ratio c. maximum value of marketed claims d. minimum firm value Financial leverage magnifies: a. gains but not losses. b. losses but not gains. c. neither losses nor gains. d. both losses and gains. Your firm has a pre-tax cost of debt of 8 percent, a required return on assets of 14 ratio of .60. What is your cost of equity if you ignore taxes? a. 14.60 percent b. 15.90 percent c. 16.40 percent

_______

5.

________ 6. percent, and a debt-equity

d. 17.60 percent

________ 7. unlevered cost of

Your firm has a debt-equity ratio of .65. The pre-tax cost of debt is 9 percent and the capital is 15 percent. What is your cost of equity if the tax rate is 35 percent? a. 13.00 percent b. 15.44 percent c. 17.12 percent d. 17.54 percent

________ equity is is the firms

8.

Tulas, Inc. has a debt-equity ratio of .70. The cost of debt is 7 percent and the cost of 12 percent. The unlevered value of the firm is $13,600 and the tax rate is 34 percent. What weighted average cost of capital? a. 8.43 percent b. 8.96 percent

c. 9.02 percent

d. 9.41 percent

________ 9. is a combination of

You are considering two different capital structures. The first is all equity. The second

debt and equity. The all equity option would consist of 45,000 shares of stock. The debt-equity option would consist of 30,000 shares of stock plus $780,000 of debt with an interest rate of 6 percent. What is the breakeven level of earnings before interest and taxes between these two options? Ignore taxes. a. $119,200 b. $122,000 c. $134,500 d. $140,400 ________ 10. have a 7 percent coupon, the tax rate is 34 percent. What is the amount of the annual interest tax shield? a. $8,330 b. $13,475 c. $24,500 d. $25,410 Your firm has a bond issue with a face value of $350,000 outstanding. The bonds pay interest semi-annually and mature in six years. The cost of equity is 11 percent and

Chapter 17 Quiz C 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. d c d c d d d b d a

Answers

R = .14 + (.14 .08) .60 = 17.60 percent R = .15 + (.15 .09) .65 (1 .35) = .17535 = 17.54 percent [(1 1.7) .12] + [(.7 1.7) .07 (1 .34)] = .08961 = 8.96 percent EBIT 45,000 = [EBIT ($780,000 .06)] 30,000; EBIT = $140,400 Annual interest tax shield = $350,000 .07 .34 = $8,330
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