Question 1

Given realistic estimates of the probability and cost of bankruptcy,the future costs of a possible bankruptcy are borne by:

Accepted Answer

A)  all investors in the firm.
B)  debtholders only because if default occurs interest and principal payments are not made.
C)  shareholders because debtholders will pay less for the debt providing less cash for the shareholders.
D)  management because if the firm defaults they will lose their jobs.
E)  None of the above.F) A) and B)
G) A) and C)

Question 2

What are the advantages of a prepackaged bankruptcy for a firm?
 What are the disadvantages?

Accepted Answer

A prepack allows a firm to minimize its ...

Question 3

The basic lesson of MM theory is that the value of a firm is dependent upon the:

Accepted Answer

A)  capital structure of the firm.
B)  total cash flows of the firm.
C)  percentage of a firm to which the bondholders have a claim.
D)  tax claim placed on the firm by the government.
E)  size of the shareholders claims on the firm.F) A) and E)
G) All of the above

Question 4

When graphing firm value against debt levels,the debt level that maximizes the value of the firm is the level where:

Accepted Answer

A)  the increase in the present value of distress costs from an additional pound of debt is greater than the increase in the present value of the debt tax shield.
B)  the increase in the present value of distress costs from an additional pound of debt is equal to the increase in the present value of the debt tax shield.
C)  the increase in the present value of distress costs from an additional pound of debt is less than the increase of the present value of the debt tax shield.
D)  distress costs as well as debt tax shields are zero.
E)  distress costs as well as debt tax shields are maximized.F) A) and B)
G) C) and D)

Question 5

The Aggie Company has EBIT of £50,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Accepted Answer

A)  £120,000
B)  £162,948
C)  £258,537
D)  £263,080
E)  £332,143F) C) and D)
G) All of the above

Question 6

Indirect costs of bankruptcy are born principally by:

Accepted Answer

A)  bondholders.
B)  shareholders.
C)  managers.
D)  the federal government.
E)  the firm's suppliers.F) B) and C)
G) A) and D)

Question 7

Given the following information,leverage will add how much value to the unlevered firm per pound of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from shares: 50%

Accepted Answer

A)  £-0.050
B)  £-0.188
C)  £0.367
D)  £0.588
E)  None of the above.F) B) and D)
G) C) and D)

Question 8

The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

Accepted Answer

A)  personal tax rate on the distribution of income to shareholders is less than the personal tax rate on interest income.
B)  personal tax rate on the distribution of income to shareholders is greater than the personal tax rate on interest income.
C)  personal tax rate on the distribution of income to shareholders is equal to the personal tax rate on interest income.
D)  personal tax rate on interest income is zero.
E)  None of the above.F) A) and B)
G) A) and E)

Question 9

The legal proceeding for liquidating or reorganizing a firm operating in default is called a:

Accepted Answer

A)  tender offer.
B)  bankruptcy.
C)  merger.
D)  takeover.
E)  proxy fight.F) A) and B)
G) D) and E)

Question 10

Which of the following is not empirically true when formulating capital structure policy?

Accepted Answer

A)  Some firms use no debt.
B)  Most corporations have low debt-asset ratios.
C)  There are no differences in the capital-structure of different industries.
D)  Debt levels across industries vary widely.
E)  Debt ratios in most countries are considerably less than 100%.F) B) and C)
G) A) and E)

Question 11

Suppose a Miller equilibrium exists with corporate tax rate of 30% and personal tax rate on income from bonds of 35%.What is the personal tax rate on income from equities?

Accepted Answer

A)  0.0%
B)  7.1%
C)  10.05%
D)  45.5%
E)  None of the above.F) A) and E)
G) B) and C) B

Question 12

Wigdor Manufacturing is currently all equity financed,had EBIT of £2 million,and is in the 34% tax bracket.Louis,the company's founder,is the lone shareholder.If the firm were to convert £4 million of equity into debt at a cost of 10%,what would be the total cash flow to Louis if he holds all the debt?
 Compare this to Louis' total cash flow if the firm remains unlevered.

Accepted Answer

$\begin{array}{|l|l|l|}
\hline
&\text { Unlevered } & \text { Levered } \
\hline \mathrm{EBIT} &£ 2,000,000 & £ 2,000,000 \
\hline Interest&-0- & 400,000 \
\hline EBT&£2,000,000 & £ 1,600,000 \
\hline Taxes&£ 680,000 & £ 544,000 \
\hline EAT&£ 1,320,000 & £ 1,056,000 \
\hline \text {Add back interest}&-0- & 400,000 \
\hline \text {Total cash flow}&£ 1,320,000 & £ 1,456,000 \
\hline
\end{array}$

Question 13

Although the use of debt provides tax benefits to the firm,debt also puts pressure on the firms to:

Accepted Answer

A)  meet interest and principal payments which,if not met,can put the company into financial distress.
B)  make dividend payments which if not met can put the company into financial distress.
C)  meet both interest and dividend payments which when met increase the firm cash flow.
D)  meet increased tax payments thereby increasing firm value.
E)  None of the above.F) D) and E)
G) B) and E)

Question 14

When firms issue more debt,the tax shield on debt _____,the agency costs on debt (i.e.,costs of financial distress) _____,and the agency costs on equity _____.

Accepted Answer

A)  increases; increases; increases
B)  decreases; decreases; decreases
C)  increases; increases; decreases
D)  decreases; decreases; increases
E)  increases; decreases; decreasesF) B) and C)
G) A) and D)

Question 15

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) A) and D)
G) B) and D)

Question 16

Describe some of the sources of business risk and financial risk.Do financial decision makers have the ability to "trade off" one type of risk for the other?

Accepted Answer

Students should intuitively recognize th...

Question 17

Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital
Structure becomes a 50/50 mix of debt and equity?

Accepted Answer

A)  9.50%
B)  10.50%
C)  11.00%
D)  11.25%
E)  12.00%F) B) and E)
G) C) and D)

Question 18

The Aggie Company has EBIT of £70,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Accepted Answer

A)  £120,000
B)  £162,948
C)  £258,537
D)  £263,080
E)  £355,938F) A) and B)
G) B) and E)

Question 19

Given the following information,leverage will add how much value to the unlevered firm per pound of debt?
Corporate tax rate: 30%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from shares: 0%

Accepted Answer

A)  £0.125
B)  £0.472
C)  £0.528
D)  £0.825
E)  None of the above.F) B) and E)
G) C) and D)

Question 20

Consider an economy in which there are three groups of investors and no others.
 $\begin{array}{l}
\begin{array}{|l}
\hline
\\hline
Group\\hline
Plumbers\\hline
Doctors\\hline
Lawyers\\hline
\end{array}
\begin{array}{|l}
\hline
\text{Marginal tax rate}\\hline
\text{on bondss}\\hline
60 \% \\hline
 50 \% \\hline
 40 \% \\hline
\end{array}
\begin{array}{|l|}
\hline
\text { Personal wealth }\
\hline(£ \text { millions) } \
\hline 2,500 \
\hline 700 \
\hline 100\
\hline
\end{array}
\end{array}$ There are no personal taxes on income from stocks.An investment is available that pays a
tax-free 4%.The tax rate is 50%.Total corporate income before earnings and taxes (EBIT)
is £224 million forever.What is the maximum debt-to-equity ratio for the economy as a whole?

Accepted Answer

The interest rate on debt = .04/(1-.5)= .08 Total corporate value = [224 - (800 * .08)] [1-.5] / .04 = £2,000 Note - Doctors,who are indifferent about holding debt,so they will hold debt. Maximum debt to equity ratio = £800/£2,000 = .40 = 40%

Exam 16: Capital Structure: Limits to the Use of Debt

Given realistic estimates of the probability and cost of bankruptcy,the future costs of a possible bankruptcy are borne by:

Correct Answer
verified

What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?

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

The basic lesson of MM theory is that the value of a firm is dependent upon the:

Correct Answer
verified

When graphing firm value against debt levels,the debt level that maximizes the value of the firm is the level where:

Correct Answer
verified

The Aggie Company has EBIT of £50,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Correct Answer
verified

Indirect costs of bankruptcy are born principally by:

Correct Answer
verified

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 20% Personal tax rate on income from shares: 50%

Correct Answer
verified

The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

Correct Answer
verified

The legal proceeding for liquidating or reorganizing a firm operating in default is called a:

Correct Answer
verified

Which of the following is not empirically true when formulating capital structure policy?

Correct Answer
verified

Suppose a Miller equilibrium exists with corporate tax rate of 30% and personal tax rate on income from bonds of 35%.What is the personal tax rate on income from equities?

Correct Answer
verified
B

Although the use of debt provides tax benefits to the firm,debt also puts pressure on the firms to:

Correct Answer
verified

When firms issue more debt,the tax shield on debt ___,the agency costs on debt (i.e.,costs of financial distress) _,and the agency costs on equity ___.

Correct Answer
verified

The value of a firm is maximized when the:

Correct Answer
verified

Describe some of the sources of business risk and financial risk.Do financial decision makers have the ability to "trade off" one type of risk for the other?

Correct Answer
verified
Students should intuitively recognize th...
View Answer

Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital Structure becomes a 50/50 mix of debt and equity?

Correct Answer
verified

The Aggie Company has EBIT of £70,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Correct Answer
verified

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 30% Personal tax rate on income from bonds: 20% Personal tax rate on income from shares: 0%

Correct Answer
verified

Correct Answer
verified
The interest rate on debt = .04/(1-.5)= .08 Total corporate value = [224 - (800 * .08)] [1-.5] / .04 = £2,000 Note - Doctors,who are indifferent about holding debt,so they will hold debt. Maximum debt to equity ratio = £800/£2,000 = .40 = 40%

Exam 16: Capital Structure: Limits to the Use of Debt

Given realistic estimates of the probability and cost of bankruptcy,the future costs of a possible bankruptcy are borne by:

Correct AnswerverifiedShow Answer

What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?

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

The basic lesson of MM theory is that the value of a firm is dependent upon the:

Correct AnswerverifiedShow Answer

When graphing firm value against debt levels,the debt level that maximizes the value of the firm is the level where:

Correct AnswerverifiedShow Answer

The Aggie Company has EBIT of £50,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Correct AnswerverifiedShow Answer

Indirect costs of bankruptcy are born principally by:

Correct AnswerverifiedShow Answer

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 20% Personal tax rate on income from shares: 50%

Correct AnswerverifiedShow Answer

The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

Correct AnswerverifiedShow Answer

The legal proceeding for liquidating or reorganizing a firm operating in default is called a:

Correct AnswerverifiedShow Answer

Which of the following is not empirically true when formulating capital structure policy?

Correct AnswerverifiedShow Answer

Suppose a Miller equilibrium exists with corporate tax rate of 30% and personal tax rate on income from bonds of 35%.What is the personal tax rate on income from equities?

Correct AnswerverifiedB

Although the use of debt provides tax benefits to the firm,debt also puts pressure on the firms to:

Correct AnswerverifiedShow Answer

When firms issue more debt,the tax shield on debt _____,the agency costs on debt (i.e.,costs of financial distress) _____,and the agency costs on equity _____.

Correct AnswerverifiedShow Answer

The value of a firm is maximized when the:

Correct AnswerverifiedShow Answer

Describe some of the sources of business risk and financial risk.Do financial decision makers have the ability to "trade off" one type of risk for the other?

Correct AnswerverifiedStudents should intuitively recognize th...View AnswerShow Answer

Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital Structure becomes a 50/50 mix of debt and equity?

Correct AnswerverifiedShow Answer

The Aggie Company has EBIT of £70,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Correct AnswerverifiedShow Answer

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 30% Personal tax rate on income from bonds: 20% Personal tax rate on income from shares: 0%

Correct AnswerverifiedShow Answer

Correct AnswerverifiedThe interest rate on debt = .04/(1-.5)= .08 Total corporate value = [224 - (800 * .08)] [1-.5] / .04 = £2,000 Note - Doctors,who are indifferent about holding debt,so they will hold debt. Maximum debt to equity ratio = £800/£2,000 = .40 = 40%

Correct Answer
verified

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

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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B

Correct Answer
verified

When firms issue more debt,the tax shield on debt ___,the agency costs on debt (i.e.,costs of financial distress) _,and the agency costs on equity ___.

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
Students should intuitively recognize th...
View Answer

Correct Answer
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Correct Answer
verified

Correct Answer
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Correct Answer
verified
The interest rate on debt = .04/(1-.5)= .08 Total corporate value = [224 - (800 * .08)] [1-.5] / .04 = £2,000 Note - Doctors,who are indifferent about holding debt,so they will hold debt. Maximum debt to equity ratio = £800/£2,000 = .40 = 40%