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Exam 15: Capital Structure: Basic Concepts

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Question 21

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The value of the firm is maximized by taking on as much debt as possible.Show graphically how adding debt can increase value through the overall cost of capital.Explain under what conditions how this impacts the cost of capital and translates into firm value.

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This is MM Proposition I and I...

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Question 22

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Bigelow SpA has a cost of equity of 13.56% and a pre-tax cost of debt of 7%.The required return on the assets is 11%. What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

A) .60
B) .64
C) .72
D) .75
E) .80

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Question 23

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You own 25% of Unique Vacations SA.You have decided to retire and want to sell your shares in this closely held, all equity firm.The other shareholders have agreed to have the firm borrow €1.5 million to purchase your 1,000 shares. What is the total value of this firm today if you ignore taxes?

Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure? I. A reduction in tax rates. II) A large tax loss carry forward. III) A large depreciation tax deduction. IV) A sizeable increase in taxable income.

The proposition that the value of the firm is independent of its capital structure is called:

A general rule for managers to follow is to set the firm's capital structure such that:

Which of the following statements are correct in relation to MM Proposition II with no taxes? I.The return on assets is equal to the weighted average cost of capital. II) Financial risk is determined by the debt-equity ratio. III) Financial risk determines the return on assets. IV) The cost of equity declines when the amount of leverage used by a firm rises.

A firm has a debt-to-equity ratio of 1.75.If it had no debt, its cost of equity would be 9%.Its cost of debt is 7%.What is its cost of equity if the corporate tax rate is 30%?

Montana Hills SA has expected earnings before interest and taxes of €8,100, an unlevered cost of capital of 11%, and debt with both a book and face value of €12,000.The debt has an annual 8% coupon.The tax rate is 34%.What is the Value of the firm?

The tax savings of the firm derived from the deductibility of interest expense is called the:

A manager should attempt to maximize the value of the firm by:

Scott's Leisure Time Sports is an unlevered firm with an after-tax net income of €86,000.The unlevered cost of capital is 10% and the tax rate is 34%.What is the value of this firm?

The cost of capital for a firm, RWACC, in a zero tax environment is:

Gail's Dance Studio is currently an all equity firm that has 80,000 shares outstanding with a market price of €42 a share.The current cost of equity is 12% and the tax rate is 34%.Gail is considering adding €1 million of debt with a Coupon rate of 8% to her capital structure.The debt will be sold at par value.What is the levered value of the equity?

The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:

A firm has a debt-to-equity ratio of 1.20.If it had no debt, its cost of equity would be 15%.Its cost of debt is 10%.What is its cost of equity if there are no taxes or other imperfections?

A firm has a debt-to-equity ratio of 1.Its cost of equity is 16%, and its cost of debt is 8%.If the corporate tax rate is 25%, what would its cost of equity be if the debt-to-equity ratio were 0?

The reason that MM Proposition I does not hold in the presence of corporate taxation is because:

The unlevered cost of capital is:

Anderson's Furniture Outlet has an unlevered cost of capital of 10%, a tax rate of 34%, and expected earnings before interest and taxes of €1,600.The company has €3,000 in bonds outstanding that have an 8% coupon and pay interest Annually.The bonds are selling at par value.What is the cost of equity?