Question 1

In a world of no corporate taxes if the use of leverage does not change the value of the levered firm relative to the unlevered firm this is known as:

Accepted Answer

A)  MM Proposition III that the cost of equity is less than the cost of debt.
B)  MM Proposition I that leverage is invariant to market value.
C)  MM Proposition II that the cost of equity is always constant.
D)  MM Proposition I that the market value of the firm is invariant to the capital structure.
E)  MM Proposition III that there is no risk associated with leverage in a no tax world. D

Question 2

MM Proposition I with corporate taxes states that:

Accepted Answer

A)  capital structure can affect firm value.
B)  by raising the debt-to-equity ratio,the firm can lower its taxes and thereby increase its total value.
C)  firm value is maximized at an all debt capital structure.
D)  All of the above.
E)  None of the above. D

Question 3

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?

Accepted Answer

A)  €48,600
B)  €50,000
C)  €52,680
D)  €56,667
E)  €60,600

Question 4

MM Proposition II with taxes:

Accepted Answer

A)  has the same general implications as MM Proposition II without taxes.
B)  reveals how the interest tax shield relates to the value of a firm.
C)  supports the argument that business risk is determined by the capital structure employed by a firm.
D)  supports the argument that the cost of equity decreases as the debt-equity ratio increases.
E)  reaches the final conclusion that the capital structure decision is irrelevant to the value of a firm.

Question 5

MM Proposition II is the proposition that:

Accepted Answer

A)  supports the argument that the capital structure of a firm is irrelevant to the value of the firm.
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 capital is a positive linear function of the firm's capital structure.
D)  the cost of equity is equivalent to the required return on the total assets of a firm.
E)  supports the argument that the size of the pie does not depend on how the pie is sliced.

Question 6

The increase in risk to equityholders when financial leverage is introduced is evidenced by:

Accepted Answer

A)  higher EPS as EBIT increases.
B)  a higher variability of EPS with debt than all equity.
C)  increased use of homemade leverage.
D)  equivalence value between levered and unlevered firms in the presence of taxes.
E)  None of the above.

Question 7

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 preference shares for a firm with equal parts debt and ordinary equity in its capital structure.
E)  equal to the profit margin for a firm with some debt in its capital structure.

Question 8

An unlevered firm has a cost of capital of 14% and earnings before interest and taxes of €150,000.A levered firm with the same operations and assets has both a book value and a face value of debt of €700,000 with a 7% annual coupon.The applicable tax rate is 35%.What is the value of the levered firm?

Accepted Answer

A)  €696,429
B)  €907,679
C)  €941,429
D)  €1,184,929
E)  €1,396,429

Question 9

The difference between a market value balance sheet and a book value balance sheet is that a market value balance sheet:

Accepted Answer

A)  places assets on the right hand side.
B)  places liabilities on the left hand side.
C)  does not equate the right hand with the left hand side.
D)  lists items in terms of market values,not historical costs.
E)  uses the market rate of return.

Question 10

A firm has debt of €5,000,equity of €16,000,a leveraged value of €8,900,a cost of debt of 8%,a cost of equity of 12%,and a tax rate of 34%.What is the firm's weighted average cost of capital?

Accepted Answer

A)  7.29%
B)  7.94%
C)  8.87%
D)  10.40%
E)  11.05%

Question 11

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

Accepted Answer

A)  equal to the expected earnings divided by market value of the unlevered firm.
B)  equal to the rate of return for that business risk class.
C)  equal to the overall rate of return required on the levered firm.
D)  is constant regardless of the amount of leverage.
E)  All of the above.

Question 12

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?

Accepted Answer

A)  €2.4 million
B)  €2.7 million
C)  €3.3 million
D)  €3.7 million
E)  €3.9 million

Question 13

Your firm has a pre-tax cost of debt of 7% and an unlevered cost of capital of 13%. Your tax rate is 35% and your cost of equity is 15.26%.What is your debt-equity ratio?

Accepted Answer

A)  .43
B)  .49
C)  .51
D)  .54
E)  .58

Question 14

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

Accepted Answer

A)  homemade leverage.
B)  dividend recapture.
C)  the weighted average cost of capital.
D)  private debt placement.
E)  personal offset.

Question 15

The interest tax shield is a key reason why:

Accepted Answer

A)  the required rate of return on assets rises when debt is added to the capital structure.
B)  the value of an unlevered firm is equal to the value of a levered firm.
C)  the net cost of debt to a firm is generally less than the cost of equity.
D)  the cost of debt is equal to the cost of equity for a levered firm.
E)  firms prefer equity financing over debt financing. C

Question 16

MM Proposition I with taxes is based on the concept that:

Accepted Answer

A)  the optimal capital structure is the one that is totally financed with equity.
B)  the capital structure of the firm does not matter because investors can use homemade leverage.
C)  the firm is better off with debt based on the weighted average cost of capital.
D)  the value of the firm increases as total debt increases because of the interest tax shield.
E)  the cost of equity increases as the debt-equity ratio of a firm increases.

Question 17

Uptown Interior Designs is an all equity firm that has 40,000 shares outstanding.The company has decided to borrow €1 million to buy out the shares of a deceased equityholder who holds 2,500 shares.What is the total value of this firm if you ignore taxes?

Accepted Answer

A)  €15.5 million
B)  €15.6 million
C)  €16.0 million
D)  €16.8 million
E)  €17.2 million

Question 18

The change in firm value in the presence of corporate taxes only is:

Accepted Answer

A)  positive as equityholders face a lower effective tax rate.
B)  positive as equityholders gain the tax shield on the debt interest.
C)  negative because of the increased risk of default and fewer shares outstanding.
D)  negative because of a reduction of equity outstanding.
E)  None of the above.

Question 19

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?

Accepted Answer

A)  10%
B)  15%
C)  18%
D)  21%
E)  None of the above.

Question 20

The firm's capital structure refers to:

Accepted Answer

A)  the way a firm invests its assets.
B)  the amount of capital in the firm.
C)  the amount of dividends a firm pays.
D)  the mix of debt and equity used to finance the firm's assets.
E)  how much cash the firm holds.

Exam 15: Capital Structure: Basic Concepts

In a world of no corporate taxes if the use of leverage does not change the value of the levered firm relative to the unlevered firm this is known as:

Correct Answer
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D

MM Proposition I with corporate taxes states that:

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D

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?

Correct Answer
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MM Proposition II with taxes:

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MM Proposition II is the proposition that:

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The increase in risk to equityholders when financial leverage is introduced is evidenced by:

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The unlevered cost of capital is:

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The difference between a market value balance sheet and a book value balance sheet is that a market value balance sheet:

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A firm has debt of €5,000,equity of €16,000,a leveraged value of €8,900,a cost of debt of 8%,a cost of equity of 12%,and a tax rate of 34%.What is the firm's weighted average cost of capital?

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

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Your firm has a pre-tax cost of debt of 7% and an unlevered cost of capital of 13%. Your tax rate is 35% and your cost of equity is 15.26%.What is your debt-equity ratio?

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The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

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The interest tax shield is a key reason why:

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C

MM Proposition I with taxes is based on the concept that:

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Uptown Interior Designs is an all equity firm that has 40,000 shares outstanding.The company has decided to borrow €1 million to buy out the shares of a deceased equityholder who holds 2,500 shares.What is the total value of this firm if you ignore taxes?

Correct Answer
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The change in firm value in the presence of corporate taxes only is:

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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?

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The firm's capital structure refers to:

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Exam 15: Capital Structure: Basic Concepts

In a world of no corporate taxes if the use of leverage does not change the value of the levered firm relative to the unlevered firm this is known as:

Correct AnswerverifiedD

MM Proposition I with corporate taxes states that:

Correct AnswerverifiedD

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?

Correct AnswerverifiedShow Answer

MM Proposition II with taxes:

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MM Proposition II is the proposition that:

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The increase in risk to equityholders when financial leverage is introduced is evidenced by:

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The unlevered cost of capital is:

Correct AnswerverifiedShow Answer

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The difference between a market value balance sheet and a book value balance sheet is that a market value balance sheet:

Correct AnswerverifiedShow Answer

A firm has debt of €5,000,equity of €16,000,a leveraged value of €8,900,a cost of debt of 8%,a cost of equity of 12%,and a tax rate of 34%.What is the firm's weighted average cost of capital?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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Your firm has a pre-tax cost of debt of 7% and an unlevered cost of capital of 13%. Your tax rate is 35% and your cost of equity is 15.26%.What is your debt-equity ratio?

Correct AnswerverifiedShow Answer

The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:

Correct AnswerverifiedShow Answer

The interest tax shield is a key reason why:

Correct AnswerverifiedC

MM Proposition I with taxes is based on the concept that:

Correct AnswerverifiedShow Answer

Uptown Interior Designs is an all equity firm that has 40,000 shares outstanding.The company has decided to borrow €1 million to buy out the shares of a deceased equityholder who holds 2,500 shares.What is the total value of this firm if you ignore taxes?

Correct AnswerverifiedShow Answer

The change in firm value in the presence of corporate taxes only is:

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

The firm's capital structure refers to:

Correct AnswerverifiedShow Answer

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D

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D

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C

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