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Exam 16: Capital Structure

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Question 31

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Equity in a firm with no debt is called:

A) risk-free equity.
B) risky equity.
C) shareholders' equity.
D) unlevered equity.
E) levered equity.

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Question 32

Multiple Choice

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Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as With.You have $5000 of your own money to invest and you plan on buying Without stock.Using homemade leverage,how much do you need to borrow in your margin account so that the payoff of your margined purchase of Without stock will be the same as a $5000 investment in With stock?

A) $10,000
B) $5250
C) $5000
D) $2500
E) $0

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Question 33

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A firm is currently financed with 40% equity and 60% debt.The firm generates perpetual earnings before interest and taxes of $2 million per year.The firm's cost of equity is 12%,its cost of debt is 5%,and it has a tax rate of 40%.What is the value of the levered firm?

By adding leverage,the returns of the firm are split between debt holders and equity holders,but equity-holder risk increases because:

With perfect capital markets,what is the market value of Luther's equity after the share repurchase?

Differences in the magnitude of financial distress costs and volatility of cash flows across industries do not impact the choice of leverage.

Suppose a project financed via an issue of debt requires five annual interest payments of $20 million each year.If the tax rate is 30%,and the present value of the interest tax shield is 25.98 million,what is the firm's cost of debt?

Suppose a project financed via an issue of debt requires six annual interest payments of $20 million each year.If the tax rate is 30% and the cost of debt is 8%,what is the value of the interest rate tax shield?

The optimal capital structure depends on ________ such as taxes,distress costs,and agency costs.

A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 60% equity and 40% debt.If the firm can borrow at 10%,what is the return on levered equity?

An unlevered firm currently has a value of $100 million.The firm has a tax rate of 30%.The firm wishes to replace $50 million of its equity with $50 million of permanent debt.What is the value of the levered firm if it goes ahead with this plan?

Consider a firm whose capital structure includes both debt and equity.If the firm must pay taxes in a given year,which of the following has the highest value?

A firm that does not have trouble meeting its debt obligations is said to be in financial distress.

The use of leverage as a way to signal ________ information to investors is known as the signalling theory of debt.

What are the issues in determining the optimal leverage for a firm?

Managerial entrenchment means that managers ________ and run the firm for their own best interests.

The under-investment problem refers to the problem that equity holders prefer not to invest in positive-NPV projects in highly levered firms because:

A firm requires an investment of $20,000.The firm's debt cost of capital is 6%,and its return on equity is 15%.If the firm's pre-tax WACC is 10.5%,how much did the firm borrow?

The E in the equation above represents:

A new business will generate a one-time cash flow of $25,000 after one year.The business will be financed with 20% equity and 80% debt.If the firm's unlevered equity cost of capital is 12%,what is the levered value of the firm with perfect capital markets?