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Fundamentals of Corporate Finance, 12e (Ross)Chapter 1 Introduction to Corporate Finance1) Which one of the following functions should be the responsibility of the controller rather than the treasurer?A) Depositing cash receiptsB) Processing cost reportsC) Analyzing equipment purchasesD) Approving credit for a customerE) Paying a vendor2) The treasurer of a corporation generally reports directly to the:A) board of directors.B) chairman of the board.C) chief executive officer.D) president.E) vice president of finance.3) Which one of the following correctly defines the upward chain of command in a typical corporate organizational structure?A) The vice president of finance reports to the chairman of the board.B) The chief executive officer reports to the president.C) The controller reports to the chief financial officer.D) The treasurer reports to the president.E) The chief operations officer reports to the vice president of production.4) An example of a capital budgeting decision is deciding:A) how many shares of stock to issue.B) whether or not to purchase a new machine for the production line.C) how to refinance a debt issue that is maturing.D) how much inventory to keep on hand.E) how much money should be kept in the checking account.5) When evaluating the timing of a project's projected cash flows, a financial manager is analyzing:A) the amount of each expected cash flow.B) only the start-up costs that are expected to require cash resources.C) only the date of the final cash flow related to the project.D) the amount by which cash receipts are expected to exceed cash outflows.E) when each cash flow is expected to occur.6) Capital structure decisions include determining:A) which one of two projects to accept.B) how to allocate investment funds to multiple projects.C) the amount of funds needed to finance customer purchases of a new product.D) how much debt should be assumed to fund a project.E) how much inventory will be needed to support a project.7) The decision to issue additional shares of stock is an example of:A) working capital management.B) a net working capital decision.C) capital budgeting.D) a controller's duties.E) a capital structure decision.8) Which one of the following questions is a working capital management decision?A) Should the company issue new shares of stock or borrow money?B) Should the company update or replace its older equipment?C) How much inventory should be on hand for immediate sale?D) Should the company close one of its current stores?E) How much should the company borrow to buy a new building?9) Which one of the following is a working capital management decision?A) What type(s) of equipment is (are) needed to complete a current project?B) Should the firm pay cash for a purchase or use the credit offered by the supplier?C) What amount of long-term debt is required to complete a project?D) How many shares of stock should the firm issue to fund an acquisition?E) Should a project should be accepted?10) Working capital management decisions include determining:A) the minimum level of cash to be kept in a checking account.B) the best method of producing a product.C) the number of employees needed to work during a particular shift.D) when to replace obsolete equipment.E) if a competitor should be acquired.11) Which one of the following terms is defined as the management of a firm's long-term investments?A) Working capital managementB) Financial allocationC) Agency cost analysisD) Capital budgetingE) Capital structure12) Which one of the following terms is defined as the mixture of a firm's debt and equity financing?A) Working capital managementB) Cash managementC) Cost analysisD) Capital budgetingE) Capital structure13) A firm's short-term assets and its short-term liabilities are referred to as the firm's:A) working capital.B) debt.C) investment capital.D) net capital.E) capital structure.14) Which one of the following questions is least likely to be addressed by financial managers?A) How should a product be marketed?B) Should customers be given 30 or 45 days to pay for their credit purchases?C) Should the firm borrow more money?D) Should the firm acquire new equipment?E) How much cash should the firm keep on hand?15) A business owned by a solitary individual who has unlimited liability for the firm's debt is called a:A) corporation.B) sole proprietorship.C) general partnership.D) limited partnership.E) limited liability company.16) A business formed by two or more individuals who each have unlimited liability for all of the firm's business debts is called a:A) corporation.B) sole proprietorship.C) general partnership.D) limited partnership.E) limited liability company.17) A business partner whose potential financial loss in the partnership will not exceed his or her investment in that partnership is called a:A) general partner.B) sole proprietor.C) limited partner.D) corporate shareholder.E) zero partner.18) A business created as a distinct legal entity and treated as a legal "person" is called a(n):A) corporation.B) sole proprietorship.C) general partnership.D) limited partnership.E) unlimited liability company.19) Which one of the following statements concerning a sole proprietorship is correct?A) A sole proprietorship is designed to protect the personal assets of the owner.B) The profits of a sole proprietorship are subject to double taxation.C) The owner of a sole proprietorship is personally responsible for all of the company's debts.D) There are very few sole proprietorships remaining in the U.S. today.E) A sole proprietorship is structured the same as a limited liability company.20) Which one of the following statements concerning a sole proprietorship is correct?A) The life of a sole proprietorship is limited.B) A sole proprietor can generally raise large sums of capital quite easily.C) Transferring ownership of a sole proprietorship is easier than transferring ownership of a corporation.D) A sole proprietorship is taxed the same as a C corporation.E) A sole proprietorship is the most regulated form of organization.21) Which of the following individuals have unlimited liability for a firm's debts based on their ownership interest?A) Only general partnersB) Only sole proprietorsC) All stockholdersD) Both limited and general partnersE) Both general partners and sole proprietors22) The primary advantage of being a limited partner is:A) the receipt of tax-free income.B) the partner's active participation in the firm's activities.C) the lack of any potential financial loss.D) the daily control over the business affairs of the partnership.E) the partner's maximum loss is limited to their capital investment.23) A general partner:A) is personally responsible for all partnership debts.B) has no say over a firm's daily operations.C) faces double taxation whereas a limited partner does not.D) has a maximum loss equal to his or her equity investment.E) receives a salary in lieu of a portion of the profits.24) A limited partnership:A) has an unlimited life.B) can opt to be taxed as a corporation.C) terminates at the death of any one limited partner.D) has at least one partner who has unlimited liability for all of the partnership's debts.E) consists solely of limited partners.25) A partnership with four general partners:A) distributes profits based on percentage of ownership.B) has an unlimited partnership life.C) limits the active involvement in the firm to a single partner.D) limits each partner's personal liability to 25 percent of the partnership's total debt.E) must distribute 25 percent of the profits to each partner.26) One disadvantage of the corporate form of business ownership is the:A) limited liability of its shareholders for the firm's debts.B) double taxation of distributed profits.C) firm's greater ability to raise capital than other forms of ownership.D) firm's potential for an unlimited life.E) firm's ability to issue additional shares of stock.27) Which one of the following statements is correct?A) The majority of firms in the U.S. are structured as corporations.B) Corporate profits are taxable income to the shareholders when earned.C) Corporations can have an unlimited life.D) Shareholders are protected from all potential losses.E) Shareholders directly elect the corporate president.28) Which one of the following statements is correct?A) A general partnership is legally the same as a corporation.B) Income from both sole proprietorships and partnerships that is taxable is treated as individual income.C) Partnerships are the most complicated type of business to form.D) All business organizations have bylaws.E) Only firms organized as sole proprietorships have limited lives.29) The articles of incorporation:A) describe the purpose of the firm and set forth the number of shares of stock that can be issued.B) are amended periodically especially prior to corporate elections.C) explain how corporate directors are to be elected and the length of their terms.D) sets forth the procedures by which a firm regulates itself.E) include only the corporation's name and intended life.30) Corporate bylaws:A) must be amended should a firm decide to increase the number of shares authorized.B) cannot be amended once adopted.C) define the name by which the firm will operate.D) describe the intended life and purpose of the organization.E) determine how a corporation regulates itself.31) A limited liability company:A) can only have a single owner.B) is comprised of limited partners only.C) is taxed similar to a partnership.D) is taxed similar to a C corporation.E) generates totally tax-free income.32) Which business form is best suited to raising large amounts of capital?A) Sole proprietorshipB) Limited liability companyC) CorporationD) General partnershipE) Limited partnership33) A ________ has all the respective rights and privileges of a legal person.A) sole proprietorshipB) general partnershipC) limited partnershipD) corporationE) limited liability company34) Sam, Alfredo, and Juan want to start a small U.S. business. Juan will fund the venture but wants to limit his liability to his initial investment and has no interest in the daily operations. Sam will contribute his full efforts on a daily basis but has limited funds to invest in the business. Alfredo will be involved as an active consultant and manager and will also contribute funds. Sam and Alfredo are willing to accept liability for the firm's debts as they feel they have nothing to lose by doing so. All three individuals will share in the firm's profits and wish to keep the initial organizational costs of the business to a minimum. Which form of business entity should these individuals adopt?A) Sole proprietorshipB) Joint stock companyC) Limited partnershipD) General partnershipE) Corporation35) Sally and Alicia are equal general partners in a business. They are content with their current management and tax situation but are uncomfortable with their unlimited liability. Which form of business entity should they consider as a replacement to their current arrangement assuming they wish to remain the only two owners of the business?A) Sole proprietorshipB) Joint stock companyC) Limited partnershipD) Limited liability companyE) Corporation36) The growth of both sole proprietorships and partnerships is frequently limited by the firm's:A) double taxation.B) bylaws.C) inability to raise cash.D) limited liability.E) agency problems.37) Corporate dividends are:A) tax-free because the income is taxed at the personal level when earned by the firm.B) tax-free because they are distributions of aftertax income.C) tax-free since the corporation pays tax on that income when it is earned.D) taxed at both the corporate and the personal level when the dividends are paid to shareholders.E) taxable income of the recipient even though that income was previously taxed.38) Financial managers should primarily focus on the interests of:A) stakeholders.B) the vice president of finance.C) their immediate supervisor.D) shareholders.E) the board of directors.39) Which one of the following best states the primary goal of financial management?A) Maximize current dividends per shareB) Maximize the current value per shareC) Increase cash flow and avoid financial distressD) Minimize operational costs while maximizing firm efficiencyE) Maintain steady growth while increasing current profits40) Which one of the following best illustrates that the management of a firm is adhering to the goal of financial management?A) An increase in the amount of the quarterly dividendB) A decrease in the per unit production costsC) An increase in the number of shares outstandingD) A decrease in the net working capitalE) An increase in the market value per share41) Financial managers should strive to maximize the current value per share of the existingstock to:A) guarantee the company will grow in size at the maximum possible rate.B) increase employee salaries.C) best represent the interests of the current shareholders.D) increase the current dividends per share.E) provide managers with shares of stock as part of their compensation.42) Decisions made by financial managers should primarily focus on increasing the:A) size of the firm.B) growth rate of the firm.C) gross profit per unit produced.D) market value per share of outstanding stock.E) total sales.43) The Sarbanes-Oxley Act of 2002 is a governmental response to:A) decreasing corporate profits.B) the terrorist attacks on 9/11/2001.C) a weakening economy.D) deregulation of the stock exchanges.E) management greed and abuses.44) Which one of the following is an unintended result of the Sarbanes-Oxley Act?A) More detailed and accurate financial reportingB) Increased management awareness of internal controlsC) Corporations delisting from major exchangesD) Increased responsibility for corporate officersE) Identification of internal control weaknesses45) A firm which opts to "go dark" in response to the Sarbanes-Oxley Act:A) must continue to provide audited financial statements to the public.B) must continue to provide a detailed list of internal control deficiencies on an annual basis.C) can provide less information to its shareholders than it did prior to "going dark".D) can continue publicly trading its stock but only on the exchange on which it was previously listed.E) ceases to exist.46) The Sarbanes-Oxley Act of 2002 holds a public company's ________ responsible for the accuracy of the company's financial statements.A) managersB) internal auditorsC) external legal counselD) internal legal counselE) Securities and Exchange Commission agent47) Which one of the following actions by a financial manager is most apt to create an agency problem?A) Refusing to borrow money when doing so will create losses for the firmB) Refusing to lower selling prices if doing so will reduce the net profitsC) Refusing to expand the company if doing so will lower the value of the equityD) Agreeing to pay bonuses based on the market value of the company's stock rather than on its level of salesE) Increasing current profits when doing so lowers the value of the company's equity48) Which one of the following is least apt to help convince managers to work in the best interest of the stockholders? Assume there are no golden parachutes.A) Compensation based on the value of the stockB) Stock option plansC) Threat of a company takeoverD) Threat of a proxy fightE) Increasing managers' base salaries49) Agency problems are most associated with:A) sole proprietorships.B) general partnerships.C) limited partnerships.D) corporations.E) limited liability companies.50) Which one of the following is an agency cost?A) Accepting an investment opportunity that will add value to the firmB) Increasing the quarterly dividendC) Investing in a new project that creates firm valueD) Hiring outside accountants to audit the company's financial statementsE) Closing a division of the firm that is operating at a loss51) Which one of the following is a means by which shareholders can replace company management?A) Stock optionsB) PromotionC) Sarbanes-Oxley ActD) Agency playE) Proxy fight52) Which one of the following grants an individual the right to vote on behalf of a shareholder?A) ProxyB) By-lawsC) Indenture agreementD) Stock optionE) Stock audit53) Which one of the following parties has ultimate control of a corporation?A) Chairman of the boardB) Board of directorsC) Chief executive officerD) Chief operating officerE) Shareholders54) Which of the following parties are considered stakeholders of a firm?A) Employees and the governmentB) Long-term creditorsC) Government and common stockholdersD) Common stockholdersE) Long-term creditors and common stockholders55) Which one of the following represents a cash outflow from a corporation?A) Issuance of new securitiesB) Payment of dividendsC) New loan proceedsD) Receipt of tax refundE) Initial sale of common stock56) Which one of the following is a cash flow from a corporation into the financial markets?A) Borrowing of long-term debtB) Payment of government taxesC) Payment of loan interestD) Issuance of corporate debtE) Sale of common stock57) Which one of the following is a primary market transaction?A) Sale of currently outstanding stock by a dealer to an individual investorB) Sale of a new share of stock to an individual investorC) Stock ownership transfer from one shareholder to another shareholderD) Gift of stock from one shareholder to another shareholderE) Gift of stock by a shareholder to a family member58) Shareholder A sold 500 shares of ABC stock on the New York Stock Exchange. This transaction:A) took place in the primary market.B) occurred in a dealer market.C) was facilitated in the secondary market.D) involved a proxy.E) was a private placement.59) Public offerings of debt and equity must be registered with the:A) New York Board of Governors.B) Federal Reserve.C) NYSE Registration Office.D) Securities and Exchange Commission.E) Market Dealers Exchange.60) Which one of the following statements is generally correct?A) Private placements must be registered with the SEC.B) All secondary markets are auction markets.C) Dealer markets have a physical trading floor.D) Auction markets match buy and sell orders.E) Dealers arrange trades but never own the securities traded.61) Which one of the following statements concerning stock exchanges is correct?A) NASDAQ is a broker market.B) The NYSE is a dealer market.C) The exchange with the strictest listing requirements is NASDAQ.D) Some large companies are listed on NASDAQ.E) Most debt securities are traded on the NYSE.62) Shareholder A sold shares of Maplewood Cabinets stock to Shareholder B. The stock is listed on the NYSE. This trade occurred in which one of the following?A) Primary, dealer marketB) Secondary, dealer marketC) Primary, auction marketD) Secondary, auction marketE) Secondary, OTC market63) Which one of the following statements is correct concerning the NYSE?A) The publicly traded shares of a NYSE-listed firm must be worth at least $250 million.B) The NYSE is the largest dealer market for listed securities in the United States.C) The listing requirements for the NYSE are more stringent than those of NASDAQ.D) Any corporation desiring to be listed on the NYSE can do so for a fee.E) The NYSE is an OTC market functioning as both a primary and a secondary market.11。
5. Business Risk versus Financial Risk Explain what is meant by business and financial risk.Suppose firm A has greater business risk than firm B. Is it true that firm A also has a higher cost of equity capital? Explain.6. MM Propositions How would you answer in the following debate?Q: Isn’t it true that the riskiness of a firm’s equity will rise if the firm increases its use of debt financing?A: Yes, that’s the essence of MM Proposition II.Q: And isn’t it true that, as a firm increases its use of borrowing, the likelihood of default increases, thereby increasing the risk of the firm’s debt?A: Yes.Q: In other words, increased borrowing increases the risk of the equity and the debt?A: That’s right.Q: Well, given that the firm uses only debt and equity financing, and given that the risks of both are increased by increased borrowing, does it not follow that increasing debtincreases the overall risk of the firm and therefore decreases the value of the firm?A: ??7. Optimal Capital Structure Is there an easily identifiable debt–equity ratio that will maximizethe value of a firm? Why or why not?8. Financial Leverage Why is the use of debt financing referred to as financial “leverage”?9. Homemade Leverage What is homemade leverage?10. Capital Structure Goal What is the basic goal of financial management with regard to capitalstructure?Questions and Problems connect™BASIC (Questions 1–16)1. EBIT and Leverage Money, Inc., has no debt outstanding and a total market value of$225,000. Earnings before interest and taxes, EBIT, are projected to be $19,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 30 percent higher. If there is a recession, then EBIT will be 60 percent lower. Money is considering a $90,000 debt issue with an 8 percent interest rate. The proceeds will be used to repurchase shares of stock.There are currently 5,000 shares outstanding. Ignore taxes for this problem.1. Calculate earnings per share, EPS, under each of the three economic scenarios before anydebt is issued. Also calculate the percentage changes in EPS when the economy expands orenters a recession.2. Repeat part (a) assuming that Money goes through with recapitalization. What do youobserve?2. EBIT, Taxes, and Leverage Repeat parts (a) and (b) in Problem 1 assuming Money has a taxrate of 35 percent.3. ROE and Leverage Suppose the company in Problem 1 has a market-to-book ratio of 1.0.1. Calculate return on equity, ROE, under each of the three economic scenarios before anydebt is issued. Also calculate the percentage changes in ROE for economic expansion and recession, assuming no taxes.2. Repeat part (a) assuming the firm goes through with the proposed recapitalization.3. Repeat parts (a) and (b) of this problem assuming the firm has a tax rate of 35 percent.4. Break-Even EBIT Rolston Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Rolston would have 240,000 shares of stock outstanding. Under Plan II, there would be 160,000 shares of stock outstanding and $3.1 million in debt outstanding. The interest rate on the debt is 10 percent and there are no taxes.1. If EBIT is $750,000, which plan will result in the higher EPS?2. If EBIT is $1,500,000, which plan will result in the higher EPS?3. What is the break-even EBIT?5. MM and Stock Value In Problem 4, use MM Proposition I to find the price per share of equityunder each of the two proposed plans. What is the value of the firm?6. Break-Even EBIT and Leverage Kolby Corp. is comparing two different capital structures.Plan I would result in 1,500 shares of stock and $20,000 in debt. Plan II would result in 1,100 shares of stock and $30,000 in debt. The interest rate on the debt is 10 percent.1. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT willbe $12,000. The all-equity plan would result in 2,300 shares of stock outstanding. Which of the three plans has the highest EPS? The lowest?2. In part (a) what are the break-even levels of EBIT for each plan as compared to that foran all-equity plan? Is one higher than the other? Why?3. Ignoring taxes, when will EPS be identical for Plans I and II?4. Repeat parts (a), (b), and (c) assuming that the corporate tax rate is 40 percent. Are thebreak-even levels of EBIT different from before? Why or why not?7. Leverage and Stock Value Ignoring taxes in Problem 6, what is the price per share of equityunder Plan I? Plan II? What principle is illustrated by your answers?8. Homemade Leverage Star, Inc., a prominent consumer products firm, is debating whether ornot to convert its all-equity capital structure to one that is 40 percent debt. Currently there are 5,000 shares outstanding and the price per share is $65. EBIT is expected to remain at $37,500 per year forever. The interest rate on new debt is 8 percent, and there are no taxes.1. Ms. Brown, a shareholder of the firm, owns 100 shares of stock. What is her cash flowunder the current capital structure, assuming the firm has a dividend payout rate of 100 percent?2. What will Ms. Brown’s cash flow be under the proposed capital structure of the firm?Assume that she keeps all 100 of her shares.3. Suppose Star does convert, but Ms. Brown prefers the current all-equity capital structure.Show how she could unlever her shares of stock to recreate the original capital structure.4. Using your answer to part (c), explain why Star’s choice of capital structure is irrelevant.9. Homemade Leverage and WACC ABC Co. and XYZ Co. are identical firms in all respectsexcept for their capital structure. ABC is all equity financed with $800,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $400,000 and the interest rate on its debt is 10 percent. Both firms expect EBIT to be $95,000. Ignore taxes.1. Richard owns $30,000 worth of XYZ’s stock. What rate of return is he expecting?2. Show how Richard could generate exactly the same cash flows and rate of return byinvesting in ABC and using homemade leverage.3. What is the cost of equity for ABC? What is it for XYZ?4. What is the WACC for ABC? For XYZ? What principle have you illustrated?10. MM Nina Corp. uses no debt. The weighted average cost of capital is 11 percent. If the currentmarket value of the equity is $43 million and there are no taxes, what is EBIT?11. MM and Taxes In the previous question, suppose the corporate tax rate is 35 percent. What isEBIT in this case? What is the WACC? Explain.12. Calculating WACC Weston Industries has a debt–equity ratio of 1.5. Its WACC is 12 percent,and its cost of debt is 9 percent. The corporate tax rate is 35 percent.1. What is Weston’s cost of equity capital?2. What is Weston’s unlevered cost of equity capital?3. What would the cost of equity be if the debt–equity ratio were 2? What if it were 1.0?What if it were zero?13. Calculating WACC Shadow Corp. has no debt but can borrow at 7 percent. The firm’s WACC iscurrently 11 percent, and the tax rate is 35 percent.1. What is Shadow’s cost of equity?2. If the firm converts to 25 percent debt, what will its cost of equity be?3. If the firm converts to 50 percent debt, what will its cost of equity be?4. What is Shadow’s WACC in part (b)? In part (c)?14. MM and Taxes Bruce & Co. expects its EBIT to be $140,000 every year forever. The firm canborrow at 9 percent. Bruce currently has no debt, and its cost of equity is 17 percent. If the tax rate is 35 percent, what is the value of the firm? What will the value be if Bruce borrows $135,000 and uses the proceeds to repurchase shares?15. MM and Taxes In Problem 14, what is the cost of equity after recapitalization? What is theWACC? What are the implications for the firm’s capital structure decision?16. MM Proposition I Levered, Inc., and Unlevered, Inc., are identical in every way except theircapital structures. Each company expects to earn $65 million before interest per year in perpetuity, with each company distributing all its earnings as dividends. Levered’s perpetual debt has a marketvalue of $185 million and costs 8 percent per year. Levered has 3.4 million shares outstanding, currently worth $100 per share. Unlevered has no debt and 7 million shares outstanding, currently worth $80 per share. Neither firm pays taxes. Is Levered’s stock a better buy than Unlevered’s stock?INTERMEDIATE (Questions 17–25)17. MM Tool Manufacturing has an expected EBIT of $42,000 in perpetuity and a tax rate of 35percent. The firm has $70,000 in outstanding debt at an interest rate of 8 percent, and its unlevered cost of capital is 15 percent. What is the value of the firm according to MM Proposition I with taxes? Should Tool change its debt–equity ratio if the goal is to maximize the value of the firm? Explain.18. Firm Value Old School Corporation expects an EBIT of $15,000 every year forever. Old Schoolcurrently has no debt, and its cost of equity is 17 percent. The firm can borrow at 10 percent. If the corporate tax rate is 35 percent, what is the value of the firm? What will the value be if Old School converts to 50 percent debt? To 100 percent debt?19. MM Proposition I with Taxes The Maxwell Company is financed entirely with equity. Thecompany is considering a loan of $1.4 million. The loan will be repaid in equal installments over the next two years, and it has an 8 percent interest rate. The company’s tax rate is 35 percent.According to MM Proposition I with taxes, what would be the increase in the value of the company after the loan?20. MM Proposition I without Taxes Alpha Corporation and Beta Corporation are identical inevery way except their capital structures. Alpha Corporation, an all-equity firm, has 10,000 shares of stock outstanding, currently worth $20 per share. Beta Corporation uses leverage in its capital structure. The market value of Beta’s debt is $50,000, and its cost of debt is 12 percent. Each firm is expected to have earnings before interest of $55,000 in perpetuity. Neither firm pays taxes.Assume that every investor can borrow at 12 percent per year.1. What is the value of Alpha Corporation?2. What is the value of Beta Corporation?3. What is the market value of Beta Corporation’s equity?4. How much will it cost to purchase 20 percent of each firm’s equity?5. Assuming each firm meets its earnings estimates, what will be the dollar return to eachposition in part (d) over the next year?6. Construct an investment strategy in which an investor purchases 20 percent of Alpha’sequity and replicates both the cost and dollar return of purchasing 20 percent of Beta’s equity.7. Is Alpha’s equity more or less risky than Beta’s equity? Explain.21. Cost of Capital Acetate, Inc., has equity with a market value of $35 million and debt with amarket value of $14 million. Treasury bills that mature in one year yield 6 percent per year, and the expected return on the market portfolio is 13 percent. The beta of Acetate’s equity is 1.15. The firm pays no taxes.1. What is Acetate’s debt–equity ratio?2. What is the firm’s weighted average cost of capital?3. What is the cost of capital for an otherwise identical all-equity firm?22. Homemade Leverage The Veblen Company and the Knight Company are identical in everyrespect except that Veblen is not levered. The market value of Knight Company’s 6 percent bonds is $1.2 million. Financial information for the two firms appears here. All earnings streams areperpetuities. Neither firm pays taxes. Both firms distribute all earnings available to common stockholders immediately.1. An investor who can borrow at 6 percent per year wishes to purchase 5 percent ofKnight’s equity. Can he increase his dollar return by purchasing 5 percent of Veblen’s equity if he borrows so that the initial net costs of the two strategies are the same?2. Given the two investment strategies in (a), which will investors choose? When will thisprocess cease?23. MM Propositions Locomotive Corporation is planning to repurchase part of its common stockby issuing corporate debt. As a result, the firm’s debt–equity ratio is expected to rise from 40 percent to 50 percent. The firm currently has $4.3 million worth of debt outstanding. The cost of this debt is 10 percent per year. Locomotive expects to have an EBIT of $1.68 million per year in perpetuity. Locomotive pays no taxes.1. What is the market value of Locomotive Corporation before and after the repurchaseannouncement?2. What is the expected return on the firm’s equity before the announcement of the stockrepurchase plan?3. What is the expected return on the equity of an otherwise identical all-equity firm?4. What is the expected return on the firm’s equity after the announcement of the stockrepurchase plan?24. Stock Value and Leverage Green Manufacturing, Inc., plans to announce that it will issue $3million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a 6 percent annual coupon rate. Green is currently an all-equity firm worth $9.5 million with 600,000 shares of common stock outstanding. After the sale of the bonds, Green will maintain the new capital structure indefinitely. Green currently generates annual pretax earnings of $1.8 million. This level of earnings is expected to remain constant in perpetuity. Green is subject to a corporate tax rate of 40 percent.1. What is the expected return on Green’s equity before the announcement of the debtissue?2. Construct Green’s market value balance sheet before the announcement of the debt issue.What is the price per share of the firm’s equity?3. Construct Green’s market value balance sheet immediately after the announcement of thedebt issue.4. What is Green’s stock price per share immediately after the repurchase announcement?5. How many shares will Green repurchase as a result of the debt issue? How many shares ofcommon stock will remain after the repurchase?6. Construct the market value balance sheet after the restructuring.7. What is the required return on Green’s equity after the restructuring?levered cost of equity. Now calculate the unlevered cost of equity, then the unlevered EBIT. What is the unlevered value of the company? What is the value of the interest tax shield and the value of the levered company?Mini Case: STEPHENSON REAL ESTATE RECAPITALIZATIONStephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson. The company purchases real estate, including land and buildings, and rents the property to tenants. The company has shown a profit every year for the past 18 years, and the shareholders are satisfied with the company’s management. Prior to founding Stephenson Real Estate, Robert was the founder and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely averse to debt financing. As a result, the company is entirely equity financed, with 20 million shares of common stock outstanding. The stock currently trades at $35.50 per share.Stephenson is evaluating a plan to purchase a huge tract of land in the southeastern United States for $60 million. The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephenson’s annual pretax earnings by $14 million in perpetuity. Kim Weyand, the company’s new CFO, has been put in charge of the project. Kim has determined that the company’s current cost of capital is 12.5 percent. She feels that the company would be more valuable if it included debt in its capital structure, so she is evaluating whether the company should issue debt to entirely finance the project. Based on some conversations with investment banks, she thinks that the company can issue bonds at par value with an 8 percent coupon rate. Based on her analysis, she also believes that a capital structure in the range of 70 percent equity/30 percent debt would be optimal. If the company goes beyond 30 percent debt, its bonds would carry a lower rating and a much higher coupon because the possibility of financial distress and the associated costs would rise sharply. Stephenson has a 40 percent corporate tax rate (state and federal).1. If Stephenson wishes to maximize its total market value, would you recommend that it issuedebt or equity to finance the land purchase? Explain.2. Construct Stephenson’s market value balance sheet before it announces the purchase.3. Suppose Stephenson decides to issue equity to finance the purchase.1. What is the net present value of the project?2. Construct Stephenson’s market value balance sheet after it announces that the firm willfinance the purchase using equity. What would be the new price per share of the firm’sstock? How many shares will Stephenson need to issue to finance the purchase?3. Construct Stephenson’s market value balance sheet after the equity issue but before thepurchase has been made. How many shares of common stock does Stephenson haveoutstanding? What is the price per share of the firm’s stock?4. Construct Stephenson’s market value balance sheet after the purchase has been made. 4. Suppose Stephenson decides to issue debt to finance the purchase.1. What will the market value of the Stephenson company be if the purchase is financed withdebt?2. Construct Stephenson’s market value balance sheet after both the debt issue and the landpurchase. What is the price per share of the firm’s stock?5. Which method of financing maximizes the per-share stock price of Stephenson’s equity?。
Fundamentals of Corporate Finance, 12e (Ross)Chapter 1 Introduction to Corporate Finance1) Which one of the following functions should be the responsibility of the controller rather than the treasurer?A) Depositing cash receiptsB) Processing cost reportsC) Analyzing equipment purchasesD) Approving credit for a customerE) Paying a vendor2) The treasurer of a corporation generally reports directly to the:A) board of directors.B) chairman of the board.C) chief executive officer.D) president.E) vice president of finance.3) Which one of the following correctly defines the upward chain of command in a typical corporate organizational structure?A) The vice president of finance reports to the chairman of the board.B) The chief executive officer reports to the president.C) The controller reports to the chief financial officer.D) The treasurer reports to the president.E) The chief operations officer reports to the vice president of production.4) An example of a capital budgeting decision is deciding:A) how many shares of stock to issue.B) whether or not to purchase a new machine for the production line.C) how to refinance a debt issue that is maturing.D) how much inventory to keep on hand.E) how much money should be kept in the checking account.5) When evaluating the timing of a project's projected cash flows, a financial manager is analyzing:A) the amount of each expected cash flow.B) only the start-up costs that are expected to require cash resources.C) only the date of the final cash flow related to the project.D) the amount by which cash receipts are expected to exceed cash outflows.E) when each cash flow is expected to occur.6) Capital structure decisions include determining:A) which one of two projects to accept.B) how to allocate investment funds to multiple projects.C) the amount of funds needed to finance customer purchases of a new product.D) how much debt should be assumed to fund a project.E) how much inventory will be needed to support a project.7) The decision to issue additional shares of stock is an example of:A) working capital management.B) a net working capital decision.C) capital budgeting.D) a controller's duties.E) a capital structure decision.8) Which one of the following questions is a working capital management decision?A) Should the company issue new shares of stock or borrow money?B) Should the company update or replace its older equipment?C) How much inventory should be on hand for immediate sale?D) Should the company close one of its current stores?E) How much should the company borrow to buy a new building?9) Which one of the following is a working capital management decision?A) What type(s) of equipment is (are) needed to complete a current project?B) Should the firm pay cash for a purchase or use the credit offered by the supplier?C) What amount of long-term debt is required to complete a project?D) How many shares of stock should the firm issue to fund an acquisition?E) Should a project should be accepted?10) Working capital management decisions include determining:A) the minimum level of cash to be kept in a checking account.B) the best method of producing a product.C) the number of employees needed to work during a particular shift.D) when to replace obsolete equipment.E) if a competitor should be acquired.11) Which one of the following terms is defined as the management of a firm's long-term investments?A) Working capital managementB) Financial allocationC) Agency cost analysisD) Capital budgetingE) Capital structure12) Which one of the following terms is defined as the mixture of a firm's debt and equity financing?A) Working capital managementB) Cash managementC) Cost analysisD) Capital budgetingE) Capital structure13) A firm's short-term assets and its short-term liabilities are referred to as the firm's:A) working capital.B) debt.C) investment capital.D) net capital.E) capital structure.14) Which one of the following questions is least likely to be addressed by financial managers?A) How should a product be marketed?B) Should customers be given 30 or 45 days to pay for their credit purchases?C) Should the firm borrow more money?D) Should the firm acquire new equipment?E) How much cash should the firm keep on hand?15) A business owned by a solitary individual who has unlimited liability for the firm's debt is called a:A) corporation.B) sole proprietorship.C) general partnership.D) limited partnership.E) limited liability company.16) A business formed by two or more individuals who each have unlimited liability for all of the firm's business debts is called a:A) corporation.B) sole proprietorship.C) general partnership.D) limited partnership.E) limited liability company.17) A business partner whose potential financial loss in the partnership will not exceed his or her investment in that partnership is called a:A) general partner.B) sole proprietor.C) limited partner.D) corporate shareholder.E) zero partner.18) A business created as a distinct legal entity and treated as a legal "person" is called a(n):A) corporation.B) sole proprietorship.C) general partnership.D) limited partnership.E) unlimited liability company.19) Which one of the following statements concerning a sole proprietorship is correct?A) A sole proprietorship is designed to protect the personal assets of the owner.B) The profits of a sole proprietorship are subject to double taxation.C) The owner of a sole proprietorship is personally responsible for all of the company's debts.D) There are very few sole proprietorships remaining in the U.S. today.E) A sole proprietorship is structured the same as a limited liability company.20) Which one of the following statements concerning a sole proprietorship is correct?A) The life of a sole proprietorship is limited.B) A sole proprietor can generally raise large sums of capital quite easily.C) Transferring ownership of a sole proprietorship is easier than transferring ownership of a corporation.D) A sole proprietorship is taxed the same as a C corporation.E) A sole proprietorship is the most regulated form of organization.21) Which of the following individuals have unlimited liability for a firm's debts based on their ownership interest?A) Only general partnersB) Only sole proprietorsC) All stockholdersD) Both limited and general partnersE) Both general partners and sole proprietors22) The primary advantage of being a limited partner is:A) the receipt of tax-free income.B) the partner's active participation in the firm's activities.C) the lack of any potential financial loss.D) the daily control over the business affairs of the partnership.E) the partner's maximum loss is limited to their capital investment.23) A general partner:A) is personally responsible for all partnership debts.B) has no say over a firm's daily operations.C) faces double taxation whereas a limited partner does not.D) has a maximum loss equal to his or her equity investment.E) receives a salary in lieu of a portion of the profits.24) A limited partnership:A) has an unlimited life.B) can opt to be taxed as a corporation.C) terminates at the death of any one limited partner.D) has at least one partner who has unlimited liability for all of the partnership's debts.E) consists solely of limited partners.25) A partnership with four general partners:A) distributes profits based on percentage of ownership.B) has an unlimited partnership life.C) limits the active involvement in the firm to a single partner.D) limits each partner's personal liability to 25 percent of the partnership's total debt.E) must distribute 25 percent of the profits to each partner.26) One disadvantage of the corporate form of business ownership is the:A) limited liability of its shareholders for the firm's debts.B) double taxation of distributed profits.C) firm's greater ability to raise capital than other forms of ownership.D) firm's potential for an unlimited life.E) firm's ability to issue additional shares of stock.27) Which one of the following statements is correct?A) The majority of firms in the U.S. are structured as corporations.B) Corporate profits are taxable income to the shareholders when earned.C) Corporations can have an unlimited life.D) Shareholders are protected from all potential losses.E) Shareholders directly elect the corporate president.28) Which one of the following statements is correct?A) A general partnership is legally the same as a corporation.B) Income from both sole proprietorships and partnerships that is taxable is treated as individual income.C) Partnerships are the most complicated type of business to form.D) All business organizations have bylaws.E) Only firms organized as sole proprietorships have limited lives.29) The articles of incorporation:A) describe the purpose of the firm and set forth the number of shares of stock that can be issued.B) are amended periodically especially prior to corporate elections.C) explain how corporate directors are to be elected and the length of their terms.D) sets forth the procedures by which a firm regulates itself.E) include only the corporation's name and intended life.30) Corporate bylaws:A) must be amended should a firm decide to increase the number of shares authorized.B) cannot be amended once adopted.C) define the name by which the firm will operate.D) describe the intended life and purpose of the organization.E) determine how a corporation regulates itself.31) A limited liability company:A) can only have a single owner.B) is comprised of limited partners only.C) is taxed similar to a partnership.D) is taxed similar to a C corporation.E) generates totally tax-free income.32) Which business form is best suited to raising large amounts of capital?A) Sole proprietorshipB) Limited liability companyC) CorporationD) General partnershipE) Limited partnership33) A ________ has all the respective rights and privileges of a legal person.A) sole proprietorshipB) general partnershipC) limited partnershipD) corporationE) limited liability company34) Sam, Alfredo, and Juan want to start a small U.S. business. Juan will fund the venture but wants to limit his liability to his initial investment and has no interest in the daily operations. Sam will contribute his full efforts on a daily basis but has limited funds to invest in the business. Alfredo will be involved as an active consultant and manager and will also contribute funds. Sam and Alfredo are willing to accept liability for the firm's debts as they feel they have nothing to lose by doing so. All three individuals will share in the firm's profits and wish to keep the initial organizational costs of the business to a minimum. Which form of business entity should these individuals adopt?A) Sole proprietorshipB) Joint stock companyC) Limited partnershipD) General partnershipE) Corporation35) Sally and Alicia are equal general partners in a business. They are content with their current management and tax situation but are uncomfortable with their unlimited liability. Which form of business entity should they consider as a replacement to their current arrangement assuming they wish to remain the only two owners of the business?A) Sole proprietorshipB) Joint stock companyC) Limited partnershipD) Limited liability companyE) Corporation36) The growth of both sole proprietorships and partnerships is frequently limited by the firm's:A) double taxation.B) bylaws.C) inability to raise cash.D) limited liability.E) agency problems.37) Corporate dividends are:A) tax-free because the income is taxed at the personal level when earned by the firm.B) tax-free because they are distributions of aftertax income.C) tax-free since the corporation pays tax on that income when it is earned.D) taxed at both the corporate and the personal level when the dividends are paid to shareholders.E) taxable income of the recipient even though that income was previously taxed.38) Financial managers should primarily focus on the interests of:A) stakeholders.B) the vice president of finance.C) their immediate supervisor.D) shareholders.E) the board of directors.39) Which one of the following best states the primary goal of financial management?A) Maximize current dividends per shareB) Maximize the current value per shareC) Increase cash flow and avoid financial distressD) Minimize operational costs while maximizing firm efficiencyE) Maintain steady growth while increasing current profits40) Which one of the following best illustrates that the management of a firm is adhering to the goal of financial management?A) An increase in the amount of the quarterly dividendB) A decrease in the per unit production costsC) An increase in the number of shares outstandingD) A decrease in the net working capitalE) An increase in the market value per share41) Financial managers should strive to maximize the current value per share of the existingstock to:A) guarantee the company will grow in size at the maximum possible rate.B) increase employee salaries.C) best represent the interests of the current shareholders.D) increase the current dividends per share.E) provide managers with shares of stock as part of their compensation.42) Decisions made by financial managers should primarily focus on increasing the:A) size of the firm.B) growth rate of the firm.C) gross profit per unit produced.D) market value per share of outstanding stock.E) total sales.43) The Sarbanes-Oxley Act of 2002 is a governmental response to:A) decreasing corporate profits.B) the terrorist attacks on 9/11/2001.C) a weakening economy.D) deregulation of the stock exchanges.E) management greed and abuses.44) Which one of the following is an unintended result of the Sarbanes-Oxley Act?A) More detailed and accurate financial reportingB) Increased management awareness of internal controlsC) Corporations delisting from major exchangesD) Increased responsibility for corporate officersE) Identification of internal control weaknesses45) A firm which opts to "go dark" in response to the Sarbanes-Oxley Act:A) must continue to provide audited financial statements to the public.B) must continue to provide a detailed list of internal control deficiencies on an annual basis.C) can provide less information to its shareholders than it did prior to "going dark".D) can continue publicly trading its stock but only on the exchange on which it was previously listed.E) ceases to exist.46) The Sarbanes-Oxley Act of 2002 holds a public company's ________ responsible for the accuracy of the company's financial statements.A) managersB) internal auditorsC) external legal counselD) internal legal counselE) Securities and Exchange Commission agent47) Which one of the following actions by a financial manager is most apt to create an agency problem?A) Refusing to borrow money when doing so will create losses for the firmB) Refusing to lower selling prices if doing so will reduce the net profitsC) Refusing to expand the company if doing so will lower the value of the equityD) Agreeing to pay bonuses based on the market value of the company's stock rather than on its level of salesE) Increasing current profits when doing so lowers the value of the company's equity48) Which one of the following is least apt to help convince managers to work in the best interest of the stockholders? Assume there are no golden parachutes.A) Compensation based on the value of the stockB) Stock option plansC) Threat of a company takeoverD) Threat of a proxy fightE) Increasing managers' base salaries49) Agency problems are most associated with:A) sole proprietorships.B) general partnerships.C) limited partnerships.D) corporations.E) limited liability companies.50) Which one of the following is an agency cost?A) Accepting an investment opportunity that will add value to the firmB) Increasing the quarterly dividendC) Investing in a new project that creates firm valueD) Hiring outside accountants to audit the company's financial statementsE) Closing a division of the firm that is operating at a loss51) Which one of the following is a means by which shareholders can replace company management?A) Stock optionsB) PromotionC) Sarbanes-Oxley ActD) Agency playE) Proxy fight52) Which one of the following grants an individual the right to vote on behalf of a shareholder?A) ProxyB) By-lawsC) Indenture agreementD) Stock optionE) Stock audit53) Which one of the following parties has ultimate control of a corporation?A) Chairman of the boardB) Board of directorsC) Chief executive officerD) Chief operating officerE) Shareholders54) Which of the following parties are considered stakeholders of a firm?A) Employees and the governmentB) Long-term creditorsC) Government and common stockholdersD) Common stockholdersE) Long-term creditors and common stockholders55) Which one of the following represents a cash outflow from a corporation?A) Issuance of new securitiesB) Payment of dividendsC) New loan proceedsD) Receipt of tax refundE) Initial sale of common stock56) Which one of the following is a cash flow from a corporation into the financial markets?A) Borrowing of long-term debtB) Payment of government taxesC) Payment of loan interestD) Issuance of corporate debtE) Sale of common stock57) Which one of the following is a primary market transaction?A) Sale of currently outstanding stock by a dealer to an individual investorB) Sale of a new share of stock to an individual investorC) Stock ownership transfer from one shareholder to another shareholderD) Gift of stock from one shareholder to another shareholderE) Gift of stock by a shareholder to a family member58) Shareholder A sold 500 shares of ABC stock on the New York Stock Exchange. This transaction:A) took place in the primary market.B) occurred in a dealer market.C) was facilitated in the secondary market.D) involved a proxy.E) was a private placement.59) Public offerings of debt and equity must be registered with the:A) New York Board of Governors.B) Federal Reserve.C) NYSE Registration Office.D) Securities and Exchange Commission.E) Market Dealers Exchange.60) Which one of the following statements is generally correct?A) Private placements must be registered with the SEC.B) All secondary markets are auction markets.C) Dealer markets have a physical trading floor.D) Auction markets match buy and sell orders.E) Dealers arrange trades but never own the securities traded.61) Which one of the following statements concerning stock exchanges is correct?A) NASDAQ is a broker market.B) The NYSE is a dealer market.C) The exchange with the strictest listing requirements is NASDAQ.D) Some large companies are listed on NASDAQ.E) Most debt securities are traded on the NYSE.62) Shareholder A sold shares of Maplewood Cabinets stock to Shareholder B. The stock is listed on the NYSE. This trade occurred in which one of the following?A) Primary, dealer marketB) Secondary, dealer marketC) Primary, auction marketD) Secondary, auction marketE) Secondary, OTC market63) Which one of the following statements is correct concerning the NYSE?A) The publicly traded shares of a NYSE-listed firm must be worth at least $250 million.B) The NYSE is the largest dealer market for listed securities in the United States.C) The listing requirements for the NYSE are more stringent than those of NASDAQ.D) Any corporation desiring to be listed on the NYSE can do so for a fee.E) The NYSE is an OTC market functioning as both a primary and a secondary market.11。
Fundamentals of Corporate Finance, 12e (Ross)Chapter 16 Financial Leverage and Capital Structure Policy1) Which one of these statements is correct?A) Capital structure has no effect on shareholder value.B) The optimal capital structure occurs when the cost of equity is minimized.C) The optimal capital structure maximizes shareholder value.D) Shareholder value is maximized when WACC is also maximized.E) Unlevered firms have more value than levered firms when firms are profitable.2) A firm should select the capital structure that:A) produces the highest cost of capital.B) maximizes the value of the firm.C) minimizes taxes.D) is fully unlevered.E) equates the value of debt with the value of equity.3) The value of a firm is maximized when the:A) cost of equity is maximized.B) tax rate equals the cost of capital.C) levered cost of capital is maximized.D) weighted average cost of capital is minimized.E) debt-equity ratio is minimized.4) The optimal capital structure has been achieved when the:A) debt-equity ratio is equal to 1.B) weight of equity is equal to the weight of debt.C) cost of equity is maximized given a pretax cost of debt.D) debt-equity ratio is such that the cost of debt exceeds the cost of equity.E) debt-equity ratio results in the lowest possible weighted average cost of capital.5) Assume you are reviewing a graph that plots earnings per share (EPS) against earnings before interest and taxes (EBIT). The steeper the slope of the plotted line the:A) lower the impact of financial leverage.B) lower the debt-equity ratio.C) higher the tax rate.D) greater the sensitivity of EPS to changes in EBIT.E) lower the probability of a negative EPS.6) You have computed the break-even point between a levered and an unlevered capital structure. Ignore taxes. At the break-even level, the:A) company is earning just enough to pay for the cost of the debt.B) company's earnings before interest and taxes are equal to zero.C) earnings per share for the levered option are exactly double those of the unlevered option.D) advantages of leverage exceed the disadvantages of leverage.E) company has a debt-equity ratio of .50.7) Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Ignore taxes.A) At the break-even point, there is no advantage to debt.B) The earnings per share will equal zero when EBIT is zero for a levered firm.C) The advantages of leverage are inversely related to the level of EBIT.D) The use of leverage at any level of EBIT increases the EPS.E) EPS are more sensitive to changes in EBIT when a firm is unlevered.8) Jessica invested in QRT stock when the company was unlevered. Since then, QRT has changed its capital structure and now has a debt-equity ratio of .36. To unlever her position, Jessica needs to:A) borrow some money and purchase additional shares of QRT stock.B) maintain her current equity position as the debt of the firm does not affect her personally.C) sell 36 percent of her shares of QRT stock and hold the proceeds in cash.D) sell 36 percent of her shares of QRT stock and loan out the sale proceeds.E) create a personal debt-equity ratio of .36.9) Which one of the following makes the capital structure of a company irrelevant?A) TaxesB) Interest tax shieldC) 100 percent dividend payout ratioD) Debt-equity ratio that is greater than 0 but less than 1E) Homemade leverage10) Homemade leverage is:A) the incurrence of debt by a corporation in order to pay dividends to shareholders.B) the exclusive use of debt to fund a corporate expansion project.C) the use of personal borrowing to alter an individual's exposure to financial leverage.D) best defined as an increase in a company's debt level.E) the term used to describe the capital structure of a levered firm.11) The concept of homemade leverage is most associated with:A) M&M Proposition I with no tax.B) M&M Proposition II with no tax.C) M&M Proposition I with tax.D) M&M Proposition II with tax.E) the static theory proposition.12) Which one of the following statements is correct in relation to M&M Proposition II, without taxes?A) The cost of equity remains constant as the debt-equity ratio increases.B) The cost of equity is inversely related to the debt-equity ratio.C) The required return on assets is equal to the weighted average cost of capital.D) Financial risk determines the return on assets.E) Financial risk is unaffected by the debt-equity ratio.13) M&M Proposition II, without taxes, is the proposition that:A) the capital structure of a company has no effect on that company's value.B) the cost of equity depends on the return on debt, the debt-equity ratio, and the tax rate.C) a company's cost of equity is a linear function with a slope equal to (R A− R D).D) the cost of equity is equivalent to the required rate of return on assets.E) the size of the pie does not depend on how the pie is sliced.14) The business risk of a company:A) depends on the company's level of unsystematic risk.B) is inversely related to the required return on the company's assets.C) is dependent upon the relative weights of the debt and equity used to finance the company.D) has a positive relationship with the company's cost of equity.E) has no relationship with the required return on a company's assets according to M&M theory.15) Financial risk is:A) the risk inherent in a company's operations.B) a type of unsystematic risk.C) inversely related to the cost of equity.D) dependent upon a company's capital structure.E) irrelevant to the value of a company.16) Which one of the following states that the value of a company is unrelated to the company's capital structure?A) Homemade leverageB) M&M Proposition I, no taxC) M&M Proposition II, no taxD) Pecking-order theoryE) Static theory of capital structure17) Which one of the following states that the cost of equity capital is directly and proportionally related to capital structure?A) Static theory of capital structureB) M&M Proposition IC) M&M Proposition IID) Homemade leverageE) Pecking-order theory18) Which one of the following is the equity risk that is most related to the daily operations of a firm?A) Market riskB) Systematic riskC) Extrinsic riskD) Business riskE) Financial risk19) Which one of the following is the equity risk related to capital structure policy?A) Market riskB) Systematic riskC) Static riskD) Business riskE) Financial risk20) M&M Proposition I with no tax supports the argument that:A) business risk has no effect on the return on assets.B) the cost of equity rises as leverage rises.C) a company's debt-equity ratio is completely irrelevant.D) business risk is irrelevant.E) homemade leverage is irrelevant.21) Westover Mills reduced its taxes last year by $210 by increasing its interest expense by $1,000. Which one of the following terms is used to describe this tax savings?A) Interest tax shieldB) Interest creditC) Homemade leverage shieldD) Current tax yieldE) Tax-loss interest22) M&M Proposition I with tax implies that the:A) weighted average cost of capital decreases as the debt-equity ratio increases.B) value of a company is inversely related to the amount of leverage used by that company.C) value of an unlevered company equals the value of a levered company plus the value of the interest tax shield.D) cost of capital is the same regardless of the mix of debt and equity used.E) cost of equity increases as the debt-equity ratio decreases.23) M&M Proposition I with taxes is based on the concept that:A) the optimal capital structure is the one that is totally financed with equity.B) capital structure is irrelevant because investors and companies have differing tax rates.C) WACC is unaffected by a change in the company's capital structure.D) the value of a taxable company increases as the level of debt increases.E) the cost of equity increases as the debt-equity ratio increases.24) M&M Proposition II with taxes:A) has the same general implications as M&M Proposition II without taxes.B) states that capital structure is irrelevant to shareholders.C) supports the argument that business risk is determined by the capital structure decision.D) supports the argument that the cost of equity decreases as the debt-equity ratio increases.E) concludes that the capital structure decision is irrelevant to the value of a firm.25) The present value of the interest tax shield is expressed as:A) T C D/R A.B) V U + T C D.C) T C DR A.D) [EBIT(T C D)]/R A.E) T C D.26) The interest tax shield is a key reason why:A) the required rate of return on assets rises when debt is added to the capital structure.B) the value of an unlevered company is equal to the value of a levered company.C) the net cost of debt is generally less than the cost of equity.D) the cost of debt is equal to the cost of equity for a levered company.E) companies prefer equity financing over debt financing.27) Based on M&M Proposition I with taxes, the weighted average cost of capital:A) is equal to the aftertax cost of debt.B) has a linear relationship with the cost of equity capital.C) is unaffected by the tax rate.D) decreases as the debt-equity ratio increases.E) is equal to R U(1 − T C).28) The symbol "R U" refers to the cost of capital for a(n) ________ while "R A" represents the:A) privately owned entity; unlevered cost of capital.B) all-equity company; weighted average cost of capital.C) levered company; cost of capital for an all-equity company.D) levered company; weighted average cost of capital.E) unlevered company; average cost of equity.29) The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as ________ costs.A) flotationB) issueC) direct bankruptcyD) indirect bankruptcyE) unlevered30) Which one of the following is a direct cost of bankruptcy?A) Bypassing a positive NPV project to avoid additional debtB) Investing in cash reservesC) Maintaining a debt-equity ratio that is lower than the optimal ratioD) Losing a key company employeeE) Paying an outside accountant to prepare bankruptcy reports31) The costs incurred by a business in an effort to avoid bankruptcy are classified as ________ costs.A) flotationB) direct bankruptcyC) indirect bankruptcyD) financial solvencyE) capital structure32) The proposition that a company borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs is called:A) the static theory of capital structure.B) M&M Proposition I, with taxes.C) M&M Proposition II, with taxes.D) the pecking-order theory.E) the open markets theorem.33) If a company has the optimal amount of debt, then the:A) direct financial distress costs must equal the present value of the interest tax shield.B) value of the levered company will exceed the value of the unlevered company.C) company has no financial distress costs.D) Value of the firm is equal to V L + T C D.E) debt-equity ratio is equal to 1.34) Which one of the following provides the greatest tendency to increase the percentage of debt included in a company's optimal capital structure?A) Exceptionally high depreciation expensesB) Very low marginal tax rateC) Substantial tax shields from other sourcesD) Low probability of financial distressE) Minimal taxable income35) The capital structure that maximizes the value of a company also:A) minimizes financial distress costs.B) minimizes the cost of capital.C) maximizes the present value of the tax shield on debt.D) maximizes the value of the debt.E) maximizes the present value of the bankruptcy costs.36) The optimal capital structure:A) will be the same for all companies within the same industry.B) will remain constant over time unless the company changes its primary operations.C) will vary over time as taxes and market conditions change.D) places more emphasis on operations than on financing.E) is unaffected by changes in the financial markets.37) The static theory of capital structure advocates that the optimal capital structure for a company:A) is highly dependent upon a constant debt-equity ratio over time.B) remains fixed over time.C) is independent of the company's tax rate.D) is independent of the company's debt-equity ratio.E) equates marginal tax savings from additional debt to the marginal increased bankruptcy costs of that debt.38) The basic lesson of M&M theory is that the value of a company is dependent upon:A) the company's capital structure.B) the total cash flows of that company.C) minimizing the marketed claims.D) the amount of the company's marketed claims.E) size of the stockholders' claims.39) Which one of the following is a marketed claim against the cash flows of a company?A) Tax payment to the IRSB) Dividend payment to shareholdersC) Payment of employees' wagesD) Payment for warranty work on a product produced by the companyE) Payment of legal claim against the company40) The optimal capital structure of a company:A) minimizes the company's tax payments.B) maximizes the value of that company's marketed claims.C) minimizes both the marketed and nonmarketed claims against that company.D) eliminates all nonmarketed claims against that company.E) equates the company's marketed and nonmarketed claims.41) Which form of financing do companies prefer to use first according to the pecking-order theory?A) Regular debtB) Convertible debtC) Common stockD) Preferred stockE) Internal funds42) Which one of the following is correct according to pecking-order theory?A) There is a direct relationship between a company's profits and its debt levels.B) Companies avoid external debt except as a last resort.C) A company's capital structure is independent of its need for external funding.D) Companies stockpile internally generated cash.E) Every company has an optimal capital structure.43) With the exception of a few industries, most corporations in the U.S. tend to:A) minimize taxes.B) underutilize debt.C) rely equally on debt and equity.D) have relatively similar debt-equity ratios across industry lines.E) rely more heavily on debt than on equity.44) In general, the capital structures of U.S. firms:A) tend to overweigh debt in relation to equity.B) generally result in debt-equity ratios between .45 and .55.C) are fairly standard for all SIC codes.D) tend to exceed a debt-equity ratio of .45.E) vary significantly across industries.45) Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business. The process this company underwent is known as a:A) merger.B) repurchase program.C) liquidation.D) reorganization.E) divestiture.46) Which one of these actions generally occurs first in a bankruptcy reorganization?A) Filing proofs of claimB) Dividing creditors into classesC) Confirming the reorganization planD) Distributing cash, property, and securities to creditorsE) Submitting a reorganization plan47) Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, how long after a company firm files for bankruptcy protection do creditors have to wait before submitting their own reorganization plan to the court?A) 60 daysB) 45 daysC) 180 daysD) 12 monthsE) 18 months48) The absolute priority rule determines:A) when a firm must be declared officially bankrupt.B) how a distressed firm is reorganized.C) which judge is assigned to a particular bankruptcy case.D) how long a reorganized firm is allowed to remain under bankruptcy protection.E) which parties receive payment first in a bankruptcy proceeding.49) Bankruptcy:A) occurs when total equity is negative.B) is a legal proceeding.C) occurs when a company cannot meet its financial obligations.D) refers to a loss of value for debt holders.E) is an inexpensive means of reorganizing a company.50) A company is technically insolvent when:A) it has a negative book value.B) its total debt exceeds its total equity.C) it is unable to meet its financial obligations.D) it files for bankruptcy protection.E) the market value of its stock is less than its book value.51) Which one of the following statements related to Chapter 7 bankruptcy is correct?A) A company in Chapter 7 bankruptcy is reorganizing its operations such that it can return to being a viable concern.B) Under a Chapter 7 bankruptcy, a trustee will assume control of the company's assets until those assets can be liquidated.C) Chapter 7 bankruptcies are always involuntary on the part of the firm.D) Under a Chapter 7 bankruptcy, the claims of creditors are paid prior to the administrative costs of the bankruptcy.E) Chapter 7 bankruptcy allows a firm to restructure its equity such that new shares of stock can be issued.52) Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?A) Consumer claimsB) Dividend payment to preferred shareholdersC) Company contribution to the employees' retirement accountD) Payment to an unsecured creditorE) Payment of employees' wages53) Which one of these statements related to Chapter 11 bankruptcy is correct?A) Prepacks apply only to Chapter 7, not Chapter 11, bankruptcies.B) Senior management must be replaced prior to exiting a Chapter 11 bankruptcy.C) A company can only file for Chapter 11 after it becomes totally insolvent.D) Companies sometimes file for Chapter 11 in an attempt to gain a competitive advantage.E) Chapter 11 involves the total liquidation of the bankrupt firm.54) The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:A) permits creditors to file a prepack immediately after a firm files for bankruptcy protection.B) prevents creditors from submitting any reorganization plans.C) prevents companies from filing for bankruptcy protection more than once.D) permits key employee retention plans only if the affected employee(s) has another job offer.E) allows the payment of bonuses to all key employees to entice those employees to remain in the company's employ.55) Katlin Markets is debating between a levered and an unlevered capital structure. The all-equity capital structure would consist of 60,000 shares of stock. The debt and equity option would consist of 45,000 shares of stock plus $250,000 of debt with an interest rate of 7.25 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes.A) $50,500B) $68,200C) $81,400D) $66,667E) $72,50056) Holly's is currently an all-equity firm that has 7,200 shares of stock outstanding at a market price of $41 a share. The firm has decided to leverage its operations by issuing $60,000 of debt at an interest rate of 7.6 percent. This new debt will be used to repurchase shares of the outstanding stock. The restructuring is expected to increase the earnings per share. What is the minimum level of earnings before interest and taxes that the firm is expecting? Ignore taxes.A) $22,435B) $19,516C) $26,400D) $17,141E) $25,02057) Paradise Travels is an all-equity firm that has 9,000 shares of stock outstanding at a market price of $27 a share. Management has decided to issue $25,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 7.3 percent. What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes.A) $2.28B) $1.97C) $1.67D) $2.12E) $1.9258) Miller's Dry Goods is an all-equity firm with 40,000 shares of stock outstanding at a market price of $50 a share. The company's earnings before interest and taxes are $160,000. Miller's has decided to add leverage to its financial operations by issuing $200,000 of debt at 7 percent interest and using the proceeds to repurchase shares of stock. Jen owns 500 shares of Miller's stock and can loan out funds at 7 percent interest. How many shares of Miller's stock must Jen sell to offset the leverage that Miller's is assuming? (Assume Jen loans out all of the funds she receives from the sale of stock. Ignore taxes.)A) 125 sharesB) 100 sharesC) 50 sharesD) 25 sharesE) 75 shares59) Theo currently owns 700 shares of JKL, which is an all-equity firm with 320,000 shares of stock outstanding at a market price of $25 a share. The company's earnings before interest and taxes are $160,000. JKL has decided to issue $500,000 of debt at 7.5 percent interest and use the proceeds to repurchase shares of stock. How many shares of JKL stock must Theo sell to unlever his position if he can loan out funds at 7.5 percent interest? (Assume partial shares can be sold.)A) 38.50B) 42.50C) 50.00D) 43.75E) 46.6760) Naylor's is an all-equity firm with 48,000 shares of stock outstanding at a market price of $25 a share. The company has earnings before interest and taxes of $87,000. Naylor's has decided to issue $400,000 of debt at 7.3 percent and use the proceeds to repurchase shares. Currently, Angela owns 600 shares of Naylor's stock. How many shares of this stock will she continue to own if she unlevers this position? Assume she can loan out funds at 7.3 percent interest. Ignore taxes.A) 200B) 333C) 400D) 425E) 26761) Eastern Markets has no debt outstanding and a total market value of $346,500. Earnings before interest and taxes, EBIT, are projected to be $14,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 13 percent higher. If there is a recession, then EBIT will be 32 percent lower. The firm is considering a debt issue of $16,000 with an interest rate of 6.8 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,500 shares outstanding. Ignore taxes. What will be the percentage change in EPS if the economy enters a recessionary period?A) −35 percentB) −41 percentC) −32 percentD) −28 percentE) −30 percent62) North Side Inc. has no debt outstanding and a total market value of $168,000. Earnings before interest and taxes, EBIT, are projected to be $18,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 22 percent higher. If there is a recession, then EBIT will be 35 percent lower. The company is considering a $50,000 debt issue with an interest rate of 7.4 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,000 shares outstanding and the tax rate is 21 percent. What will be the percentage change in EPS if the economy has a strong expansion?A) 28.80 percentB) 31.26 percentC) 27.69 percentD) 25.45 percentE) 22.00 percent63) Galaxy Products is comparing two different capital structures, an all-equity plan (Plan I) anda levered plan (Plan II). Under Plan I, the company would have 112,000 shares of stock outstanding. Under Plan II, there would be 75,000 shares of stock outstanding and $600,000 in debt. The interest rate on the debt is 6.7 percent and there are no taxes. What is the break-even EBIT?A) $87,879B) $121,686C) $101,111D) $133,333E) $91,41464) ABC and XYZ are identical firms in all respects except for their capital structures. ABC is all-equity financed with $530,000 in stock. XYZ has the same total value but uses both stock and perpetual debt; its stock is worth $310,000 and the interest rate on its debt is 7.9 percent. Both firms expect EBIT to be $62,222. Ignore taxes. The cost of equity for ABC is ________ percent and for XYZ it is ________ percent.A) 11.74; 9.82B) 11.74; 12.48C) 11.74; 14.47D) 12.09; 9.82E) 12.09; 12.4865) Lamont Corp. is debt-free and has a weighted average cost of capital of 12.7 percent. The current market value of the equity is $2.3 million and there are no taxes. According to M&M Proposition I, what will be the value of the company if it changes to a debt-equity ratio of .85?A) $18,110,236B) $1,955,000C) $15,393,701D) $2,705,882E) $2,300,00066) Ignoring taxes, Pewter & Glass has a weighted average cost of capital of 10.82 percent. The company can borrow at 7.4 percent. What is the cost of equity if the debt-equity ratio is .68?A) 12.87%B) 13.15%C) 11.09%D) 15.85%E) 12.49%67) The Jean Outlet is an all-equity firm that has 64,000 shares of stock outstanding. The company has decided to borrow $120,000 to repurchase 1,500 shares of its stock from the estate of a deceased shareholder. What is the total value of the firm if you ignore taxes?A) $5,340,000B) $4,638,000C) $5,068,700D) $4,950,000E) $5,120,00068) Noelle owns 12 percent of The Toy Factory. She has decided to retire and wants to sell all of her shares in this closely held, all-equity firm. The other shareholders have agreed to have the company borrow the $248,000 needed to repurchase her shares of stock. What is the total market value of the company? Ignore taxes.A) $2,066,667B) $2,489,111C) $2,608,515D) $2,414,141E) $2,333,33369) Winter's Toyland has a debt-equity ratio of .57. The pretax cost of debt is 8.2 percent and the required return on assets is 14.7 percent. What is the company's cost of equity if you ignoretaxes?A) 14.70 percentB) 19.74 percentC) 15.29 percentD) 17.46 percentE) 18.41 percent70) Roy's Welding has a cost of equity of 14.1 percent and a pretax cost of debt of 7.7 percent. The required return on the assets is 13.2 percent. What is the debt-equity ratio based on M&M II with no taxes?A) .164B) .217C) .408D) .108E) .58371) The Corner Bakery has a debt-equity ratio of .53. The required return on assets is 13.5 percent and its cost of equity is 15.8 percent. What is the pretax cost of debt based on M&M Proposition II with no taxes?A) 8.78 percentB) 10.68 percentC) 9.16 percentD) 7.56 percentE) 8.40 percent72) L.A. Clothing has expected earnings before interest and taxes of $63,300, an unlevered cost of capital of 14.7 percent, and a combined tax rate of 23 percent. The company also has $11,000 of debt that carries a coupon rate of 7 percent. The debt is selling at par value. What is the value of this company?A) $342,579B) $273,333C) $284,108D) $334,101E) $305,476。
共享知识分享快乐Chapter 16Capital Structure: Basic ConceptsMultiple Choice Questions1. The use of personal borrowing to change the overall amount of financial leverage to which anindividual is exposed is called:A. homemade leverage.B. dividend recapture.C. the weighted average cost of capital.D. private debt placement.E. personal offset.2. The proposition that the value of the firm is independent of its capital structure is called:A. the capital asset pricing model.B. MM Proposition I.C. MM Proposition II.D. the law of one price.E. the efficient markets hypothesis.3. The proposition that the cost of equity is a positive linear function of capital structure iscalled:A. the capital asset pricing model.B. MM Proposition I.C. MM Proposition II.D. the law of one price.E. the efficient markets hypothesis.4. The tax savings of the firm derived from the deductibility of interest expense is called the:A. interest tax shield.B. depreciable basis.C. financing umbrella.D. current yield.E. tax-loss carry forward savings.卑微如蝼蚁、坚强似大象．共享知识分享快乐5. The unlevered cost of capital is: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 preferred stock for a firm with equal parts debt and common stock in its capitalstructure.E. equal to the profit margin for a firm with some debt in its capital structure.6. The cost of capital for a firm, rWACC, in a zero tax environment is: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.7. The difference between a market value balance sheet and a book value balance sheet is that amarket value balance sheet: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.8. The firm's capital structure refers to: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.卑微如蝼蚁、坚强似大象．共享知识分享快乐9. A general rule for managers to follow is to set the firm's capital structure such that:A. the firm's value is minimized.B. the firm's value is maximized.C. the firm's bondholders are made well off.D. the firms suppliers of raw materials are satisfied.E. the firms dividend payout is maximized.10. A levered firm is a company that has:A. Accounts Payable as the only liability on the balance sheet.B. some debt in the capital structure.C. all equity in the capital structure.D. All of the above.E. None of the above.11. A manager should attempt to maximize the value of the firm by:A. changing the capital structure if and only if the value of the firm increases.B. changing the capital structure if and only if the value of the firm increases to the benefit ofinside management.C. changing the capital structure if and only if the value of the firm increases only to thebenefits of the debtholders.D. changing the capital structure if and only if the value of the firm increases although itdecreases the stockholders' value.E. changing the capital structure if and only if the value of the firm increases and stockholderwealth is constant.12. The effect of financial leverage depends on the operating earnings of the company. Whichof the following is not true?A. Below the indifference or break-even point in EBIT the non-levered structure is superior.B. Financial leverage increases the slope of the EPS line.C. Above the indifference or break-even point the increase in EPS for all equity structures isless than debt-equity structures.D. Above the indifference or break-even point the increase in EPS for all equity structures isgreater than debt-equity structures.E. The rate of return on operating assets is unaffected by leverage.卑微如蝼蚁、坚强似大象．共享知识分享快乐13. The Modigliani-Miller Proposition I without taxes states:A. a firm cannot change the total value of its outstanding securities by changing its capitalstructure proportions.B. when new projects are added to the firm the firm value is the sum of the old value plus thenew.C. managers can make correct corporate decisions that will satisfy all shareholders if they selectprojects that maximize value.D. the determination of value must consider the timing and risk of the cash flows.E. None of the above.14. MM Proposition I without taxes is used to illustrate:A. the value of an unlevered firm equals that of a levered firm.B. that one capital structure is as good as another.C. leverage does not affect the value of the firm.D. capital structure changes have no effect on stockholders' welfare.E. All of the above.15. A key assumption of MM's Proposition I without taxes is:A. that financial leverage increases risk.B. that individuals can borrow on their own account at rates less than the firm.C. that individuals must be able to borrow on their own account at rates equal to the firm.D. managers are acting to maximize the value of the firm.E. All of the above.16. In an EPS-EBI graphical relationship, the slope of the debt ray is steeper than the equity ray.The debt ray has a lower intercept because:A. more shares are outstanding for the same level of EBI.B. the break-even point is higher with debt.C. a fixed interest charge must be paid even at low earnings.D. the amount of interest per share has only a positive effect on the intercept.E. the higher the interest rate the greater the slope.卑微如蝼蚁、坚强似大象．共享知识分享快乐17. In an EPS-EBI graphical relationship, the debt ray and equity ray cross. At this point theequity and debt are:A. equivalent with respect to EPS but above and below this point equity is always superior.B. at breakeven in EPS but above this point debt increases EPS via leverage and decreases EPSbelow this point.C. equal but away from breakeven equity is better as fewer shares are outstanding.D. at breakeven and MM Proposition II states that debt is the better choice.E. at breakeven and debt is the better choice below breakeven because small payments can bemade.18. When comparing levered vs. unlevered capital structures, leverage works to increase EPSfor high levels of EBIT because:A. interest payments on the debt vary with EBIT levels.B. interest payments on the debt stay fixed, leaving less income to be distributed over lessshares.C. interest payments on the debt stay fixed, leaving more income to be distributed over lessshares.D. interest payments on the debt stay fixed, leaving less income to be distributed over moreshares.E. interest payments on the debt stay fixed, leaving more income to be distributed over moreshares.19. Financial leverage impacts the performance of the firm by:A. maintaining the same level of volatility of the firm's EBIT.B. decreasing the volatility of the firm's EBIT.C. decreasing the volatility of the firm's net income.D. increasing the volatility of the firm's net income.E. None of the above.20. The increase in risk to equityholders when financial leverage is introduced is evidenced by: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.卑微如蝼蚁、坚强似大象．共享知识分享快乐21. The reason that MM Proposition I does not hold in the presence of corporate taxation isbecause:A. levered firms pay less taxes compared with identical unlevered firms.B. bondholders require higher rates of return compared with stockholders.C. earnings per share are no longer relevant with taxes.D. dividends are no longer relevant with taxes.E. All of the above.22. MM Proposition I with corporate taxes states that: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 totalvalue.C. firm value is maximized at an all debt capital structure.D. All of the above.E. None of the above.23. The change in firm value in the presence of corporate taxes only is: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.24. A firm should select the capital structure which:A. produces the highest cost of capital.B. maximizes the value of the firm.C. minimizes taxes.D. is fully unlevered.E. has no debt.卑微如蝼蚁、坚强似大象．共享知识分享快乐25. In a world of no corporate taxes if the use of leverage does not change the value of thelevered firm relative to the unlevered firm is known as:A. MM Proposition III that the cost of stock 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.26. Bryan invested in Bryco, Inc. stock when the firm was financed solely with equity. The firmis now utilizing debt in its capital structure. To unlever his position, Bryan needs to:A. borrow some money and purchase additional shares of Bryco stock.B. maintain his current position as the debt of the firm did not affect his personal leverageposition.C. sell some shares of Bryco stock and hold the proceeds in cash.D. sell some shares of Bryco stock and loan it out such that he creates a personal debt-equityratio equal to that of the firm.E. create a personal debt-equity ratio that is equal to exactly 50% of the debt-equity ratio of thefirm.27. The capital structure chosen by a firm doesn't really matter because of:A. taxes.B. the interest tax shield.C. the relationship between dividends and earnings per share.D. the effects of leverage on the cost of equity.E. homemade leverage.28. MM Proposition I with no tax supports the argument that:A. business risk determines the return on assets.B. the cost of equity rises as leverage rises.C. it is completely irrelevant how a firm arranges its finances.D. a firm should borrow money to the point where the tax benefit from debt is equal to the costof the increased probability of financial distress.E. financial risk is determined by the debt-equity ratio.卑微如蝼蚁、坚强似大象．共享知识分享快乐29. The proposition that the value of a levered firm is equal to the value of an unlevered firm isknown as:A. MM Proposition I with no tax.B. MM Proposition II with no tax.C. MM Proposition I with tax.D. MM Proposition II with tax.E. static theory proposition.30. The concept of homemade leverage is most associated with:A. MM Proposition I with no tax.B. MM Proposition II with no tax.C. MM Proposition I with tax.D. MM Proposition II with tax.E. static theory proposition.31. Which of the following statements are correct in relation to MM Proposition II with notaxes?I. The required 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. I and III onlyB. II and IV onlyC. I and II onlyD. III and IV onlyE. I and IV only32. MM Proposition I with taxes supports the theory that:A. there is a positive linear relationship between the amount of debt in a levered firm and itsvalue.B. the value of a firm is inversely related to the amount of leverage used by the firm.C. the value of an unlevered firm is equal to the value of a levered firm plus the value of theinterest tax shield.D. a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm.E. a firm's weighted average cost of capital increases as the debt-equity ratio of the firm rises.卑微如蝼蚁、坚强似大象．共享知识分享快乐33. MM Proposition I with taxes is based on the concept that: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 homemadeleverage.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.34. MM Proposition II with taxes: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 afirm.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 thevalue of afirm.35. MM Proposition II is the proposition that: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.36. The interest tax shield has no value for a firm when:I. the tax rate is equal to zero.II. the debt-equity ratio is exactly equal to 1.III. the firm is unlevered.IV. a firm elects 100% equity as its capital structure.A. I and III onlyB. II and IV onlyC. I, III, and IV onlyD. II, III, and IV onlyE. I, II, and IV only卑微如蝼蚁、坚强似大象．共享知识分享快乐37. The interest tax shield is a key reason why: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.38. Which of the following will tend to diminish the benefit of the interest tax shield given aprogressive tax rate structure?I. a reduction in tax ratesII. a large tax loss carryforwardIII. a large depreciation tax deductionIV. a sizeable increase in taxable incomeA. I and II onlyB. I and III onlyC. II and III onlyD. I, II, and III onlyE. I, II, III, and IV39. Thompson & Thomson is an all equity firm that has 500,000 shares of stock outstanding.The company is in the process of borrowing $8 million at 9% interest to repurchase 200,000shares of the outstanding stock. What is the value of this firm if you ignore taxes?A. $20.0 millionB. $20.8 millionC. $21.0 millionD. $21.2 millionE. $21.3 million40. Uptown Interior Designs is an all equity firm that has 40,000 shares of stock outstanding.The company has decided to borrow $1 million to buy out the shares of a deceased stockholderwho holds 2,500 shares. What is the total value of this firm if you ignore taxes?A. $15.5 millionB. $15.6 millionC. $16.0 millionD. $16.8 millionE. $17.2 million卑微如蝼蚁、坚强似大象．共享知识分享快乐41. You own 25% of Unique Vacations, Inc. You have decided to retire and want to sell yourshares in this closely held, all equity firm. The other shareholders have agreed to have the firmborrow $1.5 million to purchase your 1,000 shares of stock. What is the total value of this firmtoday if you ignore taxes?A. $4.8 millionB. $5.1 millionC. $5.4 millionD. $5.7 millionE. $6.0 million42. Your firm has a debt-equity ratio of .75. Your pre-tax cost of debt is 8.5% and your requiredreturn on assets is 15%. What is your cost of equity if you ignore taxes?A. 11.25%B. 12.21%C. 16.67%D. 19.88%E. 21.38%43. Bigelow, Inc. has a cost of equity of 13.56% and a pre-tax cost of debt of 7%. The requiredreturn on the assets is 11%. What is the firm's debt-equity ratio based on MM Proposition IIwith no taxes?A. .60B. .64C. .72D. .75E. .8044. The Backwoods Lumber Co. has a debt-equity ratio of .80. The firm's required return onassets is 12% and its cost of equity is 15.68%. What is the pre-tax cost of debt based on MMProposition II with no taxes?A. 6.76%B. 7.00%C. 7.25%D. 7.40%E. 7.50%卑微如蝼蚁、坚强似大象．共享知识分享快乐45. The Winter Wear Company has expected earnings before interest and taxes of $2,100, anunlevered cost of capital of 14% and a tax rate of 34%. The company also has $2,800 of debtthat carries a 7% coupon. The debt is selling at par value. What is the value of this firm?A. $9,900B. $10,852C. $11,748D. $12,054E. $12,70046. Gail's Dance Studio is currently an all equity firm that has 80,000 shares of stock outstanding with a market price of $42 a share. The current cost of equity is 12% andthe taxrate is 34%. Gail is considering adding $1 million of debt with a coupon rate of 8% to hercapital structure. The debt will be sold at par value. What is the levered value of the equity?A. $2.4 millionB. $2.7 millionC. $3.3 millionD. $3.7 millionE. $3.9 million47. The Montana Hills Co. has expected earnings before interest and taxes of $8,100, anunlevered cost of capital of 11%, and debt with both a book and face value of $12,000. The debthas an annual 8% coupon. The tax rate is 34%. What is the value of the firm?A. $48,600B. $50,000C. $52,680D. $56,667E. $60,60048. 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?A. $567,600B. $781,818C. $860,000D. $946,000E. $1,152,400卑微如蝼蚁、坚强似大象．共享知识分享快乐49. 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 facevalue of debt of $700,000 with a 7% annual coupon. The applicable tax rate is 35%. What is thevalue of the levered firm?A. $696,429B. $907,679C. $941,429D. $1,184,929E. $1,396,42950. The Spartan Co. has an unlevered cost of capital of 11%, a cost of debt of 8%, anda tax rateof 35%. What is the target debt-equity ratio if the targeted cost of equity is 12%?A. .44B. .49C. .51D. .56E. .6251. Hey Guys!, Inc. has debt with both a face and a market value of $3,000. This debt has acoupon rate of 7% and pays interest annually. The expected earnings before interest and taxes is$1,200, the tax rate is 34%, and the unlevered cost of capital is 12%. What is thefirm's cost ofequity?A. 13.25%B. 13.89%C. 13.92%D. 14.14%E. 14.25%卑微如蝼蚁、坚强似大象．共享知识分享快乐52. Anderson's Furniture Outlet has an unlevered cost of capital of 10%, a tax rate of 34%, andexpected earnings before interest and taxes of $1,600. The company has $3,000 in bondsoutstanding that have an 8% coupon and pay interest annually. The bonds are selling at parvalue. What is the cost of equity?A. 8.67%B. 9.34%C. 9.72%D. 9.99%E. 10.46%53. Walter's Distributors has a cost of equity of 13.84% and an unlevered cost of capital of 12%.The company has $5,000 in debt that is selling at par value. The levered value of the firm is$12,000 and the tax rate is 34%. What is the pre-tax cost of debt?A. 7.92%B. 8.10%C. 8.16%D. 8.84%E. 9.00%54. Rosita's has a cost of equity of 13.8% and a pre-tax cost of debt of 8.5%. Thedebt-equityratio is .60 and the tax rate is .34. What is Rosita's unlevered cost of capital?A. 8.83%B. 12.30%C. 13.97%D. 14.08%E. 14.60%55. Your firm has a pre-tax cost of debt of 7% and an unlevered cost of capital of 13%. Your taxrate is 35% and your cost of equity is 15.26%. What is your debt-equity ratio?A. .43B. .49C. .51D. .54E. .58卑微如蝼蚁、坚强似大象．共享知识分享快乐56. Wild Flowers Express has a debt-equity ratio of .60. The pre-tax cost of debt is 9% while theunlevered cost of capital is 14%. What is the cost of equity if the tax rate is 34%?A. 7.52%B. 8.78%C. 15.98%D. 16.83%E. 17.30%57. Your firm has a $250,000 bond issue outstanding. These bonds have a 7% coupon, payinterest semiannually, and have a current market price equal to 103% of face value. What is theamount of the annual interest tax shield given a tax rate of 35%?A. $6,125B. $6,309C. $9,500D. $17,500E. $18,02558. Bertha's Boutique has 2,000 bonds outstanding with a face value of $1,000 each and acoupon rate of 9%. The interest is paid semi-annually. What is the amount of the annual interesttax shield if the tax rate is 34%?A. $58,500B. $60,100C. $60,750D. $61,200E. $62,25059. Juanita's Steak House has $12,000 of debt outstanding that is selling at par and hasa couponrate of 8%. The tax rate is 34%. What is the present value of the tax shield?A. $2,823B. $2,887C. $4,080D. $4,500E. $4,633卑微如蝼蚁、坚强似大象．共享知识分享快乐60. A firm has debt of $5,000, equity of $16,000, a leveraged value of $8,900, a cost of debt of8%, a cost of equity of 12%, and a tax rate of 34%. What is the firm's weighted average cost ofcapital?A. 7.29%B. 7.94%C. 8.87%D. 10.40%E. 11.05%61. A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm isconsidering a new capital structure with 60% debt. The interest rate on the debt would be 8%.Assuming there are no taxes or other imperfections, its cost of equity capital with the newcapital structure would be _____.A. 9%B. 10%C. 13%D. 14%E. None of the above.62. A firm has a debt-to-equity ratio of .60. Its cost of debt is 8%. Its overall cost of capital is12%. What is its cost of equity if there are no taxes or other imperfections?A. 10.0%B. 13.5%C. 14.4%D. 18.0%E. None of the above.63. A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. Ifthere are no taxes or other imperfections, what would be its cost of equity if thedebt-to-equityratio were 0?A. 8%B. 10%C. 12%D. 14%E. 16%卑微如蝼蚁、坚强似大象．共享知识分享快乐64. 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. 10%B. 15%C. 18%D. 21%E. None of the above.65. If a firm is unlevered and has a cost of equity capital of 12%, what would its cost of equitybe if its debt-equity ratio became 2? The expected cost of debt is 8%.A. 14.0%B. 14.67%C. 16.0%D. 20.0%E. None of the above.66. A firm has zero debt in its capital structure. Its overall cost of capital is 9%. The firm isconsidering a new capital structure with 40% debt. The interest rate on the debt would be 4%.Assuming that the corporate tax rate is 34%, what would its cost of equity capital with the newcapital structure be?A. 10.3%B. 11.0%C. 11.2%D. 13.9%E. None of the above.67. A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. Ifthe corporate tax rate is 25%, what would its cost of equity be if the debt-to-equity ratio were0?A. 11.11%B. 12.57%C. 13.33%D. 16.00%E. None of the above.卑微如蝼蚁、坚强似大象．共享知识分享快乐68. A firm has a debt-to-equity ratio of .5. Its cost of equity is 22%, and its cost of debt is 16%.If the corporate tax rate is .40, what would its cost of equity be if the debt-to-equity ratio were0?A. 14.00%B. 20.61%C. 21.07%D. 22.00%E. None of the above.69. A firm has a debt-to-equity ratio of 1.75. If it had no debt, its cost of equity would be 14%.Its cost of debt is 10%. What is its cost of equity if the corporate tax rate is 50%?A. 14.0%B. 16.0%D. 21.0%E. None of the above.70. What is the cost of equity for a firm if the corporate tax rate is 40%? The firm has adebt-to-equity ratio of 1.5. If it had no debt, its cost of equity would be 16%. Its current cost ofdebt is 10%.A. 17.4%B. 18.4%C. 19.6%D. 21.4%E. None of the above.71. A firm has a debt-to-equity ratio of 1.75. If it had no debt, its cost of equity would be 9%. Itscost of debt is 7%. What is its cost of equity if the corporate tax rate is 50%?A. 7.73%B. 10.00%C. 10.75%D. 12.50%E. None of the above.卑微如蝼蚁、坚强似大象．共享知识分享快乐72. Batter's Home has 3,000 bonds outstanding with a face value of $1,000 each and a couponrate of 8%. The interest is paid semi-annually. What is the amount of the annual interest taxshield if the tax rate is 30%?A. $52,000B. $60,000C. $62,500D. $68,000E. $72,00073. Reena Industries has $10,000 of debt outstanding that is selling at par and has a coupon rateof 7%. The tax rate is 34%. What is the present value of the tax shield?A. $2,800B. $3,000C. $3,400D. $3,80074. A firm has debt of $7,000, equity of $12,000, a leveraged value of $8,900, a cost of debt of7%, a cost of equity of 14%, and a tax rate of 30%. What is the firm's weighted average cost ofcapital?A. 8.45%B. 9.90%C. 10.65%D. 12.50%E. 14.00%Essay Questions卑微如蝼蚁、坚强似大象．共享知识分享快乐75. Based on MM with taxes and without taxes, how much time should a financial managerspend analyzing the capital structure of his firm? What if the analysis is based on the statictheory?76. Explain homemade leverage and why it matters.77. In each of the theories of capital structure the cost of equity rises as the amount of debtincreases. So why don't financial managers use as little debt as possible to keep the cost ofequity down? After all, isn't the goal of the firm to maximize share value and。
