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Exam 16: Financial Leverage and Capital Structure Policy

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Question 1

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A firm has debt of $12,000,a leveraged value of $26,400,a pre-tax cost of debt of 9.20 percent,a cost of equity of 17.6 percent,and a tax rate of 37 percent.What is the firm's weighted average cost of capital?

A) 11.47 percent
B) 11.52 percent
C) 11.69 percent
D) 12.23 percent
E) 12.48 percent

F) All of the above
G) D) and E)

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Question 2

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Jessica invested in Quantro stock when the firm was unlevered.Since then,Quantro has changed its capital structure and now has a debt-equity ratio of 0.30.To unlever her position,Jessica needs to:

A) borrow some money and purchase additional shares of Quantro stock.
B) maintain her current equity position as the debt of the firm did not affect her personally.
C) sell some shares of Quantro stock and hold the proceeds in cash.
D) sell some shares of Quantro stock and loan out the sale proceeds.
E) create a personal debt-equity ratio of 0.30.

F) C) and E)
G) All of the above

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Question 3

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Corporations in the U.S.tend to:

The SLG Corp.uses no debt.The weighted average cost of capital is 11 percent.The current market value of the equity is $31 million and the corporate tax rate is 34 percent.What is EBIT?

The present value of the interest tax shield is expressed as:

A firm should select the capital structure that:

Galaxy Products is comparing two different capital structures,an all-equity plan (Plan I) and a levered plan (Plan II) .Under Plan I,Galaxy would have 178,500 shares of stock outstanding.Under Plan II,there would be 71,400 shares of stock outstanding and $1.79 million in debt outstanding.The interest rate on the debt is 10 percent and there are no taxes.What is the breakeven EBIT?

M & M Proposition I with tax supports the theory that:

The absolute priority rule determines:

Country Markets has an unlevered cost of capital of 12 percent,a tax rate of 38 percent,and expected earnings before interest and taxes of $15,700.The company has $12,000 in bonds outstanding that have a 6 percent coupon and pay interest annually.The bonds are selling at par value.What is the cost of equity?

Explain how a firm loses value during the bankruptcy process from both a creditors and a shareholders perspective.

Exports Unlimited is an unlevered firm with an aftertax net income of $52,300.The unlevered cost of capital is 14.1 percent and the tax rate is 36 percent.What is the value of this firm?

A firm is technically insolvent when:

North Side,Inc.has no debt outstanding and a total market value of $175,000.Earnings before interest and taxes,EBIT,are projected to be $16,000 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 70 percent lower.North Side is considering a $70,000 debt issue with a 7 percent interest rate.The proceeds will be used to repurchase shares of stock.There are currently 2,500 shares outstanding.North Side has a tax rate of 34 percent.If the economy expands strongly,EPS will change by ____ percent as compared to a normal economy,assuming that the firm recapitalizes.

Naylor's is an all equity firm with 60,000 shares of stock outstanding at a market price of $50 a share.The company has earnings before interest and taxes of $102,000.Naylor's has decided to issue $750,000 of debt at 7.5 percent.The debt will be used to repurchase shares of the outstanding stock.Currently,you own 500 shares of Naylor's stock.How many shares of Naylor's stock will you continue to own if you unlever this position? Assume you can loan out funds at 7.5 percent interest.Ignore taxes.

Based on the M & M propositions with and without taxes,how much time should a financial manager spend analyzing the capital structure of a firm? What if the analysis is based on the static theory?

Douglass & Frank has a debt-equity ratio of 0.35.The pre-tax cost of debt is 8.2 percent while the unlevered cost of capital is 13.3 percent.What is the cost of equity if the tax rate is 39 percent?

Johnson Tire Distributors has debt with both a face and a market value of $12,000.This debt has a coupon rate of 6 percent and pays interest annually.The expected earnings before interest and taxes are $2,100,the tax rate is 30 percent,and the unlevered cost of capital is 11.7 percent.What is the firm's cost of equity?

The unlevered cost of capital refers to the cost of capital for a(n) :

Miller's Dry Goods is an all equity firm with 48,000 shares of stock outstanding at a market price of $50 a share.The company's earnings before interest and taxes are $128,000.Miller's has decided to add leverage to its financial operations by issuing $250,000 of debt at 8 percent interest.The debt will be used to repurchase shares of stock.You own 400 shares of Miller's stock.You also loan out funds at 8 percent interest.How many shares of Miller's stock must you sell to offset the leverage that Miller's is assuming? Assume you loan out all of the funds you receive from the sale of stock.Ignore taxes.