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Fundamentals of Corporate Finance, 4/c/e

Fundamentals of Corporate Finance, 4/e

Stephen A. Ross, Massachusetts Institute of Technology
Randolph W. Westerfield, University of Southern California
Bradford D. Jordan, University of Kentucky
Gordon S. Roberts, York University

Financial Leverage and Capital Structure Policy

Quick Quiz 1

After taking this quiz, click 'Submit Answers' for graded results. You'll also have the option of emailing the results to your instructor and/or yourself.


1	Which of the following is NOT accurate regarding financial leverage?
		A)	Whenever a firm's debt increases faster than its equity, financial leverage increases.
		B)	Increasing financial leverage will always increase the EPS for stockholders
		C)	Investors can undo the effects of the firm's capital structure by using homemade leverage.
		D)	Leverage is most beneficial when EBIT is relatively high.
		E)	The level of financial leverage that produces the highest firm value is the one most beneficial to stockholders.


2	Which of the following correctly completes the following: M&M I with taxes shows
		A)	the value of an unlevered firm exceeds the value of a levered firm by the present value of the interest tax shield
		B)	a levered firm can increase its value by reducing debt
		C)	the optimal amount of leverage for a firm is not possible to determine
		D)	the value of a levered firm is equal to its aftertax EBIT discounted by the unlevered cost of capital
		E)	there is a linear relationship between the amount of debt in a levered firm and its value


3	The optimal capital structure is the mixture of debt and equity which: I. Maximizes the value of the firm. II. Minimizes the firm's weighted average cost of capital. III. Maximizes the market price of the firm's bonds.
		A)	III only
		B)	I only
		C)	I and III only
		D)	I and II only
		E)	I, II and III


4	A firm's systematic risk will ___________ as its debt/equity ratio __________.
		A)	decrease; increases
		B)	increase; increases
		C)	remain unchanged; decreases
		D)	remain unchanged; increases
		E)	first increase, and then decrease; increases


5	An investor owns 500 shares of stock in a firm with a debt/equity ratio = 1.0. The investor prefers an all-equity firm. If the stock price is $2 per share, what should the investor do?
		A)	Borrow $500 and buy 250 new shares.
		B)	Borrow $1,500 and buy 750 new shares.
		C)	Borrow $2,500 and buy 1,250 new shares.
		D)	Sell 25 shares and lend $50.
		E)	Sell 250 shares and lend $500.


6	RDJ Inc. has an asset beta of 0.95. Its current capital structure is 60% debt, 40% equity. What is the firm's equity beta? Ignore taxes.
		A)	2.375
		B)	1.583
		C)	1.243
		D)	1.875
		E)	0.380


7	The Brassy Co. has expected EBIT = $910, an unlevered cost of capital of 12%, and debt with a face and market value of $2,000 paying an 8.5% annual coupon. If the tax rate is 34%, what is the WACC of Brassy Co.?
		A)	13.25%
		B)	11.12%
		C)	10.56%
		D)	14.45%
		E)	13.64%


8	ABC, Inc. has a debt/equity ratio = 1.2. The firm has a cost of equity of 12% and a cost of debt of 8%. What will the cost of equity be if the target debt/equity ratio increases to 2.0 and the cost of debt does not change? Ignore taxes.
		A)	11.12%
		B)	10.56%
		C)	12.64%
		D)	13.45%
		E)	14.45%


9	An unlevered firm has an EBIT = $250,000, aftertax net income = $165,000, and a cost of capital of 12%. A levered firm with the same assets and operations has $1.25 million in face value debt paying an 8% annual coupon; the debt sells for par value in the marketplace. What is the value of the levered firm? The tax rate is 34%.
		A)	$1,250,000
		B)	$1,375,000
		C)	$2,200,000
		D)	$1,800,000
		E)	$2,625,000


10	Suppose a firm issues perpetual debt at par with a face value of $5,000 and a coupon rate of 12%. If the firm is subject to a 40% tax rate and its WACC is 10%, what is the present value of the interest tax shield?
		A)	$1,667
		B)	$6,000
		C)	$2,000
		D)	$2,400
		E)	$3,600

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