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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 2

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1	The equity risk derived from the firm's capital structure policy is called ____________ risk.
		A)	market
		B)	systematic
		C)	extrinsic
		D)	business
		E)	financial


2	Which of the following is consistent with the order of claimants according to the absolute priority rule?
		A)	Unpaid wages, unpaid taxes, consumer claims, preferred stockholders
		B)	Unpaid taxes, bankruptcy expenses, unsecured creditors, preferred stockholders
		C)	Bankruptcy expenses, unpaid wages, unsecured creditors, preferred stockholders
		D)	Unpaid taxes, unsecured creditors, preferred stockholders, bankruptcy expenses
		E)	Bankruptcy expenses, consumer claims, unsecured creditors, unpaid taxes


3	All else the same, which of the following is true about the interest tax shield of a firm with positive EBIT?
		A)	The higher the corporate tax rate, the less valuable the interest tax shield.
		B)	If the firm dramatically increases its depreciation expense, it may have more of a need for an interest tax shield.
		C)	The interest tax shield increases as a firm reduces its level of outstanding debt.
		D)	The interest tax shield becomes more valuable as the size of the debt load increases.
		E)	Since the interest tax shield is valuable, the firm would rather pay a high coupon rate on its bonds than a low coupon rate.


4	The cost of debt is generally lower than the cost of equity; however, according to ____________, replacing equity with debt will not change the value of the firm because the savings attributable to the lower cost of debt financing will be offset by the higher required return on the remaining equity.
		A)	M&M Proposition I without taxes
		B)	M&M Proposition I with taxes
		C)	the static theory of capital structure
		D)	M&M Proposition II without taxes
		E)	M&M Proposition II with taxes


5	According to _____________ , a firm's cost of equity increases with greater debt financing, and the WACC decreases.
		A)	M&M Proposition I with taxes
		B)	M&M Proposition I without taxes
		C)	the static theory of capital structure
		D)	M&M Proposition II with taxes
		E)	M&M Proposition II without taxes


6	The Brassy Co. has expected EBIT of $910, debt with a face and market value of $2,000 paying an 8.5% annual coupon, and an unlevered cost of capital of 12%. If the tax rate is 34%, what is the value of the firm?
		A)	$3,258
		B)	$3,685
		C)	$5,685
		D)	$6,325
		E)	$7,005


7	What is the cost of equity for a firm where the required return on assets is 14%, the cost of debt is 11%, and the target debt/equity ratio is 0.5? Ignore taxes.
		A)	14.0%
		B)	12.5%
		C)	11.0%
		D)	16.0%
		E)	15.5%


8	The Wrangler Co. has expected EBIT = $9,250, and debt with a face and market value of $14,000 paying a 9% annual coupon. The market value of the firm is $58,525. If the tax rate is 34%, what is Wranger's unlevered cost of capital?
		A)	9.00%
		B)	11.35%
		C)	12.12%
		D)	12.76%
		E)	12.99%


9	Given the following, what is the WACC? EBIT = $2 million; tax rate = 34%; market value and book value of debt = $4 million; unlevered cost of capital = 14%; cost of debt = 9%.
		A)	11.4%
		B)	14.0%
		C)	13.1%
		D)	12.6%
		E)	12.0%


10	An unlevered firm with a market value of $1 million has 50,000 shares outstanding. The firm restructures itself by issuing 200 new par bonds with face value $1,000 and an 8% coupon. The firm uses the proceeds to repurchase outstanding stock. In considering the newly levered versus formerly unlevered firm, what is the breakeven EBIT? Ignore taxes.
		A)	$50,000
		B)	$25,000
		C)	$95,000
		D)	$80,000
		E)	$75,000

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