Question 1

Marcos & Sons has no debt. Its current total value is $58 million. What will the company's value be if it sells $21 million in debt and has a tax rate of 34 percent? Assume debt proceeds are used to repurchase equity.
A) $58,220,000
B) $60,370,000
C) $62,330,000
D) $64,560,000
E) $65,140,000

Accepted Answer

V_L = $58 million + $21 million(0.34) = $65,140,000

Question 2

M.G. Movers can borrow at 7.5 percent. The firm currently has no debt, and the cost of equity is 16 percent. The current value of the firm is $540,000. What will the value be if the firm borrows $160,000 and uses the proceeds to repurchase shares? The corporate tax rate is 34 percent.
A) $528,000
B) $540,000
C) $552,000
D) $571,000
E) $594,400

Accepted Answer

The answer of M.G. Movers can borrow at 7.5 percent....

Question 3

Snow Mountain Resort has a 33 percent tax rate. Its total interest payment for the year just ended was $6.8 million. What is the interest tax shield?
A) $2,006,500
B) $2,244,000
C) $2,410,600
D) $2,525,000
E) $2,618,000

Accepted Answer

The interest tax shield is calculated as the interest payment multiplied by the tax rate. So, $6.8 million * 0.33 = $2,244,000.

Question 4

Triangle Enterprises has no debt but can borrow at 9 percent. The firm's WACC is currently 14.7 percent, and there is no corporate tax. If the firm converts to 70 percent debt, what will its cost of equity be?
A) 20.67 percent
B) 22.95 percent
C) 24.47 percent
D) 26.39 percent
E) 28.00 percent

Accepted Answer

The formula to calculate the WACC is:

WACC = (E/V) x Re + (D/V) x Rd x (1-Tc)

Where:
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D
Re = cost of equity
Rd = cost of debt
Tc = corporate tax rate

We are given that Triangle Enterprises has no debt currently, so D = 0. Also, there is no corporate tax, so Tc = 0. The formula simplifies to:

WACC = (E/V) x Re

We are told that the current WACC is 14.7 percent. Since D = 0, V = E. Therefore:

14.7% = Re

Next, we are told that if the firm converts to 70 percent debt, so D = 0.7V and E = 0.3V. The WACC formula becomes:

14.7% = 0.3Re + 0.7(9%)

Solving for Re, we get:

Re = 28%

Therefore, the cost of equity for Triangle Enterprises if it converts to 70 percent debt is:

Answer: E) 28.00 percent

Question 5

Explain the primary difference between a Chapter 7 bankruptcy and a Chapter 11 bankruptcy.

Accepted Answer

The answer of Explain the primary difference between a Chapter...

Question 6

Jasper Industrial has no debt outstanding and a total market value of $110,000. Earnings before interest and taxes, EBIT, are projected to be $12,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 20 percent lower. Jasper Industrial is considering a $35,000 debt issue with a 7 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 7,500 shares outstanding. Ignore taxes for this problem. What is the percentage change in EPS when a normal economy slips into recession?
A) -33 percent
B) -25 percent
C) -20 percent
D) -16 percent
E) -10 percent

Accepted Answer

EPS_Normal = $12,000/7,500 = $1.60EPS_Recession = $12,000(0.80)/7,500 = $1.28Percentage change ($1.28 - $1.60)/$1.60 = -20 percent

Question 7

You are considering a firm under three separate scenarios: 1) no debt, taxes or bankruptcy costs, 2) with debt and taxes but no bankruptcy costs, and 3) with debt, taxes, and bankruptcy costs. Under which one of these three scenarios will the firm have the highest value?

Accepted Answer

The answer of You are considering a firm under three...

Question 8

Glass Growers has no debt. Its cost of capital is 8.7 percent. Suppose the firm converts to a debt-equity ratio of 0.65. The interest rate on the debt is 6.9 percent. What is its new WACC?
A) 7.99 percent
B) 8.13 percent
C) 8.36 percent
D) 8.44 percent
E) 8.61 percent

Accepted Answer

WACC = (1/1.65)(0.087) + (0.65/1.65)(0.069) = 7.99 percent

Question 9

Bruno's is considering a change from its current capital structure. Bruno's currently has an all-equity capital structure and is considering a capital structure with 30 percent debt. There are currently 6,500 shares outstanding at a price per share of $46. EBIT is expected to remain constant at $43,000. The interest rate on new debt is 8.5 percent and there are no taxes. Tracie owns $20,700 worth of stock in the company. The firm has a 100 percent payout. What would Tracie's cash flow be under the new capital structure assuming that she keeps all of her shares?
A) $1,998
B) $2,227
C) $2,815
D) $3,027
E) $3,499

Accepted Answer

All-equity value = 6,500 × $46 = $299,000Shares repurchased = ($299,000 × 0.30)/$46 = 1,950 sharesEPS = [$43,000 - ($299,000)(0.30)(0.085)]/(6,500 - 1,950) = $7.7748Cash flow = ($7.7748) ($20,700/$46) = $3,499

Question 10

Explain why the capital structure of a firm is irrelevant to equity investors.

Accepted Answer

The answer of Explain why the capital structure of a...

Question 11

Delta Mowers has a debt-equity ratio of 1.2. Its WACC is 10.1 percent, and its cost of debt is 7.5 percent. There is no corporate tax. What is the firm's cost of equity capital?
A) 12.60 percent
B) 13.22 percent
C) 13.83 percent
D) 14.29 percent
E) 14.80 percent

Accepted Answer

WACC = 0.101 = (1/2.2)R_E + (1.2/2.2)(0.075) = 13.22 percent

Question 12

Gabe's Market is comparing two different capital structures. Plan I would result in 11,000 shares of stock and $225,000 in debt. Plan II would result in 14,000 shares of stock and $150,000 in debt. The interest rate on the debt is 8 percent. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $45,000. The all-equity plan would result in 20,000 shares of stock outstanding. Of the three plans, the firm will have the highest EPS with _____ and the lowest EPS with _____.
A) Plan I; Plan II
B) Plan I; all-equity plan
C) Plan II; Plan I
D) Plan II; all-equity plan
E) all-equity plan; Plan I

Accepted Answer

EPS_All-equity = $45,000/20,000 = $2.25EPS_{Plan I} = [$45,000 - ($225,000 × 0.08)]/11,000 = $2.45EPS_{Plan II} = [$45,000 - ($150,000 × 0.08)]/14,000 = $2.36

Question 13

Uptown Construction is comparing two different capital structures. Plan I would result in 23,000 shares of stock and $320,000 in debt. Plan II would result in 17,000 shares of stock and $260,000 in debt. The interest rate on the debt is 10 percent. Ignoring taxes, EPS will be identical for Plans I and II when EBIT equals which one of the following?
A) $8,550
B) $9,000
C) $9,600
D) $10,400
E) $10,750

Accepted Answer

[EBIT - ($320,000 × 0.10)]/23,000 = [EBIT - ($260,000 × 0.10)]/17,000EBIT = $9,000

Question 14

Assume a fellow student made these statements during a class discussion: "Bankruptcy costs only affect a firm if the firm files a bankruptcy petition with the court. Therefore, the static theory of capital structure only applies to bankrupt firms." Write a response to your fellow student that either supports or contradicts that student's statements.

Accepted Answer

The answer of Assume a fellow student made these statements...

Quiz 13: Leverage and Capital Structure

Marcos & Sons has no debt. Its current total value is $58 million. What will the company's value be if it sells $21 million in debt and has a tax rate of 34 percent? Assume debt proceeds are used to repurchase equity.

M.G. Movers can borrow at 7.5 percent. The firm currently has no debt, and the cost of equity is 16 percent. The current value of the firm is $540,000. What will the value be if the firm borrows $160,000 and uses the proceeds to repurchase shares? The corporate tax rate is 34 percent.

Snow Mountain Resort has a 33 percent tax rate. Its total interest payment for the year just ended was $6.8 million. What is the interest tax shield?

Triangle Enterprises has no debt but can borrow at 9 percent. The firm's WACC is currently 14.7 percent, and there is no corporate tax. If the firm converts to 70 percent debt, what will its cost of equity be?

Explain the primary difference between a Chapter 7 bankruptcy and a Chapter 11 bankruptcy.

You are considering a firm under three separate scenarios: 1) no debt, taxes or bankruptcy costs, 2) with debt and taxes but no bankruptcy costs, and 3) with debt, taxes, and bankruptcy costs. Under which one of these three scenarios will the firm have the highest value?

Glass Growers has no debt. Its cost of capital is 8.7 percent. Suppose the firm converts to a debt-equity ratio of 0.65. The interest rate on the debt is 6.9 percent. What is its new WACC?

Explain why the capital structure of a firm is irrelevant to equity investors.

Delta Mowers has a debt-equity ratio of 1.2. Its WACC is 10.1 percent, and its cost of debt is 7.5 percent. There is no corporate tax. What is the firm's cost of equity capital?