Question 1

When a Canadian firm uses debt,the interest tax shield provides a corporate tax ________ each year.

Accepted Answer

The interest tax shield is a deduction in the tax calculation that results in a lower tax liability. Therefore, it provides a benefit to the Canadian firm that uses debt.

Question 2

Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and free cash flow of $27 million. FBNA's marginal corporate tax rate is 40%.
-IF FBNA increases leverage so that its interest expense rises by $1 million,then the amount its free cash flow will change is closest to:

Accepted Answer

Free cash flow is calculated after taxes and interest expenses. When FBNA increases its leverage, causing interest expenses to rise by $1 million, the pre-tax income decreases by the same amount. With a 40% tax rate, the actual reduction in net income due to the increased interest expense is $1 million * (1 - 0.40) = $600,000. However, since free cash flow considers interest expenses before taxes, the increase in interest expense directly reduces free cash flow by the full $1 million, but this is partially offset by the tax shield gained from the additional interest expense ($1 million * 40% = $400,000). Therefore, the net change in free cash flow is a decrease of $600,000 - $400,000 = $200,000. However, since the question asks for the closest amount and the provided options seem to misunderstand the calculation, the correct interpretation based on the options given would be to consider the direct impact of the interest expense increase on free cash flow without the tax shield, which is not directly represented in the options. Given the misunderstanding in calculation, the closest correct option based on the expected methodology would be to consider the tax shield on the increased interest, which would lead to a decrease in free cash flow, but none of the options accurately reflect the correct calculation. The explanation provided was based on a standard approach to calculating changes in free cash flow due to changes in interest expense, but it appears there was a mistake in the interpretation of how the options relate to the calculation. The correct answer should reflect the net effect of the interest expense increase and the tax shield, which would typically result in a smaller decrease in free cash flow than the full amount of the interest expense. However, given the options and the typical approach to such a question, the best match (though not accurately reflecting the standard financial calculation) would be to select the option that might be interpreted as the closest to the expected outcome, which is an increase in free cash flow due to the tax shield effect, but this is contrary to the standard calculation method. The explanation aimed to clarify the standard approach but acknowledges the confusion in the provided options.

Question 3

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ millions):
 
-The interest rate tax shield for Kroger in 2005 is closest to:

Accepted Answer

D)
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Question 4

Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
-The total of Rosewood's net income and interest payments is closest to:

Accepted Answer

B) Net income + Interest expense = (EBIT - Interest expense)(1 - τ_C) = (450 - 175)(1 - .35) = $178.75 + $175 = $353.73

Question 5

Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
-Rosewood's net income is closest to:

Accepted Answer

B) Net income = (EBIT - Interest expense)(1 - τ_C) = (450 - 175)(1 - .35) = $178.75

Question 6

The interest tax shield is the ________ amount that a firm would have paid in taxes if it did not have leverage.

Accepted Answer

The interest tax shield is the additional amount that a firm would save in taxes due to the deductibility of interest expense for tax purposes. This is calculated by multiplying the company's pre-tax interest expense by the tax rate. Therefore, "additional" is the correct term to use in this context.

Question 7

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ millions):
 
-The interest rate tax shield for Kroger in 2006 is closest to:

Accepted Answer

D)
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Question 8

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ millions):
 
-Calculate the interest tax shield,the total amount available to pay out to all the investors,and the income that would be available to equity holders if Kroger was not levered for the year 2004.

Accepted Answer

The answer of Use the table for the question(s) below.
Consider...

Question 9

The income that would be available to equity holders in 2005 if Kroger was not levered is closest to:

Accepted Answer

D)
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Question 10

The income that would be available to equity holders in 2006 if Kroger was not levered is closest to:

Accepted Answer

D)
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Question 11

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ millions):
 
-The total amount available to pay out to all the investors in Kroger in 2006 is closest to:

Accepted Answer

C)
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Question 12

Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
-The amount of Rosewood's interest tax shield is closest to:

Accepted Answer

D) Interest expense(τ_C) = 175(.35) = $61.25

Question 13

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ millions):
 
-The interest rate tax shield for Kroger in 2004 is closest to:

Accepted Answer

C)
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Question 14

The value of a firm is the total amount it can raise from ________.

Accepted Answer

The value of a firm is determined by the total amount it can raise from all investors, encompassing both equity (shareholders) and debt (creditors) financing sources, as well as any other forms of investment.

Question 15

Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
-If Rosewood had no interest expense,its net income would be closest to:

Accepted Answer

D) Net income = (EBIT - Interest expense)(1 - τ_C) = (450 - 0)(1 - .35) = $292.50

Question 16

Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and free cash flow of $27 million. FBNA's marginal corporate tax rate is 40%.
-FBNA's EBIT is closest to:

Accepted Answer

A) EBIT = NI + Taxes + Interest expense
FCF = NI + Interest expense => 27 = 24 + interest expense, so interest expense = 3
(EBIT - Interest Expense)(1 - .4) = NI
(EBIT - 3)(.6) = 24
EBIT = 24 / .6 + 3 = $43

Question 17

Which of the following statements is false?

Accepted Answer

C) By increasing the amount paid to debt holders through interest payments, the amount of the pretax cash flows that must be paid as taxes decreases.

Question 18

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ millions):
 
-The total amount available to pay out to all the investors in Kroger in 2005 is closest to:

Accepted Answer

C)
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Question 19

Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and free cash flow of $27 million. FBNA's marginal corporate tax rate is 40%.
-IF FBNA increases leverage so that its interest expense rises by $1 million,then the amount its net income will change is closest to:

Accepted Answer

B) (EBIT - Interest Expense - chg IE)(1 - .4) = NI + chg NI
(-1)(chg IE)(.6) = chg NI
-1,000,000(.6) = -600,000
Or, -$1 million(1 - .6) = -$600,000

Question 20

Which of the following statements is false?

Accepted Answer

D) As Modigliani and Miller made clear in their original work, capital structure does not matter in perfect capital markets. Thus, if capital structure matters, then it must stem from a market imperfection.

Quiz 18: Debt and Taxes

When a Canadian firm uses debt,the interest tax shield provides a corporate tax ________ each year.

Use the table for the question(s) below. Consider the following income statement for Kroger Inc. (all figures in $ millions) : -The interest rate tax shield for Kroger in 2005 is closest to:

Use the information for the question(s) below. Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%. -The total of Rosewood's net income and interest payments is closest to:

Use the information for the question(s) below. Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%. -Rosewood's net income is closest to:

The interest tax shield is the ________ amount that a firm would have paid in taxes if it did not have leverage.

Use the table for the question(s) below. Consider the following income statement for Kroger Inc. (all figures in $ millions) : -The interest rate tax shield for Kroger in 2006 is closest to:

The income that would be available to equity holders in 2005 if Kroger was not levered is closest to:

The income that would be available to equity holders in 2006 if Kroger was not levered is closest to:

Use the table for the question(s) below. Consider the following income statement for Kroger Inc. (all figures in $ millions) : -The total amount available to pay out to all the investors in Kroger in 2006 is closest to:

Use the information for the question(s) below. Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%. -The amount of Rosewood's interest tax shield is closest to:

Use the table for the question(s) below. Consider the following income statement for Kroger Inc. (all figures in $ millions) : -The interest rate tax shield for Kroger in 2004 is closest to:

The value of a firm is the total amount it can raise from ________.

Use the information for the question(s) below. Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%. -If Rosewood had no interest expense,its net income would be closest to:

Use the information for the question(s) below. Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and free cash flow of $27 million. FBNA's marginal corporate tax rate is 40%. -FBNA's EBIT is closest to:

Which of the following statements is false?

Use the table for the question(s) below. Consider the following income statement for Kroger Inc. (all figures in $ millions) : -The total amount available to pay out to all the investors in Kroger in 2005 is closest to:

Which of the following statements is false?