Question 1

What are some implications of market imperfections?

Accepted Answer

The answer of What are some implications of market imperfections?...

Question 2

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company uses no leverage, what is expected return to equity holders?

Accepted Answer

A) Unlevered cost of equity is given at 8%.

Question 3

Suppose a project financed via an issue of debt requires five annual interest payments of $12 million each year. If the tax rate is 35% and the cost of debt is 5%, what is the value of the interest rate tax shield?

Accepted Answer

D) Value of tax shield each year equals tax rate times the interest payment.
Compute the present value of annuity of payments calculated above.
Tax shield = 0.35 × 12 million = $4.2 million; 11ea84dc_f50e_7c03_9a63_35ebaa34cec5_TB1316_00_TB1316_00

Question 4

A firm requires an investment of $60,000 and borrows $20,000 at 8%. If the return on equity is 14% and the tax rate is 30%, what is the firm's WACC?

Accepted Answer

A) Use the WACC equation presented in this chapter. r_wacc = r_E 11ea84dc_f50f_db9a_9a63_5f898af054b2_TB1316_11_TB1316_11 + r_D (1 - T_C) 11ea84dc_f50f_db9b_9a63_7b59c279ac90_TB1316_11_TB1316_11 r_wacc =14% × ($40,000 / $60,000) + 8% × (1 - 0.3) × ($20,000 / $60,000) = 11.2%

Question 5

Use next year's Cash Flow Forecast for Blank Company to answer the question(s) below.
 
-Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. What is the value of the company if the demand is as expected?

Accepted Answer

B) Expected cash flow is $35,000. Discounted for one period, 11ea84dc_f50c_f559_9a63_7319892f9961_TB1316_00_TB1316_00 .

Question 6

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is expected return to equity holders? Assume the demand is as expected.

Accepted Answer

C) Expected cash flow is $35,000. Equity costs $22,407.40 initially 11ea84dc_f50d_6a8a_9a63_418f34536ecd_TB1316_11_TB1316_11 .
The firm must repay 11ea84dc_f50d_6a8b_9a63_4b2ccad6901e_TB1316_11_TB1316_11 to debt holders, so cash flow to equity is 11ea84dc_f50d_6a8c_9a63_3baa9306c926_TB1316_11_TB1316_11 . Expected return to equity is 11ea84dc_f50d_919d_9a63_df71a7117a7b_TB1316_11_TB1316_11 .

Question 7

The direct costs of bankruptcy are estimated to be far greater, as a percent of assets, than the indirect costs of bankruptcy.

Accepted Answer

The indirect costs of bankruptcy, such as damage to a company's reputation, loss of customers, or the inability to retain or attract talented employees, are often considered to be far greater than the direct costs, such as legal and administrative fees.

Question 8

Suppose a project financed via an issue of debt requires five annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 7%, what is the value of the interest rate tax shield?

Accepted Answer

C) Value of tax shield each year equals tax rate times the interest payment.
Compute the present value of annuity of payments calculated above.
Tax shield = 0.35 × $18 million = $6.3 million; 11ea84dc_f50e_f135_9a63_b13e4469db41_TB1316_00_TB1316_00

Question 9

A firm that does not have trouble meeting its debt obligations is said to be in financial distress.

Accepted Answer

A firm that easily meets its debt obligations is not considered to be in financial distress. Financial distress indicates that the company is struggling to meet its financial obligations and may be at risk of defaulting on its debt.

Question 10

Suppose a project financed via an issue of debt requires six annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 8%, what is the value of the interest rate tax shield?

Accepted Answer

B) Value of tax shield each year equals tax rate times the interest payment.
Compute the present value of annuity of payments calculated above.
Tax shield = 0.35 × $18 million = $6.3 million; 11ea84dc_f50e_ca24_9a63_c5a3f915c2b4_TB1316_00_TB1316_00

Question 11

Consider the following equation for the question(s) below.
 
-Which of the following statements is FALSE assuming a perfect market?

Accepted Answer

D) As the amount of debt increases, the debt becomes riskier because there is a chance the firm will default.

Question 12

A firm requires an investment of $60,000 and borrows $30,000 at 9%. If the return on equity is 22% and the tax rate is 35%, what is the firm's WACC?

Accepted Answer

B) Use the WACC equation presented in this chapter. r_wacc = r_E 11ea84dc_f50f_8d78_9a63_31c9aa966c36_TB1316_11_TB1316_11 + r_D (1 - T_C) 11ea84dc_f50f_8d79_9a63_8543b80beb83_TB1316_11_TB1316_11 r_wacc = 22% × ($30,000 / $60,000) + 9% × (1 - 0.35) × ($30,000 / $60,000) = 13.9%

Question 13

In general, the gain to investors from the tax deductibility of interest payments is referred to as the interest rate tax shield.

Accepted Answer

The statement is true. The tax deductibility of interest payments provides a financial benefit to investors, reducing the cost of borrowing and increasing the after-tax return on investment. This benefit is commonly known as the interest rate tax shield.

Question 14

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is the return to equity holders if demand is weak?

Accepted Answer

D) In the weak demand scenario, cash flow is $25,000. Equity costs $13,148.15 initially 11ea84dc_f50d_b8ae_9a63_29b49ad38f4b_TB1316_11_TB1316_11 .
The firm must repay $10,500 ($10,000 × 1.05) to debt holders, so cash flow to equity is 11ea84dc_f50d_dfbf_9a63_25b854cbd995_TB1316_11_TB1316_11 . Expected return to equity is 11ea84dc_f50d_dfc0_9a63_89f1960f229c_TB1316_11_TB1316_11 .

Question 15

A bankruptcy process is complex, time-consuming, and costly. The costs of bankruptcy include ________.

Accepted Answer

The costs of bankruptcy process include hiring legal experts, appraisers, and auctioneers which can be substantial. The other options, such as dividend payments, raw material costs, and taxes, are not directly related to the bankruptcy process.

Question 16

Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company borrows $10,000 at 5% to make the investment, what is the return to equity holders if demand is strong?

Accepted Answer

B) In the strong demand scenario, cash flow is $45,000. Equity costs $31,666.67 initially ($45,000 / 1.08 - $10,000).
The firm must repay $10,500 ($10,000 × 1.05) to debt holders, so cash flow to equity is 11ea84dc_f50e_2de1_9a63_bb699146b531_TB1316_11_TB1316_11 . Expected return to equity is 11ea84dc_f50e_2de2_9a63_6108d65d6296_TB1316_11_TB1316_11 .

Question 17

A firm requires an investment of $30,000 and borrows $20,000 at 9%. If the return on equity is 15% and the tax rate is 30%, what is the firm's WACC?

Accepted Answer

A) Use the WACC equation presented in this chapter. r_wacc = r_E 11ea84dc_f50f_3f56_9a63_37256c8d8be6_TB1316_11_TB1316_11 + r_D (1 - T_C) 11ea84dc_f50f_3f57_9a63_d5495ce56d6c_TB1316_11_TB1316_11 r_wacc = 15% × ($10,000 / $30,000) + 9% × (1 - 0.3) × ($20,000 / $30,000) = 9.20%

Question 18

How does the interest paid by a firm affect its value to investors?

Accepted Answer

The answer of How does the interest paid by a...

Question 19

What effect does debt have on a firm's weighted average cost of capital?

Accepted Answer

The answer of What effect does debt have on a...

Question 20

The following equation:  can be used to calculate all of the following EXCEPT ________.

Accepted Answer

The answer of The following equation:  can be used...

Quiz 16: Capital Structure