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Ready To Go is an all-equity firm specializing in hot ready-to-eat meals.Management has estimated the firm's earnings before interest and taxes will be $68,000 annually forever.The present cost of equity is 14.1 percent.Currently,the firm has no debt but is considering borrowing $450,000 at 8 percent interest.The tax rate is 34 percent.What is the value of the unlevered firm?


A) $323,017
B) $346,511
C) $314,141
D) $318,298
E) $305,200

F) A) and B)
G) C) and E)

Correct Answer

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Which one of the following is minimized when the value of a firm is maximized?


A) Return on equity
B) WACC
C) Debt
D) Taxes
E) Bankruptcy costs

F) B) and C)
G) A) and B)

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Paying interest reduces the taxes owed by a firm.Which one of the following terms applies to this relationship?


A) Static theory of interest rates
B) M& M Proposition I
C) Financial risk
D) Interest tax shield
E) Homemade leverage

F) A) and C)
G) All of the above

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Assume both corporate taxes and financial distress costs apply to a firm.Given this,the static theory of capital structure illustrates that:


A) a firm's value and its weighted average cost of capital are inversely related.
B) a firm's value and its tax rate are inversely related.
C) the maximum value of a firm is obtained when a firm is financed solely with debt.
D) the value of a firm rises as the interest rate on debt rises.
E) the value of a firm rises as both the interest rate on debt and the tax rate rise.

F) C) and E)
G) A) and B)

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The Fruit Mart is an all-equity firm with a current cost of equity of 17.4 percent.The estimated earnings before interest and taxes are $169,500 annually forever.Currently,the firm has no debt but is in the process of borrowing $400,000 at 9.5 percent interest.The tax rate is 35 percent.What is the value of the unlevered firm?


A) $649,207
B) $753,571
C) $656,411
D) $719,307
E) $633,190

F) A) and D)
G) B) and C)

Correct Answer

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Which one of the following is an example of a direct bankruptcy cost?


A) Operating at a debt-equity ratio that is less than the optimal ratio
B) Reducing the dividend payout ratio as a means of increasing a firm's equity
C) Forgoing a positive net present value project to conserve current cash
D) Incurring legal fees for the preparation of bankruptcy filings
E) Losing a key customer due to concerns over a firm's financial viability

F) C) and E)
G) A) and E)

Correct Answer

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Which one of the following states that a firm’s cost of equity capital is a positive linear function of the firm' s capital structure?


A) Static theory of capital structure
B) M& M Proposition I without taxes
C) M& M Proposition II without taxes
D) Homemade leverage theory
E) M& M Proposition I with taxes

F) B) and D)
G) B) and E)

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According to M& M Proposition I with taxes,the value of a levered firm will increase when the:


A) value of the unlevered firm increases.
B) tax rate is decreased.
C) debt-equity ratio is lowered.
D) interest rate on the debt is lowered.
E) interest rate on the debt is increased.

F) A) and C)
G) B) and C)

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Great Lakes Shipping is an all-equity firm with anticipated earnings before interest and taxes of $386,000 annually forever.The present cost of equity is 17.1 percent.Currently,the firm has no debt but is considering borrowing $1.48 million at 8.5 percent interest.The tax rate is 35 percent.What is the value of the levered firm?


A) $1,985,251
B) $2,006,519
C) $1,888,47
D) $1,666,667
E) $2,018,181

F) C) and D)
G) B) and E)

Correct Answer

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Which one of the following statements matches M& M Proposition I without taxes?


A) The cost of equity capital has a positive linear relationship with a firm's capital structure.
B) The dividends paid by a firm determine the firm's value.
C) The cost of equity capital varies in response to changes in a firm's capital structure.
D) The value of a firm is independent of the firm's capital structure.
E) The value of a firm is dependent on the firm's capital structure

F) All of the above
G) A) and D)

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Which one of the following statements is correct regarding bankruptcies post-2005?


A) All Chapter 7 bankruptcy filings must include a "workout" agreement.
B) Firms must remain in bankruptcy for at least 18 months.
C) Key employee retention plans are no longer permitted under any circumstances.
D) Labor contracts cannot be modified through the bankruptcy process.
E) Section 363 speeds up the bankruptcy process via a bidding process.

F) All of the above
G) A) and D)

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Which one of the following terms applies to the costs incurred by a firm that is trying to avoid filing for bankruptcy?


A) Indirect bankruptcy costs
B) Direct bankruptcy costs
C) Static theory cost
D) Optimal capital structure cost
E) Reorganization costs

F) C) and E)
G) None of the above

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Holiday Decor is an all-equity firm with a total market value of $347,000 and12,000 shares of stock outstanding.Management is considering issuing $48,000 of debt at an interest rate of 7 percent and using the proceeds on a stock repurchase.As an all-equity firm,management believes its earnings before interest and taxes (EBIT) will be $33,000 if the economy is normal,$8,000 if it is in a recession,and $41,000 if the economy booms.Ignore taxes.What will the EPS be if the economy falls into a recession and the firm maintains its all-equity status?


A) $.75
B) $.67
C) $1.21
D) $1.50
E) $1.33

F) A) and B)
G) A) and C)

Correct Answer

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Which one of the following terms is inclusive of both direct and indirect bankruptcy costs?


A) Financial distress costs
B) Capital structure costs
C) Financial leverage
D) Homemade leverage
E) Cost of capital

F) C) and D)
G) A) and B)

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Which one of the following is a direct bankruptcy cost?


A) Loss of customer goodwill resulting from a bankruptcy filing
B) Legal and accounting fees related to a bankruptcy proceeding
C) Management time spent on a bankruptcy proceeding
D) Any financial distress cost
E) Costs a firm spends trying to avoid bankruptcy

F) B) and D)
G) A) and E)

Correct Answer

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Which one of the following statements concerning financial leverage is correct?


A) Financial leverage increases profits and decreases losses.
B) Financial leverage has no effect on a firm's return on equity.
C) Financial leverage refers to the use of common stock.
D) Financial leverage magnifies both profits and losses.
E) Increasing financial leverage will always decrease the earnings per share

F) B) and E)
G) A) and C)

Correct Answer

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The level of financial risk to which a firm is exposed is dependent on the firm's:


A) tax rate.
B) debt-equity ratio.
C) return on assets.
D) level of earnings before interest and taxes.
E) operational level of risk

F) D) and E)
G) B) and C)

Correct Answer

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Brick House Markets has a tax rate of 34 percent and taxable income of $308,211.What is the value of the interest tax shield if the interest expense is $39,700?


A) $14,887
B) $15,010
C) $15,595
D) $13,498
E) $16,023

F) A) and E)
G) A) and B)

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A prepack:


A) guarantees full payment to all creditors but lengthens the time span of the debt.
B) is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan.
C) protects the interests of both the current creditors and the existing shareholders.
D) applies only if a firm files under Chapter 7 of the bankruptcy code.
E) extends the time that a firm is protected by the bankruptcy process.

F) None of the above
G) All of the above

Correct Answer

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M&M Proposition I with taxes states that:


A) the optimal capital structure is the all-equity option.
B) the levered value of a firm exceeds the firm's unlevered value.
C) a firm's capital structure is irrelevant.
D) the value of a firm is independent of taxes.
E) WACC remains constant given any debt-equity ratio

F) All of the above
G) A) and C)

Correct Answer

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