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Aaron's Tea House has a 32 percent tax rate and an interest tax shield valued at $6,728 for the year. How much did the firm pay in annual interest?


A) $2,153
B) $2,304
C) $2,468
D) $20,507
E) $21,025

F) A) and D)
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) D) and E)

Correct Answer

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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

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

Correct Answer

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Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $879,000. The current cost of equity is 18.3 percent and the tax rate is 34 percent. The company is in the process of issuing $6.2 million of 8.5 percent annual coupon bonds at par. What is the levered value of the firm?


A) $5,278,164
B) $5,541,085
C) $6,422,225
D) $6,713,185
E) $7,385,695

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

Correct Answer

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Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt?


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

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

Correct Answer

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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

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

Correct Answer

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T.L.C. Enterprises just revised its capital structure from a debt-equity ratio of 0.30 to a debt-equity ratio of 0.45. The firm's shareholders who prefer the old capital structure should:


A) sell some shares and hold the sale proceeds in cash.
B) sell all of their shares and loan out the entire sale proceeds.
C) do nothing.
D) sell some shares and loan out the sale proceeds.
E) borrow funds and purchase more shares.

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

Correct Answer

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The static theory of capital structure assumes a firm:


A) maintains a constant debt-equity ratio.
B) has an all-equity structure.
C) is fixed in terms of its assets.
D) pays no taxes.
E) is operating at the point where financial distress costs are eliminated.

F) All of the above
G) B) and E)

Correct Answer

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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

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

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Northwestern Lumber Products currently has 15,000 shares of stock outstanding. Patricia, the financial manager, is considering issuing $120,000 of debt at an interest rate of 6.75 percent. Given this, how many shares of stock will be outstanding once the debt is issued if the break-even level of EBIT between these two capital structure options is $60,000? Ignore taxes.


A) 12,975 shares
B) 13,650 shares
C) 14,025 shares
D) 14,550 shares
E) 15,000 shares

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

Correct Answer

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Cross Town Cookies is an all-equity firm with a total market value of $720,000. The firm has 150,000 shares of stock outstanding. Management is considering issuing $200,000 of debt at an interest rate of 7 percent and using the proceeds to repurchase shares. The projected earnings before interest and taxes are $58,600. What are the anticipated earnings per share if the debt is issued? Ignore taxes.


A) $0.25
B) $0.33
C) $0.38
D) $0.41
E) $0.47

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

Correct Answer

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In the process of liquidation, some types of claims receive preference over other claims. Which one of the following determines which type of claim is paid first?


A) Technical insolvency definition
B) Absolute priority rule
C) Accounting insolvency definition
D) Chapter 7 of the Federal Bankruptcy Reform Act of 1978
E) Securities and Exchange Commission

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

Correct Answer

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Southern Fried Foods has a $12 million bond issue outstanding with a coupon rate of 6.75 percent and a yield-to-maturity of 7.27 percent. What is the present value of the tax shield if the tax rate is 35 percent?


A) $283,500
B) $305,340
C) $3,053,400
D) $3,560,000
E) $4,200,000

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

Correct Answer

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Tree Farms, Inc. currently has 45,000 shares of stock outstanding and no debt. The price per share is $17.50. The firm is considering borrowing funds at 7.5 percent interest and using the proceeds to repurchase 3,000 shares of stock. Ignore taxes. How much is the firm borrowing?


A) $52,500
B) $75,000
C) $110,500
D) $125,000
E) $135,000

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

Correct Answer

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Which of the following will increase the value of a levered firm according to M&M Proposition I, with taxes? I. decrease in the amount of the debt II) increase in the value of the unlevered firm III) decrease in the tax rate IV) increase in the interest rate on the debt


A) II only
B) I and IV only
C) II and III only
D) II and IV only
E) II, III, and IV only

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

Correct Answer

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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

F) None of the above
G) A) and B)

Correct Answer

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Room and Board has determined that $36,000 is the breakeven level of earnings before interest and taxes for the two capital structures it is considering. The one structure consists of all equity with 14,000 shares of stock. The second structure consists of 10,000 shares of stock and $80,000 of debt. What is the interest rate on the debt?


A) 7.72 percent
B) 8.19 percent
C) 9.97 percent
D) 11.43 percent
E) 12.86 percent

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

Correct Answer

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Gabella's is an all-equity firm that has 21,000 shares of stock outstanding at a market price of $40 a share. The firm has earnings before interest and taxes of $84,000 and has a 100 percent dividend payout ratio. Ignore taxes. Gabella's has decided to issue $160,000 of debt at a rate of 12 percent and use the proceeds to repurchase shares. Travis owns 500 shares of Gabella's stock and has decided to continue holding those shares. How will Gabella's debt issue affect Travis' annual dividend income?


A) Decrease from $2,400 to $1,840
B) Increase from $2,400 to $2,160
C) Decrease from $2,000 to $1,906
D) Increase from $2,000 to $2,094
E) No change

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

Correct Answer

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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) B) and D)
G) C) and D)

Correct Answer

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Which one of the following is a key provision of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005?


A) Disallowance of bankruptcy prepacks
B) Right granted to creditors to file their own reorganization plan once a firm is in bankruptcy for 18 months
C) Disallowance of all management bonus payments while a firm is in bankruptcy
D) Requirement that only creditors can file reorganization plans for a bankrupt firm
E) Requirement for all Chapter 11 bankruptcies to be converted to Chapter 7 bankruptcies after 18 months

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

Correct Answer

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