Capital Structure Chapter 13 Test Questions & Answers - Corporate Finance Asia Pacific 2e Complete Test Bank by Chris Adam. DOCX document preview.
Chapter 13 – Capital structure
MULTIPLE CHOICE
1. The uncertainty caused by the variability of a company’s cash flows is called:
a. | financial risk |
b. | business risk |
c. | financial leverage |
d. | agency cost |
REF: 13.2 The Modigliani & Miller Propositions NAT: Reflective thinking
LOC: acquire an understanding of risk and return
2. Which of the following is considered an indirect cost of bankruptcy?
a. | Document printing expenses |
b. | Professional fees paid to lawyers |
c. | Loss of key employees |
d. | Travel expenses by board of directors |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
3. Which of the following is considered a direct cost of bankruptcy?
a. | Diversion of management’s time |
b. | Constrained capital investment spending |
c. | Lost sales |
d. | Professional fees paid to lawyers |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
Use the following information to answer questions 4 to 16.
Bavarian Brew, an unlevered company, has an expected EBIT of $550 000. The required return on assets for the company’s assets is 11%. The company has 250 000 shares outstanding. The company is considering raising $1 million in debt with a required return of 6%. It would use the proceeds to repurchase outstanding shares.
4. What is the value of Bavarian Brew before restructuring? Assume no corporate taxes.
a. | $500 000 |
b. | $1 000 000 |
c. | $5 000 000 |
d. | $3 300 000 |
550 000/0.11 = 5 000 000
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
5. What is the value of Bavarian Brew before restructuring? Assume a corporate tax rate of 30%.
a. | $5 000 000 |
b. | $500 000 |
c. | $3 300 000 |
d. | $3 500 000 |
550 000(1 – 0.30)/0.11 = 3 500 000
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
6. What is the value of Bavarian Brew after restructuring? Assume no corporate taxes.
a. | $3 300 000 |
b. | $5 000 000 |
c. | $500 000 |
d. | $1 000 000 |
550 000/0.11 + 0 = 5 000 000
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
7. What is the value of Bavarian Brew after restructuring? Assume corporate taxes of 30%.
a. | $5 300 000 |
b. | $5 340 000 |
c. | $3 300 000 |
d. | $1 000 000 |
500 000/0.10 + 1 000 000(0.30) = 5 300 000
PTS: 1 DIF: E
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
8. What is the present value of Bavarian Brew’s debt tax shield after the restructuring? Assume corporate taxes of 30%.
a. | $340 000 |
b. | $1 000 000 |
c. | $660 000 |
d. | $300 000 |
1 000 000(0.30) = 300 000
PTS: 1 DIF: E
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
9. What is Bavarian Brew’s required return on equity before the restructuring? Assume no corporate taxes.
a. | 10% |
b. | 6% |
c. | 11% |
d. | 12% |
0.11 + (0.11 – 0.06)(0/5 000 000) = 0.11
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
10. What is the Bavarian Brew’s required return on levered equity after the restructuring?
a. | 10.25% |
b. | 10.92% |
c. | 6.00% |
d. | 12.15% |
0.11 + (0.11 – 0.06)(1 000 000/4 340 000) = 0.1215
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
11. If the PV of bankruptcy cost is $750 000, what is the value of Bavarian Brew after the restructuring? Assume a corporate tax rate of 30%.
a. | $4 550 000 |
b. | $5 340 000 |
c. | $4 590 000 |
d. | $4 250 000 |
550 000/0.11 + 1 000 000(0.30) – 750 000 = 4 550 000
PTS: 1 DIF: E
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
12. Refer to Bavarian Brew. What is the PV of bankruptcy costs for which the company is indifferent about the proposed change in capital structure?
a. | $450 000 |
b. | $750 000 |
c. | $340 000 |
d. | $300 000 |
They are indifferent when the debt tax shield equals PV of bankruptcy costs.
1 000 000(0.30) = $300 000
PTS: 1 DIF: M
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
13. If the corporate tax rate equals 30%, what is the gain from leverage for Bavarian Brew? Note that the personal tax rate on dividends for investors is 15% and the personal income tax on interest income is 35%.
a. | $340 000 |
b. | $65 000 |
c. | $84 615 |
d. | $400 000 |
1 – [(1 – 0.30)(1 – 0.15)/(1 – 0.35)](1 000 000) = 65 00084 615
PTS: 1 DIF: E
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
14. If the corporate tax rate equals 30%, what is the gain from leverage for Bavarian Brew? Assume that the personal tax rate on interest income equals 35% and that there is no tax on dividend income.
a. | –$100 000 |
b. | -76 923 |
c. | $340 000 |
d. | –$340 000 |
[1 – (1 – 0.30)(1 – 0)/(1 – 0. 35)](1 000 000) = -76923
PTS: 1 DIF: M
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
15. Refer to Bavarian Brew. If the corporate tax rate equals 30% and dividend income is tax free, at which personal tax rate on interest income is there no gain from leverage?
a. | 34% |
b. | 40% |
c. | 15% |
d. | 30% |
1 – (1 – 0.30)(1 – 0)/(1 – t) = 0
t = 0.30
PTS: 1 DIF: M
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
16. Refer to Bavarian Brew. If the corporate tax rate equals 30% and the personal tax rate on interest income equals 35%, for which tax rate on dividend income is the gain from leverage equal to zero?
a. | 15.2% |
b. | 9.1% |
c. | 12.6% |
d. | 7.14% |
1 – (1 – 0.30)(1 – t)/(1 – 0.35) = 0
t = 0.0714 ===> 0.071
PTS: 1 DIF: H
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
Use the following information to answer questions 17 to 21.
Bavarian Brew, an unlevered company, has a perpetual EBIT of $550 000. The required return on assets for the company’s assets is 12%. The company has 250 000 shares outstanding, trading at $20 per share. The company is considering raising $1 million in debt with a required return of 6%. It would use the proceeds to repurchase 50 000 shares of outstanding share.
17. Calculate Bavarian Brew’s earnings per share after the restructuring. Assume no corporate taxes.
a. | $2.20 |
b. | $2.50 |
c. | $2.45 |
d. | $2.25 |
550 000 – (1 000 000)(0.06)/200 000 = 2.45
PTS: 1 DIF: E
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
18. What are Bavarian Brew’s earnings per share before the restructuring? Assume corporate taxes of 30%.
a. | $1.32 |
b. | $1.35 |
c. | $1.54 |
d. | $1.45 |
550 000(1 – 0.30)/250 000 = 1.54
PTS: 1 DIF: E
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
19. What are Bavarian Brew’s earnings per share before the restructuring? Assume no corporate taxes.
a. | $2.50 |
b. | $2.20 |
c. | $2.00 |
d. | $1.75 |
550 000/250 000 = 2.20
PTS: 1 DIF: E
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
20. What are Bavarian Brew’s earnings per share after the restructuring? Assume corporate taxes of 30%.
a. | $1.72 |
b. | $1.35 |
c. | $1.42 |
d. | $1.45 |
[(550 000–60 000)(1 – 0.30)]/200 000 = 1.72
PTS: 1 DIF: M
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
21. If a company issues $25 000 worth of debt and has a corporate tax rate of 30%, what is the PV of the debt tax shield?
a. | $25 000 |
b. | $10 000 |
c. | $7 500 |
d. | $20 000 |
25 000(0.3) = 7 500
PTS: 1 DIF: E
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
Use the following information to answer questions 22 and 23.
Miller’s Pharmacy has EBIT of $15 000, debt with a market value of $25 000 and a required return on assets of 12%.
22. Assuming no taxes, what is the value of Miller’s Pharmacy?
a. | $15 000 |
b. | $125 000 |
c. | $25 000 |
d. | $75 000 |
15 000(1 – 0)/0.12 + 25 000(0) = 125 000
PTS: 1 DIF: E
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
23. Assuming a corporate tax rate of 35%, what is the value of Miller’s Pharmacy?
a. | $125 000 |
b. | $25 000 |
c. | $133 750 |
d. | $75 000 |
15 000/0.12 + 25 000(0.35) = 133 750
PTS: 1 DIF: E
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
24. State Company has determined its earnings before interest and taxes (EBIT) in four possible states of the world. In the Great State, EBIT will be $3 000 000, and in the Good, Normal and Poor States, EBIT will be $2 000 000, $1 500 000 and $1 000 000, respectively. If each state has an equal probability of occurring, then what is State Company’s expected EBIT?
a. | $3 000 000 |
b. | $2 500 000 |
c. | $1 875 000 |
d. | $6 500 000 |
0.25(3 000 000 + 2 000 000 + 1 500 000 + 1 000 000) = 1 875 000
PTS: 1 DIF: E
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
25. If a company increases its use of financial leverage, then how would we generally expect that increased leverage to affect the dispersion of the company’s net income distribution?
a. | Less dispersion |
b. | No effect on dispersion |
c. | Greater dispersion |
d. | This cannot be determined. |
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
26. If a company increases its financial leverage, then how would we generally expect that increased leverage to affect the EPS if it is already quite high?
a. | EPS would be lower with financial leverage. |
b. | EPS would always be the same with financial leverage. |
c. | EPS would be higher with financial leverage. |
d. | This cannot be determined. |
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
27. If a company increases its use of financial leverage, then how would we generally expect that increased leverage to affect the EPS if it is already very low?
a. | EPS would be lower with financial leverage. |
b. | EPS would always be the same with financial leverage. |
c. | EPS would be higher with financial leverage. |
d. | This cannot be determined. |
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
28. If a company increases its use of financial leverage, then we would generally expect the shareholders of that company to:
a. | lower their demand for return on their investment |
b. | remain indifferent with respect to their return on investment |
c. | increase their demand for return on their investment |
d. | This cannot be determined. |
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
29. Company X plans to increase its financial leverage by issuing debt and using the proceeds to repurchase equity. If you assume that the Modigliani and Miller assumptions hold, then the effect of this increasing financial leverage transaction should:
a. | increase the market value of Company X’s shares |
b. | have no effect on the market value of Company X’s shares |
c. | decrease the market value of Company X’s shares |
d. | This cannot be determined. |
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
30. Lever Co.’s perpetual EBIT is expected to be $1 000 000 per year based upon total debt of $200 000. The company’s cost of debt is 5%, and its required return on company’s assets is 10%. In a world without taxes, distress costs or agency problems, what is the value of Lever Co.?
a. | $19 800 000 |
b. | $10 000 000 |
c. | $9 900 000 |
d. | $15 000 000 |
1 000 000/0.1= 10 000 000
PTS: 1 DIF: M
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
31. Roy’s Toys, Inc. currently has no debt outstanding. Its current cost of equity is 12% and the current value of the company is $20 000 000. Roy is proposing to finance 1/4 of its assets with debt at a cost of 8% per annum. What will be Roy’s cost of levered equity if things go as planned? Ignore any tax effects.
a. | 12.00% |
b. | 13.00% |
c. | 13.33% |
d. | 11.66% |
Current cost of equity = Return on assets
rl = r + (r – rd)(D/E)
rl = 0.12 + (0.12 – 0.08)(5 000 000/15 000 000) = 0.1333
PTS: 1 DIF: H
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
32. Nuclear Widgets has a current cost of levered equity equal to 13%. Its return on assets is 12% and its cost of debt is 8%. Nuclear Widgets has borrowed a total of $5 000 000. What is the current value of Nuclear Widgets’ equity? Ignore the effect of taxes.
a. | $1 250 000 |
b. | $20 000 000 |
c. | The problem yields a negative number, which means the problem is not realistic. |
d. | There is not enough information to answer this question. |
rl = r + (r – rd)(D/E)
rl = 0.13 = 0.12 + (0.12 – 0.08)(5 000 000/E)
E = 20 000 000
PTS: 1 DIF: H
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
33. A newly appointed CFO of a company tells you that he needs to determine the required return on unlevered equity. He further tells you that the required return on assets is 10% and that his cost of debt is 3% based upon a current borrowed amount of $50 000 000, but he does not know the market value of his equity. If his company eliminates all of its debt, what is the required return on equity?
a. | 10.0% |
b. | 11.5% |
c. | 13.0% |
d. | There is not enough information to answer this question. |
rl = r + (r – rd)(D/E)
rl = 0.10 + (0.10 – 0.03)(0/E) = 0.1
PTS: 1 DIF: M
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
34. Bilever Co.’s perpetual EBIT is expected to be $1 000 000 per year based upon total debt of $200 000. The company’s cost of debt is 5%, and its required return on company’s assets is 10%. In a world without distress costs or agency problems, what is the value of Bilever Co.? Assume that Bilever is in the 30% marginal tax rate.
a. | $14 000 000 |
b. | $7 000 000 |
c. | $5 600 000 |
d. | $3 000 000 |
(1 000 000 × 0.7)/0.1 = 7 000 000
PTS: 1 DIF: M
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
35. Big Corp. anticipates issuing $5 000 000 of debt to repurchase equity. If Big can issue the debt to yield 8% per year, then what is the increase in value to Big? Assume the company is subject to a 34% marginal tax rate.
a. | $136 000 |
b. | $400 000 |
c. | $1 700 000 |
d. | $13 600 |
5 000 000 × 0.34 = 1 700 000
PTS: 1 DIF: M
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
36. Large Corp. anticipates issuing $5 000 000 of debt to repurchase equity. If Large can issue the debt to yield 8% per year, then what is the single year increase in cash flow to Large? Assume the company is subject to a 34% marginal tax rate.
a. | $136 000 |
b. | $400 000 |
c. | $2 720 000 |
d. | $666 667 |
5 000 000 × 0.08 × 0.34 = 136 000
PTS: 1 DIF: M
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
37. If we start with the M&M perfect capital markets assumption and relax the no-tax assumption on corporations, then we would expect for companies that go from no leverage to some leverage:
a. | to be at least as valuable as the no-leverage company |
b. | to be at least as valuable as the levered company |
c. | to change in value depending upon the level of personal taxes |
d. | to change in value depending upon the level of dividend paid to shareholders |
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
38. You need to calculate the gains from using $1 000 000 of additional leverage on the average company in the Australian economy. You are told that the average investor’s personal tax rate on income from shares is 15% and that investors can generally avoid personal taxes on income from debt. You are also told that the average corporation is subject to the 35% marginal corporate tax rate. What is the benefit to company value for this additional debt load?
a. | $650 000 |
b. | $447 500 |
c. | $350 000 |
d. | $500 000 |
GL = {1 – [(1 – Tc)(1 – Tps)/(1 – Tpd)]} × D
GL = {1 – [(1 – 0.35)(1 – 0.15)/(1 – 0)]} × 1 000 000
GL = 447 500
PTS: 1 DIF: H
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
39. Costs associated with the requirement that management divert its attention away from strategically managing a corporation in favour of spending time with financial attorneys could be best described as:
a. | direct bankruptcy costs |
b. | indirect bankruptcy costs |
c. | managerial–shareholder related agency costs |
d. | opportunity cost |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
40. Company Y issued $100 000 000 of bonds last year for the purpose of building a new widget manufacturing plant. Company Y instead used the proceeds to fund gamblers in Las Vegas. Which of the following best describes the general problem that Y’s investors must face?
a. | The underinvestment problem |
b. | The overinvestment problem |
c. | The asset substitution problem |
d. | The Enron problem |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire an understanding of risk and return
41. Lord Brack has recently sold 90% of his company to the general public but he remains the CEO. Unfortunately, the Lord prefers to eat $1000 lunches in the corporate dining room (for which he does not reimburse the company). What is Lord Brack’s cost of these lunches?
a. | $1000 |
b. | $900 |
c. | $100 |
d. | $0 |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
42. Molotov Cranberry Cocktail Corp. finds that the value of the company is equal to $100 000 000 with no debt. It knows that if it issues new debt, the value of the tax shield will be $3 000 000 while the value of the bankruptcy costs, outside agency costs and inside agency costs will be $1 000 000, $2 000 000 and $4 000 000, respectively. What will the value of Molotov be if it issues the debt?
a. | $0 |
b. | $96 000 000 |
c. | $100 000 000 |
d. | $107 000 000 |
100 + 3 – 1 + 2 – 4 = 100 million
PTS: 1 DIF: M
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
43. Fidget, Inc. is currently worth $10 000 000. It is told that if it issues $1 000 000 of perpetual debt (and uses the proceeds to repurchase equity), the value of the company will increase by $290 000. If the total bankruptcy costs and agency costs combine total $20 000, what is Fidget’s marginal corporate tax rate? Ignore personal taxes.
a. | 29% |
b. | 30% |
c. | 31% |
d. | 34% |
290 000 = (1 000 000 × Tc) – 20 000
Tc = 0.31
PTS: 1 DIF: M
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
44. You are evaluating a company and have found a new way to calculate the present value of bankruptcy costs, agency costs of outside equity and debt. You find that the agency costs of outside equity is $100 while the agency cost of outside debt is $1 000 000. The costs of bankruptcy are also $1 000 000. What type of company does most likely describe?
a. | A company with too little leverage |
b. | A company with too much leverage |
c. | A company with too much equity |
d. | A company that should disregard its agency costs |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
45. If you were to look at leverage for companies in a country where attorneys and accountants are very expensive, all other things being equal you would expect that companies in those countries would use:
a. | less leverage than in other countries |
b. | more leverage than in other countries |
c. | no leverage |
d. | as much leverage as is mathematically possible |
REF: 13.5 The Pecking-Order Theory NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
46. DebtCo. has $100 000 000 of perpetual debt outstanding with a cost of 9%. DebtCo. is currently subject to a 30% marginal tax rate. A new prime minister enters office and surprisingly gets a law passed that increases the marginal tax rate for companies like DebtCo. to 35%. What will be the likely immediate value change of DebtCo.?
a. | –$35 000 000 |
b. | –$5 000 000 |
c. | $5 000 000 |
d. | $35 000 000 |
Old value = 100 000 000 × 0.3 = 30 000 000
New value = 100 000 000 × 0.35 = 35 000 000
Change in value = 5 000 000
PTS: 1 DIF: M
REF: 13.5 The Pecking-Order Theory NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
Use the following information to answer questions 47 to 52.
As chief financial officer of the Kennesaw Steel Corporation (KSC), you are considering a recapitalisation plan that would convert KSC from its current all-equity capital structure to one including substantial financial leverage. KSC now has 100 000 ordinary shares outstanding, which are selling for $50 each, and the recapitalisation proposal is to issue $2 000 000 worth of long-term debt at an interest rate of 8.0%. The proceeds would then be used to repurchase $2 000 000 of ordinary shares.
47. Refer to Kennesaw Steel Corporation. What is the new debt-to-equity ratio if the recapitalisation is completed? (Assume that a share can be repurchased for $50.)
a. | 1.50 |
b. | 1.00 |
c. | 0.67 |
d. | 0.33 |
Before recapitalisation:
Equity = 50 × 100 000 = 5 000 000
After:
Equity = 5 000 000 – 2 000 000 = 3 000 000
Debt = 2 000 000
D/E = 2 000 000/3 000 000 = 0.67
PTS: 1 DIF: E
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
48. Refer to Kennesaw Steel Corporation. How many shares will be left outstanding after the recapitalisation? (Assume that a share can be repurchased for $50.)
a. | 60 000 |
b. | 50 000 |
c. | 45 000 |
d. | 40 000 |
Before recapitalisation:
Equity = 50 × 100 000 = 5 000 000
After:
Equity = 5 000 000 – 2 000 000 = 3 000 000
Debt = 2 000 000
Number of shares = 3 000 000/50 = 60 000
PTS: 1 DIF: M
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
49. Refer to Kennesaw Steel Corporation. The tax rate is 40%. Under the new capital structure, at what level of EBIT will earnings per share equal zero for shareholders? (Assume that a share can be repurchased for $50.)
a. | $0 |
b. | $60 000 |
c. | $120 000 |
d. | $160 000 |
Before recapitalisation:
Equity = 50 × 100 000 = 5 000 000 (Number of shares = 100 000)
After:
Equity = 5 000 000 – 2 000 000 = 3 000 000
Debt = 2 000 000
Interest paid = 2 000 000 × 0.08 = 160 000
Number of shares = 3 000 000/50 = 60 000
EPS = (x – 160 000) × (1 – 0.40) = 0
x = 160 000
PTS: 1 DIF: M
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
50. Refer to Kennesaw Steel Corporation. The tax rate is 40%. At what level of EBIT will earnings per share be equal for shareholders under each capital structure? (Assume that a share can be repurchased for $50.)
a. | $350 000 |
b. | $400 000 |
c. | $450 000 |
d. | $500 000 |
Before recapitalisation:
Equity = 50 × 100 000 = 5 000 000 (Number of shares = 100 000)
After:
Equity = 5 000 000 – 2 000 000 = 3 000 000
Debt = 2 000 000
Interest paid = 2 000 000 × 0.08 = 160 000
Number of shares = 3 000 000/50 = 60 000
Breakeven = (x – 0) × (1 – 0.4)/100 000
Breakeven = (x – 160 000) × (1 – 0.4)/75 000
x = 400 000
PTS: 1 DIF: M
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
51. Refer to Kennesaw Steel Corporation. The tax rate is 40%. If EBIT is $600 000 in the next year, what is the earnings per share under the new plan? (Assume that a share can be repurchased for $50.)
a. | $4.40 |
b. | $4.20 |
c. | $4.00 |
d. | $3.80 |
Before recapitalisation:
Equity = 50 × 100 000 = 5 000 000 (Number of shares = 100 000)
After:
Equity = 5 000 000 – 2 000 000 = 3 000 000
Debt = 2 000 000
Interest paid = 2 000 000 × 0.08 = 160 000
Number of shares = 3 000 000/50 = 60 000
NI = (600 000 – 160 000) × (1 – 0.40) = 264 000
EPS = 264 000/60 000 = 4.40
PTS: 1 DIF: M
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
52. Refer to Kennesaw Steel Corporation. The tax rate is 40%. If EBIT is $600 000 in the next year, what is the return on equity under the new plan? (Assume that a share can be repurchased for $50.)
a. | 7.4% |
b. | 8.1% |
c. | 8.8% |
d. | 9.5% |
Before recapitalisation:
Equity = 50 × 100 000 = 5 000 000 (Number of shares = 100 000)
After:
Equity = 5 000 000 – 2 000 000 = 3 000 000
Debt = 2 000 000
Interest paid = 2 000 000 × 0.08 = 160 000
Number of shares = 3 000 000/50 = 60 000
NI = (600 000 – 160 000) × (1 – 0.40) = 264 000
Shareholder equity = 60 000 × 50 = 3 000 000
ROE = 0.088 = 8.8%
PTS: 1 DIF: M
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
53. Which statement is true regarding a company that increases financial leverage?
a. | Average earnings per share increases while shareholder risk increases. |
b. | Average earnings per share increases while shareholder risk decreases. |
c. | Average earnings per share decreases while shareholder risk decreases. |
d. | Average earnings per share decreases while shareholder risk increases. |
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
54. The Globe, Inc. has EBIT of $20 million for the current year. On the company’s balance sheet, there is $80 million of debt outstanding that carries a coupon rate of 8%. Investors seek a return of 12% on the company, and the company has a corporate tax rate of 40%. What is the value of the company?
a. | $124 000 000 |
b. | $128 000 000 |
c. | $132 000 000 |
d. | $136 000 000 |
Levered | Unlevered | ||
EBIT | $20 000 000 | $20 000 000 | |
INT | $80 × 8% | $ 6 400 000 | $ 0 |
EBT | $13 600 000 | $20 000 000 | |
Taxes | at 40% | $ 5 440 000 | $ 8 000 000 |
NI | $ 8 160 000 | $12 000 000 | |
+ Interest | $ 6 400 000 | $ 0 | |
Available to investors | $14 560 000 | $12 000 000 |
PV of tax shield = 80 000 000 × 0.40 = 32 000 000
Value of unlevered company = 12 000 000/0.12 = 100 000 000
Value of levered company = 100 000 000 + 32 000 000
PTS: 1 DIF: H
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
55. The Globe, Inc. has EBIT of $30 million for the current year. On the company’s balance sheet, there is $90 million of debt outstanding that carries a coupon rate of 9%. Investors seek a return of 12% on the company, and the company has a corporate tax rate of 40%. What is the value of the company?
a. | $152 000 000 |
b. | $160 000 000 |
c. | $174 000 000 |
d. | $186 000 000 |
Levered | Unlevered | ||
EBIT | $30 000 000 | $30 000 000 | |
INT | $80 × 8% | $ 8 100 000 | $ 0 |
EBT | $21 900 000 | $30 000 000 | |
Taxes | at 40% | $ 8 760 000 | $12 000 000 |
NI | $13 140 000 | $18 000 000 | |
+ Interest | $ 8 100 000 | $ 0 | |
Available to investors | $21 240 000 | $18 000 000 |
PV of tax shield = 90 000 000 × 0.40 = 36 000 000
Value of unlevered company = 18 000 000/0.12 = 150 000 000
Value of levered company = 150 000 000 + 36 000 000
PTS: 1 DIF: H
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
56. The Globe, Inc. has EBIT of $20 million for the current year. On the company’s balance sheet, there is $80 million of debt outstanding that carries a coupon rate of 8%. Investors seek a return of 12% on the company, and the company has a corporate tax rate of 40%. What is the present value of the company’s tax shields?
a. | $32 000 000 |
b. | $30 000 000 |
c. | $24 000 000 |
d. | $6 400 000 |
PV of tax shield = 80 000 000 × 0.40 = 32 000 000
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
57. Which statement correctly describes Proposition I of Modigliani and Miller?
a. | The value of the company is independent of its capital structure. |
b. | If there is no default risk, companies should exclusively use debt to finance projects. |
c. | If there is no default risk, companies should exclusively use equity to finance projects. |
d. | The value of the company’s tax shields depends solely on the amount of debt issued. |
REF: 13.2 The Modigliani & Miller Propositions NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
58. Lightyear Technology Corporation finances its operations with $75 million in shares with a required return of 12% and $45 million in bonds with a required return of 8%. Suppose the company issues $15 million in additional bonds at 8% and uses the proceeds to retire $15 million worth of equity. What will be the company’s new debt-to-equity ratio? (Assume zero taxes and perfect capital markets.)
a. | 0.75 |
b. | 0.90 |
c. | 1.00 |
d. | 1.10 |
Debt total = 45 + 15 = 60
Equity = 75 – 15 = 60
D/E = 1
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
59. Burdell Scientific, Inc. finances its operations with $40 million in shares with a required return of 12% and $10 million in bonds with a required return of 6%. Suppose the company issues $15 million in additional bonds at 8% and uses the proceeds to retire $15 million worth of equity. If the WACC remains the same, what will be the company’s new cost of equity? (Assume zero taxes and perfect capital markets.)
a. | 15.60% |
b. | 15.00% |
c. | 14.40% |
d. | 13.80% |
Old WACC:
rs = r + (r – rd) × D/E
0.12 = r + (r – 0.06) × 10/40
0.12 = r + 0.25 r – 0.015
r = (0.12 + 0.15)/1.25 = 0.1080
New rs:
rd = 10/25 × 0.06 + 15/25 × 0.08 = 0.072
rs = r + (r – rd) × D/E
rs = 0.1080 + (0.1080 – 0.072) × 25/25 = 0.1080 + 0.036 = 0.144
PTS: 1 DIF: M
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
60. Oak Barrel Company has net operating income of $10 million. The company has $80 million of debt outstanding with a required rate of return of 7%; the required rate of return for the industry is 11%. The corporate tax rate is 40%. If the personal tax rate on income from shares is 20% and the personal tax rate on debt income is 30%, what is the gain from leverage?
a. | $22.34 million |
b. | $23.77 million |
c. | $24.63 million |
d. | $25.14 million |
PV of tax shield = 80 × 0.40 = 32 ===> 32 million
Value of unlevered company = NI/r = 10 million × (1 – 0.40)/0.11 = 6/0.11 = 54.55 million
Value of levered company = 54.55 + 32 = 86.55 ===> 86.55 million
Gain from leverage = {1 – [(1 – 0.4) × (1 – 0.2)/(1 – 0.3)]}× $80
Gain from leverage = 25.14 ===> 25.14 million
PTS: 1 DIF: M
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
61. Oak Barrel Company has net operating income of $10 million. The company has $80 million of debt outstanding with a required rate of return of 7%; the required rate of return for the industry is 11%. The corporate tax rate is 40%. What is the value of the Oak Barrel Company?
a. | $86.55 million |
b. | $83.77 million |
c. | $81.46 million |
d. | $72.28 million |
PV of tax shield = 80 × 0.40 = 32 ===> 32 million
Value of unlevered company = NI/r = 10 million × (1 – 0.40)/0.11 = 6/0.11 = 54.55 million
Value of levered company = 54.55 + 32 = 86.55 ===> 86.55 million
PTS: 1 DIF: M
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
62. Which statement is false regarding empirical evidence of capital structures?
a. | Capital structures show strong industry patterns. |
b. | Economy-wide leverage ratios are consistent across countries. |
c. | Leverage ratios are negatively related to the cost of financial distress. |
d. | Within industries, the most profitable companies borrow the least. |
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
63. In a world with only company-level taxation of operating profits, no bankruptcy costs and tax-deductible interest payments, what is the optimal corporate strategy?
a. | A company should use all equity to maximise company value. |
b. | A company should use all debt to maximise its value. |
c. | A company’s value is independent of the way it is financed. |
d. | A company should maximise the use of preferred shares to create value. |
REF: 13.2 The Modigliani & Miller Propositions NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
Use the following information to answer questions 64 to 66.
ABC Corporation has a capital structure that consists of $20 million in debt and $40 million in equity. The debt has a coupon rate of 10%, while the industry return on equity is 15%. ABC Corporation is unsure of the state of the economy in the next year. The tax rate facing the company is 40%.
State of the economy | Bad | Good | Great |
EBIT | $2 000 000 | $5 000 000 | $10 000 000 |
Probability | 0.40 | 0.40 | 0.20 |
64. Refer to ABC Corporation. Given the information in the table, what are the expected earnings per share if the company has 1 million shares outstanding?
a. | $1.44 |
b. | $1.56 |
c. | $1.68 |
d. | $1.78 |
Interest payment = 20 × 0.10 = 2 million
NIBad = (2 – 2) × (1 – 0.4) = 0
NIGood = (5 – 2) × (1 – 0.4) = 1.8 million
NIGreat = (10 – 2) × (1 – 0.4) = 4.8 million
Expected EPS = (0 × 0.4 + 1.8 × 0.4 + 4.8 × 0.2)/1 = 1.68
PTS: 1 DIF: M
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
65. Refer to ABC Corporation. The company is considering the issue of $10 million in new debt at a rate of 10%. The funds from the new debt will be used to retire $10 million in equity. Currently, there are 1 million shares outstanding that trade at $40 per share. Assuming the share price will remain the same. If the company goes through with the recapitalisation, what are the expected earnings per share in the next year?
a. | $1.32 |
b. | $1.56 |
c. | $1.68 |
d. | $1.76 |
Recapitalise:
Total debt = 20 mil + 10 mil = 30 mil
Number of shares = 30 million/40 per share = 750 000
Interest payment = 30 × 0.10 = 3 million
NIBad = (3 – 3) × (1 – 0.4) = 0
NIGood = (5 – 3) × (1 – 0.4) = 1.2 million
NIGreat = (10 – 3) × (1 – 0.4) = 4.2 million
Expected EPS = (0 × 0.4 + 1.2 × 0.4 + 4.2 × 0.2)/0.75 = 1.76
PTS: 1 DIF: H
REF: 13.1 What Is Financial Leverage and What Are Its Effects?
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
66. Which statement is false concerning capital structure?
a. | Companies with large amounts of tangible assets tend to use a lot of debt in their capital structures. |
b. | When corporate profits are taxed at the corporate and personal level, the benefits of leverage are greatly reduced. |
c. | Modern tradeoff theory predicts that a company’s optimal debt level is set by trading off the tax benefits of leverage against the agency costs of increased debt. |
d. | Debt is used more frequently abroad (e.g. in Germany and the UK), as international laws tend to favour debtors. |
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
Exhibit 13-1
An all-equity company has 80 000 shares outstanding worth $20 each. The company is considering a project requiring an investment of $500 000 and has an NPV of $30 000. The company is also considering financing this project with a new issue of equity.
67. Refer to Exhibit 13-1. To ensure that existing shareholders are indifferent to whether the company takes on this project with the equity financing, at what price does the company need to issue the new shares?
a. | $18.44 |
b. | $18.87 |
c. | $19.71 |
d. | $20.00 |
Old company value = 20 × 80 000 = 1 600 000
New value of the company = Old company value + New assets + NPV of project
New value of the company = 1 600 000 + 500 000 + 30 000 = 2 130 000
2 130 000 = 1 600 000 + $20 × x
x = 26 500 shares
$500 000 needed/26 500 shares = $18.87
PTS: 1 DIF: H
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
68. Refer to Exhibit 13-1. To ensure that existing shareholders capture the full benefit associated with the new project, at what price does the company need to issue the new shares?
a. | $20.48 |
b. | $20.38 |
c. | $20.15 |
d. | $20.07 |
Old company value = 20 × 80 000 = 1 600 000
New value of the company = Old company value + New assets + NPV of project
New value of the company = 1 600 000 + 500 000 + 30 000 = 2 130 000
$30 000 in NPV ===> Shareholders capture $30 000/80 000 = $0.375 per shareholder
Issue at $20.375 ===> $20.38
PTS: 1 DIF: H
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
69. One method to prevent or reduce the chance that corporate management will harm bondholders to the benefit of shareholders is to:
a. | require that key executives own a certain percentage of the company’s outstanding shares |
b. | require that key executives own a certain percentage of the company’s outstanding bonds |
c. | write detailed covenants into bond contracts |
d. | write detailed covenants into shares contracts |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
Use the following information to answer questions 70 to 74.
70. A graphical representation of the tradeoff model is shown with various components labelled. Which of the following corresponds to line 1?
a. | Present value of interest tax shields on debt |
b. | Present value of expected bankruptcy and agency costs |
c. | Value of levered company with bankruptcy costs |
d. | Value of levered company in the absence of bankruptcy and agency costs |
e. | Value of company under all-equity financing |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
71. A graphical representation of the tradeoff model is shown with various components labelled. Which of the following corresponds to line 2?
a. | Present value of interest tax shields on debt |
b. | Present value of expected bankruptcy and agency costs |
c. | Value of levered company with bankruptcy costs |
d. | Value of levered company in the absence of bankruptcy and agency costs |
e. | Value of company under all-equity financing |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
72. A graphical representation of the tradeoff model is shown with various components labelled. Which of the following corresponds to line 3?
a. | Present value of interest tax shields on debt |
b. | Present value of expected bankruptcy and agency costs |
c. | Value of levered company with bankruptcy costs |
d. | Value of levered company in the absence of bankruptcy and agency costs |
e. | Value of company under all-equity financing |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
73. A graphical representation of the tradeoff model is shown with various components labelled. Which of the following corresponds to line 4?
a. | Present value of interest tax shields on debt |
b. | Present value of expected bankruptcy and agency costs |
c. | Value of levered company with bankruptcy costs |
d. | Value of levered company in the absence of bankruptcy and agency costs |
e. | Value of company under all-equity financing |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
74. A graphical representation of the tradeoff model is shown with various components labelled. Which of the following corresponds to line 5?
a. | Present value of interest tax shields on debt |
b. | Present value of expected bankruptcy and agency costs |
c. | Value of levered company with bankruptcy costs |
d. | Value of levered company in the absence of bankruptcy and agency costs |
e. | Value of company under all-equity financing |
REF: 13.4 The Tradeoff Model of Capital Structure NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
75. Roxy, Inc. has EBIT of $2 million for the current year. The company has $5 million of debt outstanding with a coupon rate of 8%. Investors require a return of 15% on the company, and the company has a corporate tax rate of 40%. What is the present value of the company’s tax shields?
a. | $2 000 000 |
b. | $400 000 |
c. | $800 000 |
d. | $750 000 |
PV of tax shield = 5 000 000 × 0.40 = 2 000 000
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
76. Emma, Inc. has EBIT of $875 000 for the current year. The company has $350 000 of debt outstanding with a coupon rate of 7%. Investors require a return of 15% on the company, and the company has a corporate tax rate of 40%. What is the present value of the company’s tax shields?
a. | $24 500 |
b. | $350 000 |
c. | $140 000 |
d. | $52 500 |
PV of tax shield = 350 000 × 0.40 = 140 000
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
77. Louis Corporation finances its operations with $80 million in share and $30 million in bonds. If the company issues $20 million in additional bonds and uses the proceeds to retire $20 million worth of equity, what will be the company’s new debt-to-equity ratio? (Assume zero taxes and perfect capital markets.)
a. | 0.75 |
b. | 0.60 |
c. | 0.63 |
d. | 0.83 |
Debt total = 30 + 20 = 50
Equity = 80 – 20 = 60
D/E = 0.83
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
78. Roxy International has EBIT of $25 million, debt with a market value of $40 million and a required return on assets of 15%. Assuming no taxes, what is the company’s value?
a. | $166 666 667 |
b. | $266 666 667 |
c. | $291 666 667 |
d. | $100 000 000 |
25/0.15 + 40(0) = 166 666 667
PTS: 1 DIF: E
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
79. Roxy International has EBIT of $15 000, debt with a market value of $25 000 and a required return on assets of 12%. Assuming a corporate tax rate of 40%, what is company’s value?
a. | $266 666 667 |
b. | $182 666 667 |
c. | $106 666 667 |
d. | $100 000 000 |
25/0.15 + 40(0.4) = 182 666 667
PTS: 1 DIF: E
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
80. Emma International has EBIT of $35 million, debt with a market value of $30 million and a required return on assets of 13%. Assuming no taxes, what is the company’s value?
a. | $269 230 769 |
b. | $230 769 231 |
c. | $265 769 231 |
d. | $161 538 462 |
35/0.13+ 30(0) = 269 230 769
PTS: 1 DIF: E
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
81. Emma International has EBIT of $35 million, debt with a market value of $30 million and a required return on assets of 13%. Assuming a corporate tax rate of 40%, what is company’s value?
a. | $230 769 231 |
b. | $281 230 769 |
c. | $92 307 692 |
d. | –$38 461 538 |
35/0.13 + 30(0.4) = 281 230 769
PTS: 1 DIF: E
REF: 13.3 The M&M Capital Structure Model with Taxes NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
SHORT ANSWER
1. What is a recapitalisation?
PTS: 1 DIF: E
REF: 13.1 What Is Financial Leverage and What Are its Effects?
2. What are the important direct and indirect costs of insolvency?
PTS: 1 DIF: E
REF: 13.4 The Tradeoff Model of Capital Structure
3. Distinguish between a business risk and financial risk.
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions
4. According to Modigliani and Miller Propositions, does a company’s capital structure matter?
PTS: 1 DIF: E
REF: 13.2 The Modigliani & Miller Propositions
5. What is the pecking-order theory?
PTS: 1 DIF: E
REF: 13.5 The Pecking-Order Theory
6. Briefly describe financial risk.
PTS: 1 DIF: E
REF: 13.2 The Modigliani and Miller Propositions