Question 1

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

Accepted Answer

A) True 
 B)False

Question 2

The Miller model begins with the MM model with corporate taxes and then adds personal taxes.

Accepted Answer

A) True 
 B)False

Question 3

The Anson Jackson Court Company (AJC)  currently has $200,000 market value (and book value)  of perpetual debt outstanding carrying a coupon rate of 6%. Its earnings before interest and taxes (EBIT)  are $100,000, and it is a zero growth company. AJC's current cost of equity is 8.8%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00.
-Refer to the data for the Anson Jackson Court Company (AJC) . Now assume that AJC is considering changing from its original capital structure to a new capital structure that results in a stock price of $64 per share. The resulting capital structure would have a $336,000 total market value of equity and a $504,000 market value of debt. How many shares would AJC repurchase in the recapitalization?

Accepted Answer

A)   4,250
B)   4,500
C)   4,750
D)   5,000
E)   5,250F) A) and B)
G) A) and C)

Question 4

Hernandez Corporation expects to have the following data during the coming year. What is Hernandez's expected ROE?
  Assets $200,000 Interest rate 8% D/A 65% Tax rate 40% EBIT $25,000\begin{array}{l}\begin{array}{lc}	ext { Assets } & \$ 200,000 	ext { Interest rate } &8\%\	ext { D/A } & 65 \% 	ext { Tax rate } &40\%\	ext { EBIT } & \$ 25,000\end{array}\\end{array} Assets  D/A  EBIT ​$200,000 Interest rate 65% Tax rate $25,000​8%40%​​

Accepted Answer

A)   12.51%
B)   13.14%
C)   13.80%
D)   14.49%
E)   15.21% F) A) and B)
G) A) and C)

Question 5

Pennewell Publishing Inc. (PP)  is a zero growth company. It currently has zero debt and its earnings before interest and taxes (EBIT)  are $80,000. PP's current cost of equity is 10%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $48.00.
-Refer to the data for Pennewell Publishing Inc. (PP) . Assume that PP is considering changing from its original capital structure to a new capital structure with 35% debt and 65% equity. This results in a weighted average cost of capital equal to 9.4% and a new value of operations of $510,638. Assume PP raises $178,723 in new debt and purchases T-bills to hold until it makes the stock repurchase. PP then sells the T-bills and uses the proceeds to repurchase stock. How many shares remain after the repurchase, and what is the stock price per share immediately after the repurchase?

Accepted Answer

A)   7,500; $71.49
B)   7,000; $59.57
C)   6,500; $51.06
D)   6,649; $53.33
E)   6,959; $58.78F) A) and B)
G) A) and C)

Question 6

Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.

Accepted Answer

A) True 
 B)False  False

Question 7

A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.

Accepted Answer

A) True 
 B)False

Question 8

Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Accepted Answer

A)   the costs that would be incurred in the event of bankruptcy increase.
B)   management believes that the firm's stock has become overvalued.
C)   its degree of operating leverage increases.
D)   the corporate tax rate increases.
E)   its sales become less stable over time.F) A) and B)
G) A) and D)

Question 9

Which of the following statements is CORRECT?As a firm increases the operating leverage used to produce a given quantity of output, this will

Accepted Answer

A)   normally lead to a decrease in its business risk.
B)   normally lead to a decrease in the standard deviation of its expected ebit.
C)   normally lead to a decrease in the variability of its expected eps.
D)   normally lead to a reduction in its fixed assets turnover ratio.
E)   normally lead to an increase in its fixed assets turnover ratio.F) A) and D)
G) C) and E)

Question 10

The MM model is the same as the Miller model, but with zero corporate taxes.

Accepted Answer

A) True 
 B)False

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A)   the factors that affect a firm's business risk are affected by industry characteristics and economic conditions. unfortunately, these factors are generally beyond the control of the firm's management.
B)   one of the benefits to a firm of being at or near its target capital structure is that this eliminates any risk of bankruptcy.
C)   a firm's financial risk can be minimized by diversification.
D)   the amount of debt in its capital structure can under no circumstances affect a company's business risk.
E)   a firm's business risk is determined solely by the financial characteristics of its industry.F) C) and E)
G) A) and B)

Question 12

Best Bagels, Inc. (BB)  currently has zero debt. Its earnings before interest and taxes (EBIT)  are $100,000, and it is a zero growth company. BB's current cost of equity is 13%, and its tax rate is 40%. The firm has 20,000 shares of common stock outstanding selling at a price per share of $23.08.
-Refer to the data for Best Bagels, Inc. (BB) . Now assume that BB is considering changing from its original capital structure to a new capital structure with 45% debt and 55% equity. This results in a weighted average cost of capital equal to 10.4% and a new value of operations of $576,923. Assume BB raises $259,615 in new debt and purchases T-bills to hold until it makes the stock repurchase. BB then sells the T-bills and uses the proceeds to repurchase stock. How many shares remain after the repurchase, and what is the stock price per share immediately after the repurchase?

Accepted Answer

A)   11,001; $28.85
B)   12,711; $35.62
C)   13,901; $42.57
D)   15,220; $54.31
E)   17,105; $89.67F) A) and E)
G) B) and D)

Question 13

Daylight Solutions is considering a recapitalization that would increase its debt ratio and increase its interest expense. The company would issue new bonds and use the proceeds to buy back shares of its common stock. The company's CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share (EPS) . Assuming the CFO's estimates are correct, which of the following statements is CORRECT?

Accepted Answer

A)   if the plan reduces the wacc, the stock price is also likely to decline.
B)   since the plan is expected to increase eps, this implies that net income is also expected to increase.
C)   if the plan does increase the eps, the stock price will automatically increase at the same rate.
D)   under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds.
E)   since the proposed plan increases daylight's financial risk, the company's stock price still might fall even if eps increases.F) A) and D)
G) None of the above

Question 14

Which of the following statements is CORRECT?

Accepted Answer

A)   a change in the personal tax rate should not affect firms' capital structure decisions.
B)   "business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage.
C)   the optimal capital structure is the one that simultaneously (1)  maximizes the price of the firm's stock, (2)  minimizes its wacc, and (3)  maximizes its eps.
D)   if changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation.
E)   if corporate tax rates were decreased while other things were held constant, and if the modigliani-miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.F) B) and E)
G) A) and B)

Question 15

A new company to produce state-of-the-art car stereo systems is being considered by Jagger Enterprises. The sales price would be set at 1.5 times the variable cost per unit; the VC/unit is estimated to be $2.50; and fixed costs are estimated at $120,000. What sales volume would be required in order to break even, i.e., to have an EBIT of zero for the stereo business?

Accepted Answer

A)   86,640
B)   91,200
C)   96,000
D)   100,800
E)   105,840F) None of the above
G) B) and E) C

Question 16

Two operationally similar companies, HD and LD, have the same total assets, operating income (EBIT) , tax rate, and business risk. Company HD, however, has a much higher debt ratio than LD. Also HD's return on invested capital (ROIC)  exceeds its after-tax cost of debt, (1-T) rd. Which of the following statements is CORRECT?

Accepted Answer

A)   hd should have a higher times interest earned (tie)  ratio than ld.
B)   hd should have a higher return on equity (roe)  than ld, but its risk, as measured by the standard deviation of roe, should also be higher than ld's.
C)   given that roic > (1-t)  rd, hd's stock price must exceed that of ld.
D)   given that roic > (1-t)  rd, ld's stock price must exceed that of hd.
E)   hd should have a higher return on assets (roa)  than ld.F) C) and D)
G) A) and B)

Question 17

The major contribution of the Miller model is that it demonstrates that

Accepted Answer

A)   personal taxes decrease the value of using corporate debt.
B)   financial distress and agency costs reduce the value of using corporate debt.
C)   equity costs increase with financial leverage.
D)   debt costs increase with financial leverage.
E)   personal taxes increase the value of using corporate debt.F) A) and C)
G) C) and E)

Question 18

Barette Consulting currently has no debt in its capital structure, has $500 million of total assets, and its basic earning power is 15%. The CFO is contemplating a recapitalization where it will issue debt at a cost of 10% and use the proceeds to buy back shares of the company's common stock, paying book value. If the company proceeds with the recapitalization, its operating income, total assets, and tax rate will remain unchanged. Which of the following is most likely to occur as a result of the recapitalization?

Accepted Answer

A)   the roa would remain unchanged.
B)   the basic earning power ratio would decline.
C)   the basic earning power ratio would increase.
D)   the roe would increase.
E)   the roa would increase.F) C) and D)
G) A) and E)

Question 19

Which of the following statements is CORRECT?

Accepted Answer

A)   the capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share.
B)   all else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio.
C)   since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its wacc.
D)   since debt is cheaper than equity, increasing a company's debt ratio will always reduce its wacc.
E)   when a company increases its debt ratio, the costs of equity and debt both increase. therefore, the wacc must also increase.F) C) and E)
G) A) and B)

Question 20

Which of the following statements is CORRECT, holding other things constant?

Accepted Answer

A)   an increase in the personal tax rate is likely to increase the debt ratio of the average corporation.
B)   if changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation.
C)   an increase in the company's degree of operating leverage is likely to encourage a company to use more debt in its capital structure.
D)   an increase in the corporate tax rate is likely to encourage a company to use more debt in its capital structure.
E)   firms whose assets are relatively liquid tend to have relatively low bankruptcy costs, hence they tend to use relatively little debt.F) A) and D)
G) A) and C) D

Exam 16: Capital Structure Decisions

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

Correct Answer
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The Miller model begins with the MM model with corporate taxes and then adds personal taxes.

Correct Answer
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Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.

Correct Answer
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False

A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.

Correct Answer
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Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Correct Answer
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Which of the following statements is CORRECT?As a firm increases the operating leverage used to produce a given quantity of output, this will

Correct Answer
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The MM model is the same as the Miller model, but with zero corporate taxes.

Correct Answer
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Which of the following statements is CORRECT?

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Which of the following statements is CORRECT?

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C

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The major contribution of the Miller model is that it demonstrates that

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Which of the following statements is CORRECT?

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Which of the following statements is CORRECT, holding other things constant?

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D

Exam 16: Capital Structure Decisions

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

Correct AnswerverifiedShow Answer

The Miller model begins with the MM model with corporate taxes and then adds personal taxes.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.

Correct AnswerverifiedFalse

A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.

Correct AnswerverifiedShow Answer

Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?As a firm increases the operating leverage used to produce a given quantity of output, this will

Correct AnswerverifiedShow Answer

The MM model is the same as the Miller model, but with zero corporate taxes.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

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Correct AnswerverifiedC

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The major contribution of the Miller model is that it demonstrates that

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

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Which of the following statements is CORRECT, holding other things constant?

Correct AnswerverifiedD

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False

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C

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D