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Saint MBA570 week 7 quiz (August 15 2014)




Question;1.Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%. The NPV for this project is closest to __________. (Points: 10) $6,250$14,100$10,000$18,600Question 2.2.Which of the following is not one of Modigliani and Miller's sets of conditions referred to as perfect capital markets? (Points: 10) All investors hold the efficient portfolio of assets.There are no taxes, transaction costs, or issuance costs associated with security trading.A firm's financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them.Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows.Question 3.3.Which of the following statements is false? (Points: 10) While debt itself may be cheap, it increases the risk and therefore the cost of capital of the firm's equity.Although debt does not have a lower cost of capital than equity, we can consider this cost in isolation.We can use Modigliani and Miller's first proposition to derive an explicit relationship between leverage and the equity cost of capital.According to Modigliani and Miller, the total market value of the firm's securities is equal to the market value of its assets, whether the firm is unlevered or levered.Question 4.4.Assume that Rose Corporation's (RC) has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00. Following the borrowing of $12 and subsequent share repurchase, the number of shares that RC will have outstanding is closest to __________. (Points: 10) 4.0 million6.0 million4.9 million4.5 millionQuestion 5.5.Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%. Rosewood's net income is closest to __________. (Points: 10) $450 million$179 million$290 million$95 millionQuestion 6.6.Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the foreseeable future. Wyatt's annual interest tax shield is closest to __________. (Points: 10) $2.8 million$4.2 million$7.0 million$40 millionQuestion 7.7.Which of the following statements regarding recapitalizations is false? (Points: 10) With a recapitalization, even though leverage reduces the total value of equity, shareholders capture the benefits of the interest tax shield up front.Some of the original shareholders, those that sell their shares, do not benefit from the interest tax shield involved in a recapitalization.Leveraged recaps were especially popular in the mid- to late-1980s, when many firms found that these transactions could reduce their tax payments.When a firm makes a significant change to its capital structure, the transaction is called a recapitalization.Question 8.8.KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt. KD has had consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares. The present value of KD's interest tax shield is closest to __________. (Points: 10) $130 million$200 million$400 million$70 millionQuestion 9.9.Which of the following statements is false? (Points: 10) The value of a firm is equal to the amount of money the firm can raise by issuing securities.By reducing a firm's corporate tax liability, debt allows the firm to pay more of its cash flows to investors.Equity investors must pay taxes on dividends but not capital gains.For individuals, interest payments received from debt are taxed as income.Question 10.10.Which of the following statements is false? (Points: 10) A biotech firm might be developing drugs with tremendous potential, but it has yet to receive any revenue from these drugs. Such a firm will not have taxable earnings. In that case, a tax-optimal capital structure does not include debt.No corporate tax benefit arises from incurring interest payments that regularly exceed EBIT.The optimal level of leverage from a tax saving perspective is the level such that interest equals EBIT.In general, as a firm's interest expense approaches its expected taxable earnings, the marginal tax advantage of debt increases, limiting the amount of equity the firm should use.


Paper#49027 | Written in 18-Jul-2015

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