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Managerial Finance ? Problem Review Set ? Capital Structure and Leverage




Question;Managerial Finance ? Problem Review Set;? Capital Structure and Leverage;1);If a firm utilizes debt financing;an X% decline in earnings before interest and taxes (EBIT) will result in a;decline in earnings per share that is larger than X.;a.;True;b.;False;2);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.;a.;True;b.;False;3);It is possible that two firms;could have identical financial and operating leverage, yet have different;degrees of risk as measured by the variability of EPS.;a.;True;b.;False;4);Which of the following events is;likely to encourage a company to raise its target debt ratio, other things;held constant?;a.;An increase in the corporate tax;rate.;b.;An increase in the personal tax;rate.;c.;An increase in the company?s;operating leverage.;d.;The Federal Reserve tightens;interest rates in an effort to fight inflation.;e.;The company's stock price hits a;new high.;5);The firm?s target capital;structure should be consistent with which of the following statements?;a.;Maximize the earnings per share;(EPS).;b.;Minimize the cost of debt (rd).;c.;Obtain the highest possible bond;rating.;d.;Minimize the cost of equity (rs).;e.;Minimize the weighted average cost;of capital (WACC).;6);Which of the following statements;is CORRECT? As a firm increases;the operating leverage used to produce a given quantity of output, this will;a.;normally lead to an increase in;its fixed assets turnover ratio.;b.;normally lead to a decrease in its;business risk.;c.;normally lead to a decrease in the;standard deviation of its expected EBIT.;d.;normally lead to a decrease in the;variability of its expected EPS.;e.;normally lead to a reduction in;its fixed assets turnover ratio.;7);Reynolds;Resorts is currently 100% equity financed.;The CFO is considering a recapitalization plan under which the firm;would issue long-term debt with a yield of 9% and use the proceeds to;repurchase common stock. The;recapitalization would not change the company?s total assets, nor would it;affect the firm?s basic earning power, which is currently 15%. The CFO believes that this recapitalization;would reduce the WACC and increase stock price. Which of the following would also be likely;to occur if the company goes ahead with the recapitalization plan?;a.;The company?s net income would;increase.;b.;The company?s earnings per share;would decline.;c.;The company?s cost of equity would;increase.;d.;The company?s ROA would increase.;e.;The company?s ROE would decline.;8);Vu Enterprises expects to have the;following data during the coming year.;What is Vu's expected ROE?;Assets;$200,000;Interest rate;8%;D/A;65%;Tax rate;40%;EBIT;$25,000;a.;12.51%;b.;13.14%;c.;13.80%;d.;14.49%;e.;15.21%;9);Ang Enterprises;has a levered beta of 1.10, its capital structure consists of 40% debt and;60% equity, and its tax rate is 40%.;What would Ang's beta be if it used no debt, i.e., what is its;unlevered beta?;a.;0.64;b.;0.67;c.;0.71;d.;0.75;e.;0.79;10);Firms HD and LD are identical;except for their level of debt and the interest rates they pay on debt--HD;has more debt and pays a higher interest rate on that debt. Based on the data given below, what is the;difference between the two firms' ROEs?;Applicable to Both;Firms;Firm HD's Data;Firm LD's Data;Assets;$200;Debt ratio;50%;Debt ratio;30%;EBIT;$40;Interest rate;12%;Interest rate;10%;Tax rate;35%;a.;2.18%;b.;2.29%;c.;2.41%;d.;2.54%;e.;2.66%;11);Michaely Inc. is an all-equity;firm with 200,000 shares outstanding.;It has $2,000,000 of EBIT, which is expected to remain constant in the;future. The company pays out all of its;earnings, so earnings per share (EPS) equal dividends per shares (DPS). Its tax rate is 40%.;The company is considering issuing;$5,000,000 of 10.0% bonds and using the proceeds to repurchase stock. The risk-free rate is 6.5%, the market risk;premium is 5.0%, and the beta is currently 0.90, but the CFO believes beta;would rise to 1.10 if the recapitalization occurs.;Assuming that the shares can be;repurchased at the price that existed prior to the recapitalization, what;would the price be following the recapitalization?;a.;$65.77;b.;$69.23;c.;$72.69;d.;$76.33;e.;$80.14;12);The MM model is the same as the Miller;model, but with zero corporate taxes.;a. True;b. False;13);The major contribution of the Miller;model is that it demonstrates that;a. personal taxes increase the value of using;corporate debt.;b. personal taxes decrease the value of using;corporate debt.;c. financial distress and agency costs reduce the;value of using corporate debt.;d. equity costs increase with financial leverage.;e. debt costs increase with financial leverage.;14);Which of the following statements;concerning capital structure theory is NOT;CORRECT?;a. The major contribution of Miller's theory is;that it demonstrates that personal taxes decrease the value of using corporate;debt.;b. Under MM with zero taxes, financial leverage;has no effect on a firm?s value.;c. Under MM with corporate taxes, the value of a;levered firm exceeds the value of the unlevered firm by the product of the tax;rate times the market value dollar amount of debt.;d. Under MM with corporate taxes, rs;increases with leverage, and this increase exactly offsets the tax benefits of;debt financing.;e. Under MM with corporate taxes, the effect of;business risk is automatically incorporated because rsL is a;function of rsU.;15);The Kimberly Corporation is a zero;growth firm with an expected EBIT of $100,000 and a corporate tax rate of;30%. Kimberly uses $500,000 of 12.0%;debt, and the cost of equity to an unlevered firm in the same risk class is;16.0%.;[i]. What;is the value of the firm according to MM with corporate taxes?;a. $475,875;b. $528,750;c. $587,500;d. $646,250;e. $710,875;[ii]. What is the firm's cost;of equity?;a. 21.0%;b. 23.3%;c. 25.9%;d. 28.8%;e. 32.0%;[iii]. Assume;that the firm's gain from leverage according to the Miller model is;$126,667. If the effective personal tax;rate on stock income is TS = 20%, what is the implied personal tax;rate on debt income?;a. 16.4%;b. 18.2%;c. 20.2%;d. 22.5%;e. 25.0%


Paper#50982 | Written in 18-Jul-2015

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