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A firm has a weighted average cost of capital of 11.28 percent and a cost of equity of 14.7 percent.
The debt-equity ratio is .72. There are no taxes. What is the firm's cost of debt?
 
6.44 percent
6.27 percent
7.08 percent
6.53 percent
7.23 percent
 
WACC = debt*cost of debt + equity*cost of equity
1.72 * 11.28 = 0.72* cost of debt + 14.7
cost of debt = 6.53%
   
According to M&M Proposition I with taxes, the value of a levered firm will increase when the:
 
debt-equity ratio is lowered.
interest rate on the debt is lowered.
value of the unlevered firm increases
tax rate is decreased.
interest rate on the debt is increased.
   
Which one of the following states that a firm’s cost of equity capital is a positive linear function of the
firm’s capital structure?
 
M&M Proposition II without taxes
Homemade leverage theory
M&M Proposition I with taxes
M&M Proposition I without taxes
Static theory of capital structure
   
Taunton's is an all-equity firm that has 160,000 shares of stock outstanding. Neal, the financial vice
president, is considering borrowing $275,000 at 7.45 percent interest to repurchase 25,000 shares.
Ignoring taxes, what is the current value of the firm?
 
$1,760,000
$1,260,000
$1,485,000
$1,520,000
$1,800,000
 
Share price:
= $275,000/25,000
= $11 per share
Current value of firm:
= $11×160,000 shares
= $1,760,000
   
The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as:
 
A. M& M Proposition I.
B. capital restructuring.
C. homemade leverage.
D. M& M Proposition II.
E. financial risk management
 
Which one of the following statements matches M& M Proposition I without taxes?
 
A. The cost of equity capital has a positive linear relationship with a firm's capital structure.
B. The dividends paid by a firm determine the firm's value.
C. The cost of equity capital varies in response to changes in a firm's capital structure.
D. The value of a firm is independent of the firm's capital structure.
E. The value of a firm is dependent on the firm's capital structure
   
Which one of the following states that a firms cost of equity capital is a positive linear function of the firm' s
capital structure?
 
A. Static theory of capital structure
B. M& M Proposition I without taxes
C. M& M Proposition II without taxes
D. Homemade leverage theory
E. M& M Proposition I with taxes
M & M Proposition II without taxes
 
Which one of the following is the equity risk arising from the daily operations of a firm?
 
A. Strategic risk
B. Financial risk
C. Liquidity risk
D. Industry risk
E. Business risk
Business risk
 
Which one of the following is the equity risk arising from the capital structure selected by a firm?
 
A. Strategic risk
B. Financial risk
C. Liquidity risk
D. Industry risk
E. Business risk
Financial risk
   
Which one of the following will generally receive the highest priority in a bankruptcy liquidation,
assuming the absolute priority rule is followed?
 
Employee wages
Bankruptcy administrative expenses
Contributions to employee retirement plans
Claims by unsecured creditors
Government tax claims
   
A firm is considering two different capital structures. The first option is an all-equity firm with 40,000
shares of stock. The second option is 28,000 shares of stock plus some debt. Ignoring taxes, the break-even
level of earnings before interest and taxes between these two options is $52,000. How much money is the
firm considering borrowing if the interest rate is 9 percent?
 
$173,333
$216,667
$175,000
$208,333
$225,000
 
Let the debt be x
EPS = (EBIT-Interest)/Number of Shares
52000/40000 = (52000-0.09 x)/28000
or (52000-0.09 x) = 36400
or 0.09 x = 52000-36400
or x = 15600/0.09
x = 173333
   
Which one of the following terms is inclusive of both direct and indirect bankruptcy costs?
 
Financial leverage
Financial distress costs
Cost of capital
Homemade leverage
Capital structure costs
   
The use of borrowing by an individual to adjust his or her overall
exposure to financial leverage is referred to as:
 
A. M& M Proposition I.
B. capital restructuring.
C. homemade leverage.
D. M& M Proposition II.
E. financial risk management
   
Which one of the following statements matches M& M Proposition I without taxes?
 
A. The cost of equity capital has a positive linear relationship with a firm's capital structure.
B. The dividends paid by a firm determine the firm's value.
C. The cost of equity capital varies in response to changes in a firm's capital structure.
D. The value of a firm is independent of the firm's capital structure.
E. The value of a firm is dependent on the firm's capital structure
   
Which one of the following states that a firm’s cost of equity capital is a positive linear function of
the firm' s capital structure?
 
A. Static theory of capital structure
B. M& M Proposition I without taxes
C. M& M Proposition II without taxes
D. Homemade leverage theory
E. M& M Proposition I with taxes
   
Which one of the following is the equity risk arising from the daily operations of a firm?
 
A. Strategic risk
B. Financial risk
C. Liquidity risk
D. Industry risk
E. Business risk
   
Which one of the following is the equity risk arising from the capital structure selected by a firm?
 
A. Strategic risk
B. Financial risk
C. Liquidity risk
D. Industry risk
E. Business risk
   
Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship?
 
A. Static theory of interest rates
B. M& M Proposition I
C. Financial risk
D. Interest tax shield
E. Homemade leverage
   
Which one of the following is a direct bankruptcy cost?
 
A. Loss of customer goodwill resulting from a bankruptcy filing
B. Legal and accounting fees related to a bankruptcy proceeding
C. Management time spent on a bankruptcy proceeding
D. Any financial distress cost
E. Costs a firm spends trying to avoid bankruptcy
   
Which one of the following terms applies to the costs incurred by a firm that is trying to avoid filing for bankruptcy?
 
A. Indirect bankruptcy costs
B. Direct bankruptcy costs
C. Static theory cost
D. Optimal capital structure cost
E. Reorganization costs
   
Which one of the following terms is inclusive of both direct and indirect bankruptcy costs?
 
A. Financial distress costs
B. Capital structure costs
C. Financial leverage
D. Homemade leverage
E. Cost of capital
financial distress costs
   
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
   
Which one of the following best defines legal bankruptcy?
 
A. Negotiating new payment terms with a firm's creditors
B. A temporary technical insolvency
C. A legal proceeding for liquidating or reorganizing a business
D. The internal process of revising the capital structure of a firm
E. The failure of a firm to meet its financial obligations in a timely manner
   
Which one of the following terms refers to the termination of a firm as a going concern?
 
A. Insolvency
B. Reorganization
C. Chapter 11 bankruptcy
D. Prepack
E. Liquidation
   
Greenwood Motels has filed a petition for bankruptcy but hopes to continue its operations both during and after
the bankruptcy process. Which one of the following terms best applies to this situation?
 
A. Chapter 7 bankruptcy
B. Liquidation
C. Technical insolvency
D. Accounting insolvency
E. Reorganization
  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
   
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
   
Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered.
Which one of the following statements is correct regarding these two firms?
 
A. The levered firm has higher EPS (earnings per share) than the unlevered firm at the break-even point.
B. The levered firm will have higher EPS than the unlevered firm at all levels of EBIT.
C. The unlevered firm will have higher EPS than the levered firm at relatively high levels of EBIT.
D. The EPS for the unlevered firm will always exceed those of the levered firm.
E. The unlevered firm will have higher EPS at relatively low levels of EBIT
   
Which one of the following statements concerning financial leverage is correct?
 
A. Financial leverage increases profits and decreases losses.
B. Financial leverage has no effect on a firm's return on equity.
C. Financial leverage refers to the use of common stock.
D. Financial leverage magnifies both profits and losses.
E. Increasing financial leverage will always decrease the earnings per share
   
You are comparing two possible capital structures for a firm. The first option is an all-equity firm.
The second option involves the use of $3.8 million of debt.
The break-even point between these two financing options occurs when the earnings before interest and
taxes (EBIT) are $428,000. Given this, you know that leverage is beneficial to the firm:
 
A. whenever EBIT is less than $428,000.
B. only when EBIT is $428,000.
C. whenever EBIT exceeds $428,000.
D. only if the debt is decreased by $428,000.
E. only if the debt is increased by $428,000
   
Which one of the following statements concerning financial leverage is correct?
 
A. The benefits of leverage are unaffected by the amount of a firm's earnings.
B. The use of leverage will always increase a firm's earnings per share.
C. The shareholders of a firm are exposed to less risk anytime a firm uses financial leverage.
D. Changes in the capital structure of a firm will generally change the firm's earnings per share.
E. Financial leverage is beneficial to a firm only when the firm has negative earnings
   
T.L.C. Enterprises just revised its capital structure from a debt-equity ratio of .37 to a debt-equity ratio of .48. 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
   
Which one of the following statements is the core principle of M&M Proposition I, without taxes?
 
A. A firm's cost of equity is directly related to the firm's debt-equity ratio.
B. A firm's WACC is directly related to the firm's debt-equity ratio.
C. The interest tax shield increases the value of a firm.
D. The capital structure of a firm is totally irrelevant.
E. Levered firms have greater value than unlevered firms
   
Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases?
 
A. M&M Proposition I without taxes
B. M&M Proposition II without taxes
C. M& M Proposition I with taxes
D. Static theory of capital structure
E. No theory suggests this
   
Which one of the following is an implication of M&M Proposition II without taxes?
 
A. A firm's optimal capital structure is 100 percent debt.
B. WACC is unaffected by the capital structure of a firm.
C. WACC decreases as the debt-equity ratio increases.
D. A firm's capital structure is irrelevant.
E. The risk of equity is affected by both financial and operating leverage
   
M& M Proposition II, without taxes, states that the:
 
A. capital structure of a firm is highly relevant.
B. weighted average cost of capital decreases as the debt-equity ratio decreases.
C. cost of equity increases as a firm increases its debt-equity ratio.
D. return on equity is equal to the return on assets multiplied by the debt-equity ratio.
E. return on equity remains constant as the debt-equity ratio increases.
   
The level of financial risk to which a firm is exposed is dependent on the firm's:
 
A. tax rate.
B. debt-equity ratio.
C. return on assets.
D. level of earnings before interest and taxes.
E. operational level of risk
   
Which one of the following represents the present value of the interest tax shield?
 
A. D × (1 -Tc)
B. D (1 -Tc)
C. D / Tc
D. D-D (Tc)
E. Tc × D
   
According to M& M Proposition I with taxes, the value of a levered firm will increase when the:
 
A. value of the unlevered firm increases.
B. tax rate is decreased.
C. debt-equity ratio is lowered.
D. interest rate on the debt is lowered.
E. interest rate on the debt is increased.
   
M&M Proposition I with taxes states that:
 
A. the optimal capital structure is the all-equity option.
B. the levered value of a firm exceeds the firm's unlevered value.
C. a firm's capital structure is irrelevant.
D. the value of a firm is independent of taxes.
E. WACC remains constant given any debt-equity ratio
   
Which one of the following is an example of a direct bankruptcy cost?
 
A. Operating at a debt-equity ratio that is less than the optimal ratio
B. Reducing the dividend payout ratio as a means of increasing a firm's equity
C. Forgoing a positive net present value project to conserve current cash
D. Incurring legal fees for the preparation of bankruptcy filings
E. Losing a key customer due to concerns over a firm's financial viability
   
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 and operations.
D. pays no taxes.
E. is operating at the point where financial distress costs are eliminated
   
Which one of the following conditions exists at the point where a firm maximizes its value?
 
A. The tax benefit from an additional dollar of debt is zero.
B. Financial distress costs are equal to zero.
C. The debt-equity ratio is 1.0.
D. WACC is minimized.
E. The cost of equity is minimized
   
Which one of the following statements related to the static theory of capital structure is correct?
 
A. A firm begins to lose value as soon as the first dollar of debt is incurred.
B. The actual value of a firm continually rises in direct proportion to the increased use of debt.
C. The linear function of a firm's value has a constant positive slope.
D. A firm's value is maximized when a firm operates at its optimal debt level.
E. The value of a firm will automatically decrease whenever the
debt-equity ratio is decreased
   
Which one of the following is correct based on the static theory of capital structure?
 
A. A firm receives the greatest benefit from debt financing when its tax rate is relatively low.
B. A debt-equity ratio of 1 is considered to be the optimal capital structure.
C. The costs of financial distress decrease the value of a firm.
D. The more debt a firm assumes, the greater the incentive with 100 percent debt.
E. At the optimal level of debt a firm also optimizes its tax shield on debt.
The costs of financial distress decrease the value of a firm.
   
Assume both corporate taxes and financial distress costs apply to a firm.
Given this, the static theory of capital structure illustrates that:
 
A. a firm's value and its weighted average cost of capital are inversely related.
B. a firm's value and its tax rate are inversely related.
C. the maximum value of a firm is obtained when a firm is financed solely with debt.
D. the value of a firm rises as the interest rate on debt rises.
E. the value of a firm rises as both the interest rate on debt and the tax rate rise.
   
When is a firm insolvent from an accounting perspective?
 
A. When the firm is unable to meet its financial obligations in a timely manner
B. When the firm's debt exceeds the value of the firm's equity
C. When the firm has a negative net worth
D. When the firm's revenues cease
E. When the market value of the firm's equity equals zero
   
Peter's Tools recently defaulted on a bank loan. To avoid a bankruptcy proceeding, the bank agreed to a composition.
This composition would do which one of the following?
 
A. Forgive the loan payment in its entirety
B. Extend the due date on the missed loan payment
C. Reduce the amount of the loan payments so Peter's can pay on time
D. Transfer some of Peter's assets to the bank in lieu of the loan payment
E. Transfer all the equity shares in Peter’s to the lending bank
   
Which one of the following will generally receive the highest priority in a bankruptcy liquidation,
assuming the absolute priority rule is followed?
 
A. Claims by unsecured creditors
B. Employee wages
C. Government tax claims
D. Contributions to employee retirement plans
E. Bankruptcy administrative expenses
   
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
   
Which statement is true?
 
A. A prepack is a plan of liquidation used to distribute a firm's assets.
B. Bankruptcy courts have "cram-down" powers.
C. The absolute priority rule must be strictly followed in all bankruptcy proceedings.
D. Creditors cannot force a firm into bankruptcy even though they might like to do so.
E. A reorganization plan can be approved only if the firm's creditors all agree with the plan.
   
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.
   
Which one of the following statements is correct regarding bankruptcies post-2005?
 
A. All Chapter 7 bankruptcy filings must include a "workout" agreement.
B. Firms must remain in bankruptcy for at least 18 months.
C. Key employee retention plans are no longer permitted under any
circumstances.
D. Labor contracts cannot be modified through the bankruptcy process.
E. Section 363 speeds up the bankruptcy process via a bidding process.
   
Holiday Decor is an all-equity firm with a total market value of $347,000 and12,000 shares of stock outstanding.
Management is considering issuing $48,000 of debt at an interest rate of 7 percent and using the proceeds on a stock repurchase.
As an all-equity firm, management believes its earnings before interest and taxes (EBIT) will be $33,000 if the economy is normal,
$8,000 if it is in a recession, and $41,000 if the economy booms. Ignore taxes.
What will the EPS be if the economy falls into a recession and the firm maintains its all-equity status?
 
A. $.75
B. $.67
C. $1.21
D. $1.50
E. $1.33
$.67
 
EPSRecession= $8,000/12,000 = $.67
   
Bird Houses is an all-equity firm with a total market value of $388,980 and 18,000 shares of stock outstanding.
Management is considering issuing $68,000 of debt at an interest rate of 6.5 percent and using the
proceeds on a stock repurchase. Ignore taxes. How many shares will the firm repurchase if it issues the debt securities?
(Round the number of shares repurchased down to the nearest whole share.)
 
A. 3,167 shares
B. 3,116 shares
C. 3,021 shares
D. 3,207 shares
E. 3,146 shares
 
Shares repurchased = $68,000/($388,980/18,000) = 3,146 shares
   
Flour Mills is an all-equity firm with a total market value of $891,860. The firm has 38,000 shares of stock outstanding.
Management is considering issuing $275,000 of debt at an interest rate of 7.5 percent and using the proceeds on a stock repurchase.
Ignore taxes. How many shares can the firm repurchase if it issues the debt securities?
(Round the number of shares repurchased down to the nearest whole share.)
 
A. 11,717 shares
B. 11,618 shares
C. 11,647 shares
D. 11,656 shares
E. 11,699 shares
11,717 shares
 
Shares repurchased = $275,000/($891,860/38,000) = 11,717 shares
   
Northern Wood Products is an all-equity firm with 14,000 shares of stock outstanding and a total market value of $585,480.
Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $46,800 if the economy is normal,
$21,200 if the economy is in a recession, and $56,000 if the economy booms. Ignore taxes.
Management is considering issuing $150,000 of debt at a coupon rate of 7 percent. If the firm issues the debt,
the proceeds will be used to repurchase stock. What will the earnings per share be if the debt is issued and the economy is in a recession?
(Round the number of shares repurchased down to the nearest whole share.)
 
A. $.97
B. $1.03
C. $1.36
D. $.88
E. $.68
 
Shares repurchased $150,000/($585,480/14,000) = 3,586 shares
Shares outstanding = 14,000 -3,586 = 10,414 shares
EPSRecession = [$21,200- ($150,000 × .07)]/10,414 = $1.03
   
Cross Town Cookies is an all-equity firm with a total market value of
$4,187,100. The firm has 127,500 shares of stock outstanding. Management
is considering issuing $300,000 of debt at an interest rate of 6 percent
and using the proceeds to repurchase shares. The projected earnings
before interest and taxes are $215,600. What are the anticipated
earnings per share if the debt is issued? Ignore taxes. (Round the
number of shares repurchased down to the nearest whole share.)
 
A. $1.59
B. $1.76
C. $1.38
D. $1.67
E. $1.47
$1.67
 
Shares repurchased = $300,000/($4,187,100/127,500) = 9,135 shares
Shares outstanding = 127,500-9,135 = 118,365 shares
EPS = [$215,600 - ($300,000 ×.06)]/118,365 = $1.67
   
Ernst Electrical has 7,500 shares of stock outstanding and no debt. The new CFO is considering issuing $50,000 of debt and using the
proceeds to retire 600 shares of stock. The coupon rate on the debt is 8.5 percent. What is the break-even level of earnings before
interest and taxes between these two capital structure options?
 
A. $48,360
B. $50,020
C. $49,740
D. $52,500
E. $53,125
 
EPSU= EPSL
EBIT /7,500 = [EBIT - ($50,000 × .085)] / (7,500 - 600)
EBIT = $53,125
   
Northwestern Lumber Products currently has 12,400 shares of stock outstanding and no debt.
Patricia, the financial manager, is considering issuing $160,000 of debt at an interest rate of 6.95 percent and using
the proceeds to repurchase shares. 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 $48,000? Ignore taxes.
 
A. 2,873 shares
B. 3,051 shares
C. 3,025 shares
D. 2,558 shares
E. 2,667 shares
2,873 shares
 
EPSU= EPSL
$48,000 / 12,400 = [$48,000 - ($160,000 × .0695)] / (12,400 - x)
x = 2,873
   
Chick 'N Fish is considering two different capital structures. The first option is an all-equity firm with22,500 shares of stock.
The second option consists of 18,750 shares of stock plus $120,000 of debt at an interest rate of 7.8 percent.
Ignore taxes. What is the break-even level of earnings before interest and taxes (EBIT) between these two options?
 
A. $62,813
B. $54,204
C. $60,410
D. $56,150
E. $61,290
 
EPSU= EPSL
EBIT / 22,500 = [EBIT - ($120,000 × .078)] / 18,750
EBIT = $56,150
   
A firm is considering two different capital structures. The first option is an all-equity firm with 40,000 shares of stock.
The second option is 28,000 shares of stock plus some debt. Ignoring taxes, the break-even level of earnings before interest and
taxes between these two options is $52,000.
How much money is the firm considering borrowing if the interest rate is 9 percent?
 
A. $175,000
B. $173,333
C. $208,333
D. $216,667
E. $225,000
$173,333
 
EPSU= EPSL
$52,000 / 40,000 = [$52,000 - (D × .09)] / 28,000
D = $173,333
   
Room and Board has determined that $41,650 is the break-even level of earnings before interest and taxes for the two capital
structures it is considering. The one structure consists of all equity with 15,500 shares of stock. The second structure consists of
12,500 shares of stock and $65,000 of debt. What is the interest rate on the debt?
 
A. 7.72 percent
B. 8.19 percent
C. 9.38 percent
D. 11.55 percent
E. 12.40 percent
 
EPSU= EPSL
$41,650 / 15,500 = [$41,650 - ($65,000× r)] / 12,500
r = 12.40 percent
   
Shoe Box Stores is currently an all-equity firm with 25,000 shares of stock outstanding.
Management is considering changing the capital structure to 35 percent debt. The interest rate on the debt would be 8
percent. Ignore taxes. Jamie owns 600 shares of Shoe Box Stores stock that is priced at $22 a share.
What should Jamie do if she prefers the all-equity structure but Shoe Box Stores adopts the new capital structure?
 
A. Borrow money and buy an additional 180 shares
B. Borrow money and buy an additional 210 shares
C. Keep her shares but loan out all of the dividend income at 8 percent
D. Sell 210 shares and loan out the proceeds at 8 percent
E. Sell 180 shares and loan out the proceeds at 8 percent
 
Since the firm is using 35 percent leverage, Jamie can offset the firm's
leverage by selling shares and loaning out 35 percent of her investment
at 8 percent interest.
Number of shares to be sold = 600 shares × .35 = 210 shares
   
Katz is an all-equity development company that has 52,000 shares of stock outstanding at a market price of $32 a share.
The firm's earnings before interest and taxes are $46,000. Katz has decided to issue
$176,000 of debt at a rate of 8 percent and use the proceeds to repurchase shares.
What should Leslie do if she owns 500 shares of Katz stock and wants to use homemade leverage to offset the leverage being
assumed by the firm?
 
A. Borrow money and buy an additional 53 shares
B. Borrow money and buy an additional 56 shares
C. Sell 48 shares and loan out the proceeds
D. Sell 56 shares and loan out the proceeds
E. Sell 53 shares and loan out the proceeds
 
Shares repurchased = $176,000/$32 = 5,500
Value of equity = (52,000 -5,500) ×$32 = $1,488,000
Value of debt = $176,000
Debt ratio = $176,000/($176,000 + 1,488,000) = .1057
Since the firm is using 10.57 percent debt, Leslie will need to reduce
her investment in the firm by 10.57 percent.
Shares to be sold = 500 ×.1057 =53 shares
   
Gabella's is an all-equity firm that has 36,000 shares of stock outstanding at a market price of $27 a share.
The firm has earnings before interest and taxes of $57,600 and has a 100 percent dividend payout ratio. Ignore taxes.
Gabella's has decided to issue $125,000 of debt at a rate of 9 percent and use the proceeds to repurchase shares.
Terry owns 800 shares of Gabella's stock and has decided to continue holding those shares.
How will Gabella's debt issue affect Terry's annual dividend income?
 
A. Decrease from $640 to $567
B. Increase from $2,160 to $1,890
C. Decrease from $640 to $591
D. Increase from $1,890 to $2,160
E. No change
 
All-equity EPS = $57,600/36,000 = $1.60
Debt and equity EPS = [$57,600 - ($125,000 ×.09)]/[36,000 -
($125,000/$27)] = $1.4775
Terry's all-equity dividend income = 400 ×$1.60 = $640
Terry's debt and equity dividend income = 400 ×$1.4775 = $591
   
Taunton's is an all-equity firm that has 160,000 shares of stock outstanding. Neal, the financial vice president, is considering
borrowing $275,000 at 7.45 percent interest to repurchase 25,000 shares. Ignoring taxes, what is the current value of the firm?
 
A. $1,260,000
B. $1,800,000
C. $1,485,000
D. $1,520,000
E. $1,760,000
 
Value per share = $275,000/25,000 = $11
Firm value = 160,000 ×$11 = $1,760,000
   
Tree Farms currently has 48,000 shares of stock outstanding and no debt.
The price per share is $22.50. The firm is considering borrowing funds
at 8.5 percent interest and using the proceeds to repurchase 1,750
shares of stock. Ignore taxes. How much is the firm borrowing?
 
A. $42,500
B. $39,375
C. $32,750
D. $32,500
E. $40,000
 
1,750 × $22.50 = $39,375
   
The Bethlehem Inn is an all-equity firm with 9,000 shares outstanding at a value per share of $26.80.
The firm is issuing $39,932 of debt and using the proceeds to reduce the number of outstanding shares.
How many shares of stock will be outstanding once the debt is issued? Ignore taxes.
 
A. 7,970 shares
B. 7,510 shares
C. 7,846 shares
D. 8,030 shares
E. 7,561 shares
 
9,000 - ($39,932/$26.80) = 7,510 shares
   
Gulf Shores Inn is comparing two separate capital structures.
The first structure consists of 64,000 shares of stock and no debt.
The second structure consists of 50,000 shares of stock and $1.01 million of debt.
What is the price per share of equity?
 
A. $75.50
B. $69.97
C. $72.14
D. $68.36
E. $74.00
$72.14
 
P = $1,010,000 / (64,000 - 50,000) = $72.14
 
The Tree House has a pretax cost of debt of 7.3 percent and a return on assets of 12.8 percent.
The debt-equity ratio is .46. Ignore taxes. What is the cost of equity?
 
A. 14.50 percent
B. 14.82 percent
C. 15.47 percent
D. 14.98 percent
E. 15.33 percent
 
RE = .128 + [(.128 -.073) × .46] = .1533, or 15.33 percent
   
The Outlet Mall has a cost of equity of 16.3 percent, a pretax cost of debt of 7.9 percent,
and a return on assets of 13.4 percent. Ignore taxes. What is the debt-equity ratio?
 
A. .46
B. .53
C. .44
D. .59
E. .57
 
.163 = .134 + [(.134-.079) ×D/E]
D/E = .53
   
Weston Mines has a cost of equity of 14.9 percent, a pretax cost of debt of 7.3 percent, and a return on assets of 12.6 percent.
Ignore taxes. What is the debt-equity ratio?
 
A. .52
B. .84
C. .43
D. .77
E. .56
 
0.149 = .126 + [(.126 -.073) × D/E]
D/E = 0.43
 

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