EBF 401 EBF401 Quiz 4 with Answers (Penn State University)

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EBF 401 EBF401 Quiz 4 Answers (Penn State University)

1. The reason that M&M Proposition I does not hold in the presence of corporate taxation is because:

a. Levered firms pay less taxes compared with identical unlevered firms;

b. Bondholders require higher rates of return compared with stockholders;

c. Earnings per share are no longer relevant with taxes;

d. Dividends are no longer relevant with taxes;

e. All of these.

2. M&M Proposition I with corporate taxes states that:

a. Capital structure can affect firm value;

b. By raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value;

c. Firm value is maximized at an all debt capital structure;

d. All of these;

e. None of these.

3. The change in firm value in the presence of corporate taxes is:

a. Positive as equityholders face a lower effective tax rate;

b. Positive as equityholders gain the tax shield on the debt interest;

c. Negative because of the increased risk of default and fewer shares outstanding;

d. Negative because of a reduction of equity outstanding;

e. None of these.

4. The concept of homemade leverage is associated with:

a. M&M Proposition I with no tax;

b. M&M Proposition II with no tax;

c. M&M Propositions I and II with no tax;

d. M&M Proposition I with corporate tax;

e. M&M Proposition II with corporate tax.

5. The Winter Wear Companyhas expected earnings before interest and taxes of $2,100, an unlevered cost of capital of 14% and a tax rate of 34%. The company also has $2,800 of debt that carries a 7% coupon. The debt is selling at par value. What is the value of this firm?

a. $9,900;

b. $10,852;

c. $11,748;

d. $12,054;

e. $12,700.

6. Gail’s Dance Studiois currently an all equity firm that has 80,000 shares of stock outstanding with a market price of $42 a share. The current cost of equity is 12% and the tax rate is 34%. Gail is considering adding $1 million of debt with a coupon rate of 8% to her capital structure. The debt will be sold at par value. What is the levered value of the equity?

a. $2.4 million;

b. $2.7 million;

c. $3.3 million;

d. $3.7 million;

e. $3.9 million.

7. Joe's Leisure Time Sports is an unlevered firm with an after-tax net income of $86,000. The unlevered cost of capital is 10% and the tax rate is 34%. What is the value of this firm?

a. $567,600;

b. $781,818;

c. $860,000;

d. $946,000;

e. $1,152,400.

8. Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of 8%. The tax rate is 34%. What is the present value of the tax shield?

a. $2,823;

b. $2,887;

c. $4,080;

d. $4,500;

e. $4,633.

9. M&M Proposition II with taxes:

a. has the same general implications as M&M Proposition II without taxes;

b. reveals how the interest tax shield relates to the value of a firm;

c. supports the argument that business risk is determined by the capital structure employed by a firm;

d. supports the argument that the cost of equity decreases as the debt-equity ratio increases;

e. reaches the final conclusion that the capital structure decision is irrelevant to the value of a firm.

10. The interest tax shield has no value for a firm when:

I. the tax rate is equal to zero.

II. the debt-equity ratio is exactly equal to 1.

III. the firm is unlevered.

IV. a firm elects 100% equity as its capital structure.

a. I and III only;

b. II and IV only;

c. I, III and IV;

d. II, III and IV;

e. I, II and IV.