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