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Exam 13: Leverage and Capital Structure

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Question 51

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Uptown Construction is comparing two different capital structures.Plan I would result in 23,000 shares of stock and $320,000 in debt.Plan II would result in 17,000 shares of stock and $260,000 in debt.The interest rate on the debt is 10 percent.Ignoring taxes,EPS will be identical for Plans I and II when EBIT equals which one of the following?

A) $8,550
B) $9,000
C) $9,600
D) $10,400
E) $10,750

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Question 52

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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.

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Question 53

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Which of the following will increase the value of a levered firm according to M&M Proposition I,with taxes? I.Decrease in the amount of the debt II.Increase in the value of the unlevered firm III.Decrease in the tax rate IV.Increase in the interest rate on the debt

Gabella's is an all-equity firm that has 21,000 shares of stock outstanding at a market price of $40 a share.The firm has earnings before interest and taxes of $84,000 and has a 100 percent dividend payout ratio.Ignore taxes.Gabella's has decided to issue $160,000 of debt at a rate of 12 percent and use the proceeds to repurchase shares.Terry owns 400 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?

Which of the following statements correctly relate to M&M Proposition I,with taxes? I.Debt decreases the value of a firm. II.The levered value of a firm exceeds the firm's unlevered value. III.The weighted average cost of capital (WACC) is constant. IV.The optimal capital structure is zero debt.

The static theory of capital structure assumes a firm:

A firm has a weighted average cost of capital of 11.68 percent and a cost of equity of 15.5 percent.The debt-equity ratio is 0.65.There are no taxes.What is the firm's cost of debt?

Which one of the following best defines legal bankruptcy?

Which one of the following statements related to the static theory of capital structure is correct?

A firm is considering two different capital structures.The first option is an all-equity firm with 32,000 shares of stock.The second option is 20,000 shares of stock plus some debt.Ignoring taxes,the break-even level of earnings before interest and taxes between these two options is $48,000.How much money is the firm considering borrowing if the interest rate is 8 percent?

Assume a fellow student made these statements during a class discussion: "Bankruptcy costs affect a firm only if the firm files a bankruptcy petition with the court.Therefore,the static theory of capital structure only applies to bankrupt firms." Write a response to your fellow student that either supports or contradicts that student's statements.

A firm has a cost of debt of 7.5 percent and a cost of equity of 16.2 percent.The debt-equity ratio is 0.45.There are no taxes.What is the firm's weighted average cost of capital?

M&M Proposition II,without taxes,states that the:

Ernst Electrical has 9,000 shares of stock outstanding and no debt.The new CFO is considering issuing $80,000 of debt and using the proceeds to retire 1,500 shares of stock.The coupon rate on the debt is 7.5 percent.What is the break-even level of earnings before interest and taxes between these two capital structure options?