1.A firm's choice of how much debt it should have relative to equity is what type of decision? (Circle one; )

a)Borrowing decision

b)Capital structure decision

c) Debt financing decision

d)Valuation decision

2.Please indicate true or false for the following questions (each is worth):

a)Debt is beneficial to shareholders when EBIT is sufficiently high.

True/False

b)The cost of equity rises when a company increases its use of financial leverage because the financial risk of the equity increases, all else equal.

True/False

c)Firms with no debt have an interest tax shield that increases their earnings per share.

True/False

d)The optimal capital structure for a corporate firm is 100% debt.

True/False

1.Cummings Corporation has no debt outstanding and a total market value of $200,000.Earnings before interest and taxes are projected to be $20,000.The CEO is considering a $50,000 debt issue with an interest rate of 5%.The proceeds will be used to repurchase shares of stock.There are currently 5,000 shares outstanding.Ignore taxes.

a)Calculate earnings per share, EPS, before any debt is issued

b)Assume we recapitalize.What is the new EPS?

c)What is the break-even EBIT?

d)At the breakeven EBIT, all else equal, what is the EPS for the firm when it is debt free; what is the EPS after it takes on debt?

2.Cummings Corporation has a weighted average cost of capital (WACC) of 10%.The company has no debt, but can borrow at 5%.There is no corporate tax.

a)What is Cummings' cost of equity?

b)If the firm converts to 30% debt, what will its cost of equity be?

3.Cummings Corporation anticipates an EBIT of $200,000 per year in perpetuity.The company has no debt and its cost of equity is 10%.

a)What is the current value of Cummings Corporation?

b)Suppose the company can borrow at 10%.If the corporate tax rate is 35%, what will the value of the firm be if the company takes on debt equal to 50% of its unlevered value?

4.Use the letter I (for increase), the letter D (for decrease), and the letter N (for no change) to indicate the impact of the following on the cash cycle:

a)Increase the amount of inventory paid with cash.__________

b)Increase cash discounts to customers.__________

c)Suppliers increase their cash discounts. __________

e)Inventories sell out frequently.__________

5.Please note whether the following activity increases cash within the organization (with "I") or decreases cash within the organization (with "D") :

a)Purchase inventory.__________

b)Issue bonds.__________

c)Decrease a long-term liability.__________

d)Decrease a current asset other than cash.__________

6.Cummings Corporation has projected the following monthly sales amounts in the coming year.Accounts receivables at the beginning of the year are $1,100.The company has a 15-day collection period.Calculate cash collections in each of the three months by completing the table below.

JanuaryFebruaryMarch

$2,200$3,200$1,200

January

February

March

Beginning Receivables

Sales

Cash Collections

Ending Receivables