Practice quiz 14

We can consider a firm's capital restructuring decisions in isolation from its investment decisions because

Select one:

a.investment decisions affect operations while capital restructuring decisions affect financing decisions.

b.a company's assets are not directly affected by capital restructuring decisions.

c.investment decisions and capital restructuring decisions are mutually exclusive.

d.investors demand a separation of these two decisions due to agency conflicts.

e.investment and capital restructuring decisions use different sets of criteria and discount rates.

A firm has the following information for the last two years. Calculate its degree of financial leverage.

This year

Last year

Sales

$1,500,000

$1,400,000

Operating costs

$900,000

$850,000

Net income

$150,000

$130,000

Number of shares outstanding

50,000

50,000

Select one:

a.0.21

b.1.04

c.1.25

d.1.69

e.1.98

Allegra Inc. has one million shares outstanding. The company is considering the issue of debt of $10 million. The interest rate on this new debt issue will be 8%, and the number of shares after the debt issue will be reduced to 500,000. Given a corporate tax rate of 35%, what is the EBIT that will cause the firm's earnings per share to be indifferent between issuing and not issuing debt?

Select one:

a.$1,200,000

b.$1,600,000

c.$1,800,000

d.$2,400,000

e.$2,600,000

Mrs. Abecrombus has $2,000 to invest in one of two possible investments: a levered firm with a D/E ratio of 1 and a share price of $20, and a risk-free asset with a return of 10%. If Mrs. Abecrombus prefers a D/E ratio of 2, how can she use homemade leverage to achieve her goal?

Select one:

a.Borrow $2,000 at the risk-free rate and buy 200 shares.

b.Borrow $1,000 at the risk-free rate and buy 150 shares.

c.Borrow $1,500 at the risk-free rate and buy 175 shares.

d.Lend $2,000 at the risk-free rate and sell 100 shares.

e.Lend $1,000 at the risk-free rate and sell 50 shares.

Async Inc. and Sync Corp. both have the same EBIT of $5 million and tax rate of 35%. Async is all-equity financed with a cost of capital of 13%, whereas Sync has debt of $8million. What is Sync's firm value using the M&M Proposition?

Select one:

a.$15,250,000

b.$17,500,000

c.$19,750,000

d.$25,000,000

e.$27,800,000

According to M&M Proposition I with taxes,

Select one:

a.the optimal capital structure is 100% debt.

b.the optimal capital structure is 50% debt.

c.the optimal capital structure is 25% debt.

d.the optimal capital structure is 0% debt.

e.capital structure decisions are irrelevant.

You are a business analyst with a big investment bank, and you are evaluating the equity risk, business risk, and financial risk of Abilon's Inc. You went online and found that the industry consensus on Abilon's equity risk is 1.5. You also know that the company's debt-equity ratio is 1. What is Abilon's estimated business and financial risk based on the model A(1 + D/E)?

Select one:

a.0.5; 1

b.0.5; 2

c.0.75 and 0.5

d.0.75 and 0.75

e.1 and 1

According to the static theory of capital structure,

Select one:

a.the greater the volatility in EBIT, the less a firm should borrow.

b.the higher the financial costs, the less a firm should borrow.

c.the higher the accumulated losses, the less a firm should borrow.

d.the higher the tax rate, the more a firm should borrow.

e.all of the above are true.

In a normal liquidation situation, ___________ are lower than preferred stockholders on the priority list of claims on liquidation proceeds.

Select one:

a.contributions to employee benefit plans

b.consumer claims

c.common stockholders

d.unsecured creditors

e.administrative expenses associated with the bankruptcy

Aceline Corporation is currently all-equity financed, with a cost of capital of 15% and afirm value of $10 million. The company is considering a $3 million debt issue at an 8% interest rate. The money raised will be used to repurchase shares. The company's marginal tax rate is 35%. According to the M&M Proposition, what is Aceline's WACC after the debt issue?

Select one:

a.13.09%

b.13.57%

c.14.10%

d.15.00%

e.16.70%