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chap141513SOL
Chapter14
1. TheModigliani-MillerPropositionIwithouttaxesstates:
*A. Afirmcannotchangethetotalvalueofitsoutstandingsecuritiesbychangingitscapitalstructureproportions.
B. Whennewprojectsareaddedtothefirmthefirmvalueisthesumoftheoldvalueplusthenew.
C. Managerscanmakecorrectcorporatedecisionsthatwillsatisfyallshareholdersiftheyselectprojectsthatmaximizevalue.
D. Thedeterminationofvaluemustconsiderthetimingandriskofthecashflows.
E. Noneoftheabove.
Difficultylevel:
Medium
Topic:
MmPropositionI
2. Financialleverageimpactstheperformanceofthefirmby:
A. increasingthevolatilityofthefirm'sEBIT.
B. decreasingthevolatilityofthefirm'sEBIT.
C. decreasingthevolatilityofthefirm'snetincome.
*D. increasingthevolatilityofthefirm'snetincome
E. Noneoftheabove.
Difficultylevel:
Medium
Topic:
FinancialLeverage
Difficultylevel:
Medium
Topic:
MmPropositionI
3. Thechangeinfirmvalueinthepresenceofcorporatetaxesonlyis:
A. positiveasequityholdersfacealowereffectivetaxrate.
*B. negativeasequityholdersgainthetaxshieldonthedebtinterest.
C. negativebecauseoftheincreasedriskofdefaultandfewersharesoutstanding.
D. negativebecauseofareductionofequityoutstanding.
E. Noneoftheabove.
Difficultylevel:
Medium
Topic:
FirmVariationwithCorporateTaxes
4. BryaninvestedinBryco,Inc.stockwhenthefirmwasfinancedsolelywithequity.Thefirmisnowutilizingdebtinitscapitalstructure.Tounleverhisposition,Bryanneedsto:
A. borrowsomemoneyandpurchaseadditionalsharesofBrycostock.
*B. sellsomesharesofBrycostockandloanitoutsuchthathecreatesapersonaldebt-equityratioequaltothatofthefirm.
C. sellsomesharesofBrycostockandholdtheproceedsincash.
D. maintainhiscurrentpositionasthedebtofthefirmdidnotaffecthispersonalleverageposition.
E. createapersonaldebt-equityratiothatisequaltoexactly50%ofthedebt-equityratioofthefirm.
Difficultylevel:
Medium
Topic:
HomemadeLeverage
5. WhichofthefollowingstatementsarecorrectinrelationtoMMPropositionIIwithnotaxes?
I.Thereturnonassetsisequaltotheweightedaveragecostofcapital.
II.Financialriskisdeterminedbythedebt-equityratio.
III.Financialriskdeterminesthereturnonassets.
IV.Thecostofequitydeclineswhentheamountofleverageusedbyafirmrises.
A. IandIIIonly
B. IIandIVonly
*C. IandIIonly
D. IIIandIVonly
E. IandIVonly
Difficultylevel:
Medium
Topic:
MmPropositionIi,NoTax
6. Theinteresttaxshieldhasnovalueforafirmwhen:
I.thetaxrateisequaltozero.
II.thedebt-equityratioisexactlyequalto1.
III.thefirmisunlevered.
IV.afirmelects100%equityasitscapitalstructure.
A. IandIIIonly
B. IIandIVonly
*C. I,III,andIVonly
D. II,III,andIVonly
E. I,II,andIVonly
Difficultylevel:
Medium
Topic:
InterestTaxShield
7. Whichofthefollowingwilltendtodiminishthebenefitoftheinteresttaxshieldgivenaprogressivetaxratestructure?
I.areductionintaxrates
II.alargetaxlosscarryforward
III.alargedepreciationtaxdeduction
IV.asizeableincreaseintaxableincome
A. IandIIonly
B. IandIIIonly
C. IIandIIIonly
*D. I,II,andIIIonly
E. I,II,III,andIV
Difficultylevel:
Medium
Topic:
InterestTaxShield
8. Thompson&Thomsonisanallequityfirmthathas500,000sharesofstockoutstanding.Thecompanyisintheprocessofborrowing$10millionat9%interesttorepurchase200,000sharesoftheoutstandingstock.Whatisthevalueofthisfirmifyouignoretaxes?
A. $23.0million
B. $24.8million
*C. $25.0million
D. $26.2million
E. $27.3million
Pricepershare=$10m200k=$50;[（500,000-200,000）$50]+$10m=500,000$50=$25m;Valueofthefirmis$25m
Difficultylevel:
Medium
Topic:
MmPropositionI,NoTax
9. TheBackwoodsLumberCo.hasadebt-equityratioof.80.Thefirm'srequiredreturnonassetsis12%anditscostofequityis16.00%.Whatisthepre-taxcostofdebtbasedonMMPropositionIIwithnotaxes?
A. 6.76%
*B. 7.00%
C. 7.25%
D. 7.40%
E. 7.50%
.1600=.12+（.12-Rd）.80;Rd=.070=7.00%
Difficultylevel:
Medium
Topic:
MmPropositionIi,NoTax
10. TheWinterWearCompanyhasexpectedearningsbeforeinterestandtaxesof$2,100,anunleveredcostofcapitalof14%andataxrateof34%.Thecompanyalsohas$2,800ofdebtthatcarriesa7%coupon.Thedebtissellingatparvalue.Whatisthevalueofthisfirm?
A. $9,900
*B. $10,852
C. $11,748
D. $12,054
E. $12,700
VU=[$2,100（1-.34）].14=$9,900;VL=$9,900+（.34$2,800）=$10,852
Difficultylevel:
Medium
Topic:
MmPropositionI,WithTax
11. Anunleveredfirmhasacostofcapitalof14%andearningsbeforeinterestandtaxesof$150,000.Aleveredfirmwiththesameoperationsandassetshasbothabookvalueandafacevalueofdebtof$700,000witha7%annualcoupon.Theapplicabletaxrateis35%.Whatisthevalueoftheleveredfirm?
A. $696,429
B. $907,679
*C. $941,429
D. $1,184,929
E. $1,396,429
VU=[$150,000（1-.35）].14=$696,428.57;VL=$696,428.57+（.35$700k）=$941,428.57=$941,429
Difficultylevel:
Medium
Topic:
MmPropositionI,WithTax
12. HeyGuys!
Inc.hasdebtwithbothafaceandamarketvalueof$3,000.Thisdebthasacouponrateof7%andpaysinterestannually.Theexpectedearningsbeforeinterestandtaxesis$1,200,thetaxrateis34%,andtheunleveredcostofcapitalis12%.Whatisthefirm'scostofequity?
A. 13.25%
B. 13.89%
C. 13.92%
*D. 14.14%
E. 14.25%
VU=[EBIT（1-Tc）]RU=[$1,200（1-.34）].12=$6,600VL=VU+（TcD）=$6,600+（.34$3,000）=$7,620VL-VD=VE=$7,620-$3,000=$4,620RE=RU+（RU-RD）D/E（1-TC）=.12+[（.12-.07）（$3,000$4,620）（1-.34）]=.12+.02143=.14143=14.14%
Difficultylevel:
Challenge
Topic:
MmPropositionIi,WithTax
13. Anderson'sFurnitureOutlethasanunleveredcostofcapitalof10%,ataxrateof34%,andexpectedearningsbeforeinterestandtaxesof$1,600.Thecompanyhas$3,000inbondsoutstandingthathavean8%couponandpayinterestannually.Thebondsaresellingatparvalue.Whatisthecostofequity?
A. 8.67%
B. 9.34%
C. 9.72%
D. 9.99%
*E. 10.46%
VU=[EBIT（1-Tc）]RU=[$1,600（1-.34）].10=$10,560
VL=VU+（TcD）=$10,560+（.34$3,000）=$11,580
VL-VD=VE=$11,580-$3,000=$8,580
RE=RU+（RU-RD）D/E（1-TC）=.10+[（.10-.08）（$3,000$8,580）（1-.34）]=.10+.00462=.10462=10.46%
Difficultylevel:
Challenge
Topic:
MmPropositionIi,WithTax
14. Rosita'shasacostofequityof12.41%andapre-taxcostofdebtof8.5%.Thedebt-equityratiois.60andthetaxrateis.34.WhatisRosita'sunleveredcostofcapital?
*A. 11.30%
B. 12.33%
C. 13.97%
D. 14.08%
E. 14.60%
.1241=RU+（RU-.085）.60（1-.34）;.15776=1.396RU;RU=.11300=11.30%
Difficultylevel:
Medium
Topic:
MmPropositionIi,WithTax
15. Afirmhasdebtof$5,000,equityof$16,000,aleveragedvalueof$8,900,acostofdebtof8%,acostofequityof12%,andataxrateof34%.Whatisthefirm'sweightedaveragecostofcapital?
A. 7.29%
B. 7.94%
C. 8.87%
*D. 10.40%
E. 11.05%
WACC=[（$16k$21k）.12]+[（$5k$21k）.08（1-.34）]=.091429+.012571=.1040=10.40%
Difficultylevel:
Medium
Topic:
WeightedAverageCostofCapital
16. Afirmhaszerodebtinitscapitalstructure.Itsoverallcostofcapitalis10%.Thefirmisconsideringanewcapitalstructurewith60%debt.Theinterestrateonthedebtwouldbe8%.Assumingtherearenotaxesorotherimperfections,itscostofequitycapitalwiththenewcapitalstructurewouldbe:
A. 9%
B. 10%
*C. 13%
D. 14%
E. Noneoftheabove.
rs=.11+.60/.40（.11-.08）=.10+.045=.0145=14.5%
Difficultylevel:
Medium
Topic:
CostofEquity
17. Afirmhasadebt-to-equityratioof.60.Itscostofdebtis8%.Itsoverallcostofcapitalis12%.Whatisitscostofequityiftherearenotaxesorotherimperfections?
A. 10.0%
B. 13.5%
*C. 14.4%
D. 18.0%
E. Noneoftheabove.
RWACC=.12=（.6/1.6）（.08）+.625（rs）.12=.375（.08）+.625（X）9=.625xX=.144=14.4%
Difficultylevel:
Medium
Topic:
CostofEquity
18. Afirmhasadebt-to-equityratioof1.Itscostofequityis16%,anditscostofdebtis8%.Iftherearenotaxesorotherimperfections,whatwouldbeitscostofequityifthedebt-to-equityratiowere0?
A. 8%
B. 10%
*C. 12%
D. 14%
E. 16%
rs=16=r0+1（r0-.08）.16=2r0-.08.24=2r0r0=.12=12%WACC=rdwd+rdwe=.08（.5）+.16（.5）=.12=12%
Difficultylevel:
Challenge
Topic:
CostofEquity
19. Ifafirmisunleveredandhasacostofequitycapitalof12%,whatwoulditscostofequitybeifitsdebt-equityratiobecame2?
Theexpectedcostofdebtis9%.
A. 14.0%
B. 14.67%
C. 16.0%
*D. 20.0%
E. Noneoftheabove.
rs=rsu+（B/S）（rsu-ru）rs=.12+2（.12-.09）=.1800=18.0%
Difficultylevel:
Medium
Topic:
CostofEquity
20. Afirmhaszerodebtinitscapitalstructure.Itsoverallcostofcapitalis9%.Thefirmisconsideringanewcapitalstructurewith40%debt.Theinterestrateonthedebtwouldbe4%.Assumingthatthecorporatetaxrateis34%,whatwoulditscostofequitycapitalwiththenewcapitalstructurebe?
A. 10.3%
B. 11.0%
*C. 11.2%
D. 13.9%
E. Noneoftheabove.
rs=ro+（B/S）（1-Tc）（ro-rB）rs=.09+（.4/.6）（1-.34）（.09-.04）=.09+.022=.112=11.2%
Difficultylevel:
Challenge
Topic:
CostofEquitywithDebt
21. Afirmhasad
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