Module 8 Flashcards
A general rule for managers to follow is to set the firm’s capital structure such that the firm’s:
A) size is maximized. B) value is maximized C) bondholders are secured. D) suppliers of raw materials are satisfied. E) dividend payout is maximized
B) value is maximized
The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:
homemade leverage.
A key underlying assumption of MM Proposition I without taxes is that:
A) Financial leverage increase risk
B) individuals can borrow at lower rates than corporations
C) individuals and corporations borrow at the same rate
D) managers always act to maximize the value of the firm
E) Corporations are all-equity financed
C) individuals and corporations borrow at the same rate
According to MM Proposition II with no taxes, the:
required return on equity is a linear function of the firm’s debt-equity ratio.
The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:
MM Proposition I with no tax.
MM Proposition II is the proposition that:
a firm’s cost of equity capital is a positive linear function of the firm’s capital structure.
You own 25 percent of Unique Vacations, Inc. You have decided to retire and want to sell your shares in this closely held, all-equity firm. The other shareholders have agreed to have the firm borrow $1.5 million to purchase your 1,000 shares of stock. What is the total value of this firm if you ignore taxes?
6M
4*1.5M
Bigelow has a levered cost of equity of 14.29 percent and a pretax cost of debt of 7.23 percent. The required return on the assets is 11 percent. What is the firm’s debt-equity ratio based on MM Proposition II with no taxes?
.87
A firm has a debt-equity ratio of 1, a cost of equity of 16 percent, and a cost of debt of 8 percent. If there are no taxes or other imperfections, what is its unlevered cost of equity?
12 percent
MM II (No Taxes)
16 = R0+1 x (R0-8)
16 = 2R0 -8
24 =2R0
The Winter Wear Company has expected earnings before interest and taxes of $3,800, an unlevered cost of capital of 15.4 percent and a tax rate of 22 percent. The company also has $2,600 of debt with a coupon rate of 5.7 percent. The debt is selling at par value. What is the value of this firm?
$19,819
V_L=(EBIT x (1-T_C) )/R_0 + T_C x B
=((3800(1-.22))/.154 + (2600.22)
Anderson’s Furniture Outlet has an unlevered cost of capital of 10.3 percent, a tax rate of 21 percent, and expected earnings before interest and taxes of $1,900. The company has $4,000 in bonds outstanding that have an annual coupon of 7 percent. If the bonds are selling at par, what is the cost of equity?
11.21 percent
Wild Flowers Express has a debt-equity ratio of .60. The pretax cost of debt is 9 percent while the unlevered cost of capital is 14 percent. What is the cost of equity if the tax rate is 23 percent?
16.31 percent
RS = R0 + (B/S)×(1-TC)×(R0 - RB) R0 14 B/S 0.6 RB 9 1-Tc 0.77
Your firm has a bond issue with a face value of $250,000 outstanding. These bonds have a coupon rate of 7 percent, pay interest semiannually, and have a current market price equal to 103 percent of face value. What is the amount of the annual tax shield on debt given a tax rate of 21 percent?
3675
(TC) x (B) x (RB)
Tc 0.21
B 250000
Rb 0.07
PV 3675
The pecking order states that firms should:
use internal financing first.
The optimal capital structure:
of a particular firm can change if tax rates change.
