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Western Shores is comparing two separate capital structures. The first structure consists of 260,000 shares of stock and no debt. The second structure consists of 210,000 shares of stock and $1.5 million of debt. What is the price per share of equity?


A) $18
B) $22
C) $27
D) $30
E) $33

F) D) and E)
G) A) and E)

Correct Answer

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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?


A) 5.80 percent
B) 6.27 percent
C) 6.44 percent
D) 7.23 percent
E) 7.81 percent

F) All of the above
G) B) and D)

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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 breakeven 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?


A) $175,000
B) $225,000
C) $250,000
D) $275,000
E) $300,000

F) D) and E)
G) A) and B)

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The Green Briar is an all-equity firm with a total market value of $418,000 and 20,000 shares of stock outstanding. Management is considering issuing $120,000 of debt at an interest rate of 9 percent and using the proceeds on a stock repurchase. Ignore taxes. How many shares will the firm repurchase if it issues the debt securities?


A) 2,871 shares
B) 3,516 shares
C) 3,921 shares
D) 4,607 shares
E) 5,742 shares

F) B) and E)
G) D) and E)

Correct Answer

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The Outlet has a cost of equity of 16.8 percent, a pre-tax cost of debt of 8.1 percent, and a return on assets of 14.5 percent. Ignore taxes. What is the debt-equity ratio?


A) 0.28
B) 0.36
C) 0.44
D) 0.52
E) 0.57

F) D) and E)
G) A) and D)

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Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship?


A) Static theory of interest rates
B) M&M Proposition I
C) Financial risk
D) Interest tax shield
E) Homemade leverage

F) All of the above
G) B) and D)

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Delta Mowers has a debt-equity ratio of 1.2. Its WACC is 10.1 percent, and its cost of debt is 7.5 percent. There is no corporate tax. What is the firm's cost of equity capital?


A) 12.60 percent
B) 13.22 percent
C) 13.83 percent
D) 14.29 percent
E) 14.80 percent

F) A) and E)
G) B) and C)

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When is a firm insolvent from an accounting perspective?


A) When the firm is unable to meet its financial obligations in a timely manner
B) When the firm's debt exceeds the value of the firm's equity
C) When the firm has a negative net worth
D) When the firm's revenues cease
E) When the market value of the firm's equity equals zero

F) A) and B)
G) None of the above

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Which one of the following is a direct bankruptcy cost?


A) Loss of customer goodwill resulting from a bankruptcy filing
B) Legal and accounting fees related to a bankruptcy proceeding
C) Management time spent on a bankruptcy proceeding
D) Any financial distress cost
E) Costs a firm spends trying to avoid bankruptcy

F) B) and D)
G) All of the above

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Which one of the following will generally receive the highest priority in a bankruptcy liquidation, assuming the absolute priority rule is followed?


A) Claims by unsecured creditors
B) Employee wages
C) Government tax claims
D) Contributions to employee retirement plans
E) Bankruptcy administrative expenses

F) C) and D)
G) B) and E)

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Which one of the following statements is correct?


A) A prepack is a plan of liquidation used to distribute a firm's assets.
B) Bankruptcy courts have "cram-down" powers.
C) The absolute priority rule must be strictly followed in all bankruptcy proceedings.
D) Creditors cannot force a firm into bankruptcy even though they might like to do so.
E) A reorganization plan can only be approved if the firm's creditors all agree with the plan.

F) None of the above
G) A) and D)

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Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered. Which one of the following statements is correct regarding these two firms?


A) The levered firm has higher EPS than the unlevered firm at the break-even point.
B) The levered firm will have higher EPS than the unlevered firm at all levels of EBIT.
C) The unlevered firm will have higher EPS than the levered firm at relatively high levels of EBIT.
D) The EPS for the unlevered firm will always exceed those of the levered firm.
E) The unlevered firm will have higher EPS at relatively low levels of EBIT.

F) B) and C)
G) A) and D)

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Great Lakes Shipping is an all-equity firm with anticipated earnings before interest and taxes of $439,000 annually forever. The present cost of equity is 16.4 percent. Currently, the firm has no debt but is considering borrowing $1.25 million at 8.5 percent interest. The tax rate is 36 percent. What is the value of the levered firm?


A) $2,163,171
B) $2,406,519
C) $2,588,547
D) $2,666,667
E) $2,818,181

F) A) and D)
G) C) and D)

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Hot To Go is an all-equity firm specializing in hot ready-to-eat meals. Management has estimated the firm's earnings before interest and taxes will be $167,000 annually forever. The present cost of equity is 15.1 percent. Currently, the firm has no debt but is considering borrowing $750,000 at 9 percent interest. The tax rate is 34 percent. What is the value of the unlevered firm?


A) $623,017
B) $646,511
C) $704,141
D) $729,934
E) $755,200

F) A) and E)
G) B) and E)

Correct Answer

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Peterboro recently defaulted on a bank loan. To avoid a bankruptcy proceeding, the bank agreed to a composition. This composition would do which one of the following?


A) Forgive the loan payment in its entirety
B) Extend the due date on the missed loan payment
C) Reduce the amount of the loan payments so Peterboro can pay timely
D) Transfer some of Peterboro's assets to the bank in lieu of the loan payment
E) Transfer all the equity shares in Peterboro to the lending bank

F) A) and B)
G) C) and D)

Correct Answer

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Stevenson's Bakery is an all-equity firm that has projected perpetual earnings before interest and taxes of $138,000 a year. The cost of equity is 13.7 percent and the tax rate is 32 percent. The firm can borrow money at 6.75 percent. Currently, the firm is considering converting to a debt-equity ratio of 0.45. What is the firm's levered value?


A) $527,613
B) $689,919
C) $752,987
D) $829,507
E) $903,682

F) B) and E)
G) B) and D)

Correct Answer

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Tropical Fruit Extracts expects its earnings before interest and taxes to be $218,000 a year forever. Currently, the firm has no debt. The cost of equity is 16.3 percent and the tax rate is 35 percent. The company is in the process of issuing $2 million of bonds at par that carry a 6.5 percent annual coupon. What is the unlevered value of the firm?


A) $371,429
B) $431,971
C) $747,485
D) $869,325
E) $988,315

F) B) and D)
G) A) and E)

Correct Answer

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Henderson's is an all-equity firm that has 135,000 shares of stock outstanding. Neal, the financial vice-president, is considering borrowing $220,000 at 7.25 percent interest to repurchase 20,000 shares. Ignoring taxes, what is the value of the firm?


A) $1,260,000
B) $1,400,000
C) $1,485,000
D) $1,620,000
E) $1,750,000

F) None of the above
G) B) and C)

Correct Answer

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Explain the primary difference between a Chapter 7 bankruptcy and a Chapter 11 bankruptcy.

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A Chapter 7 bankruptcy is the ...

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Liz's Home Remedy has a $24 million bond issue outstanding with a coupon rate of 7.75 percent and a current yield of 7.67 percent. What is the present value of the tax shield if the tax rate is 34 percent?


A) $632,400
B) $625,872
C) $6.28 million
D) $8.16 million
E) $8.68 million

F) B) and D)
G) A) and E)

Correct Answer

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