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Gabella's is an all-equity firm that has 36,000 shares of stock outstanding at a market price of $27 a share.The firm has earnings before interest and taxes of $57,600 and has a 100 percent dividend payout ratio.Ignore taxes.Gabella's has decided to issue $125,000 of debt at a rate of 9 percent and use the proceeds to repurchase shares.Terry owns 800 shares of Gabella's stock and has decided to continue holding those shares.How will Gabella's debt issue affect Terry's annual dividend income?


A) Decrease from $640 to $567
B) Increase from $2,160 to $1,890
C) Decrease from $640 to $591
D) Increase from $1,890 to $2,160
E) No change

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

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The static theory of capital structure assumes a firm:


A) maintains a constant debt-equity ratio.
B) has an all-equity structure.
C) is fixed in terms of its assets and operations.
D) pays no taxes.
E) is operating at the point where financial distress costs are eliminated

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

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Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $628,000.The current cost of equity is 17.6 percent and the tax rate is 35percent.The company is in the process of issuing $4.3 million of 8.3 percent annual coupon bonds at par.What is the levered value of the firm?


A) $3,824,318
B) $3,541,085
C) $3,422,225
D) $2,713,185
E) $3,385,695

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

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Gabe's Market is comparing two different capital structures.Plan I would result in 15,000 shares of stock and $210,000 in debt.Plan II would result in 13,000 shares of stock and $252,000 in debt.The interest rate on the debt is 8 percent.Ignoring taxes,compare both of these plans to an all-equity plan assuming that EBIT will be $52,000.The all-equity plan would result in 25,000 shares of stock outstanding.Of the three plans,the firm will have the highest EPS with _____ and the lowest EPS with ____.


A) Plan I; Plan II
B) Plan II; the all-equity plan
C) Plan II; Plan I
D) Plan I; the all-equity plan
E) the all-equity plan; Plan I

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

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Southern Foods has a $13 million bond issue outstanding with a coupon rate of 7.15 percent and a yield to maturity of 7.39 percent.What is the present value of the tax shield if the tax rate is 34 percent?


A) $283,140
B) $316,030
C) $4,053,400
D) $3,960,000
E) $4,420,000

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

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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 (earnings per share) 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 E)
G) A) and E)

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Triangle Enterprises has no debt but can borrow at 8 percent.The firm's WACC is currently 13.2 percent,and there is no corporate tax.If the firm converts to 30 percent debt,what will its cost of equity be?


A) 16.67 percent
B) 12.95 percent
C) 14.47 percent
D) 16.39 percent
E) 15.43 percent

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

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Which one of the following terms refers to the termination of a firm as a going concern?


A) Insolvency
B) Reorganization
C) Chapter 11 bankruptcy
D) Prepack
E) Liquidation

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

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Which one of the following is an implication of M&M Proposition II without taxes?


A) A firm's optimal capital structure is 100 percent debt.
B) WACC is unaffected by the capital structure of a firm.
C) WACC decreases as the debt-equity ratio increases.
D) A firm's capital structure is irrelevant.
E) The risk of equity is affected by both financial and operating leverage

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

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T.L.C.Enterprises just revised its capital structure from a debt-equity ratio of .37 to a debt-equity ratio of .48.The firm's shareholders who prefer the old capital structure should:


A) sell some shares and hold the sale proceeds in cash.
B) sell all of their shares and loan out the entire sale proceeds.
C) do nothing.
D) sell some shares and loan out the sale proceeds.
E) borrow funds and purchase more shares

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

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Which one of the following is correct based on the static theory of capital structure?


A) A firm receives the greatest benefit from debt financing when its tax rate is relatively low.
B) A debt-equity ratio of 1 is considered to be the optimal capital structure.
C) The costs of financial distress decrease the value of a firm.
D) The more debt a firm assumes, the greater the incentive to acquire even more debt until such time as the firm is financed with 100 percent debt.
E) At the optimal level of debt a firm also optimizes its tax shield on debt.

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

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Which one of the following statements concerning financial leverage is correct?


A) The benefits of leverage are unaffected by the amount of a firm's earnings.
B) The use of leverage will always increase a firm's earnings per share.
C) The shareholders of a firm are exposed to less risk anytime a firm uses financial leverage.
D) Changes in the capital structure of a firm will generally change the firm's earnings per share.
E) Financial leverage is beneficial to a firm only when the firm has negative earnings

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

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Room and Board has determined that $41,650 is the break-even level of earnings before interest and taxes for the two capital structures it is considering.The one structure consists of all equity with 15,500 shares of stock.The second structure consists of 12,500 shares of stock and $65,000 of debt.What is the interest rate on the debt?


A) 7.72 percent
B) 8.19 percent
C) 9.38 percent
D) 11.55 percent
E) 12.40 percent

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

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Debbie's Cookies has a return on assets of 12.6 percent and a cost of equity of 14.8 percent.What is the pretax cost of debt if the debt-equity ratio is .38? Ignore taxes.


A) 5.87 percent
B) 95.29 percent
C) 9.04 percent
D) 7.31 percent
E) 6.81 percent

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

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Uptown Construction is comparing two different capital structures.Plan I would result in 16,000 shares of stock and $160,000 in debt.Plan II would result in 18,000 shares of stock and $110,000 in debt.The interest rate on the debt is 9 percent.Ignoring taxes,EPS will be identical for Plans I and II when EBIT equals which one of the following?


A) $48,550
B) $50,400
C) $69,600
D) $53,700
E) $60,750

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

Correct Answer

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Which one of the following is a key provision of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005?


A) Disallowance of bankruptcy prepacks
B) Right granted to creditors to file their own reorganization plan once a firm is in bankruptcy for 18 months
C) Disallowance of all management bonus payments while a firm is in bankruptcy
D) Requirement that only creditors can file reorganization plans for a bankrupt firm
E) Requirement for all Chapter 11 bankruptcies to be converted to Chapter 7 bankruptcies after 18 months

F) None of the above
G) All of the above

Correct Answer

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Glass Growers has a cost of capital of 11.1 percent.The company is considering converting to a debt-equity ratio of .46.The interest rate on debt is7.3 percent.What would be the company’s new cost of equity? Ignore taxes.


A) 12.85 percent
B) 11.13 percent
C) 12.36 percent
D) 12.44 percent
E) 11.61 percent

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

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Peter's Tools 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 Peter's can pay on time
D) Transfer some of Peter's assets to the bank in lieu of the loan payment
E) Transfer all the equity shares in Peter’s to the lending bank

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

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Tree Farms currently has 48,000 shares of stock outstanding and no debt.The price per share is $22.50.The firm is considering borrowing funds at 8.5 percent interest and using the proceeds to repurchase 1,750 shares of stock.Ignore taxes.How much is the firm borrowing?


A) $42,500
B) $39,375
C) $32,750
D) $32,500
E) $40,000

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

Correct Answer

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A firm has a cost of debt of 7.8 percent and a cost of equity of 15.6 percent.The debt-equity ratio is .52.There are no taxes.What is the firm's weighted average cost of capital?


A) 11.76 percent
B) 11.29 percent
C) 12.93 percent
D) 12.47 percent
E) 10.20 percent

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

Correct Answer

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