Deck 8: Capital Structure

Question 1

Bavarian Brew
Bavarian Brew, an unlevered firm, has an expected EBIT of $500,000. The required return on assets for the firm's assets is 10%. The company has 250,000 shares outstanding. The company is considering raising $1 million in debt with a required return of 6% and would use the proceeds to repurchase outstanding stock.

-What is the value of Bavarian Brew before restructuring? Assume no corporate taxes.

A) $500,000
B) $5,000,000
C) $1,000,000
D) $3,300,000

Answer 1

$5,000,000

Question 2

Bavarian Brew
Bavarian Brew, an unlevered firm, has an expected EBIT of $500,000. The required return on assets for the firm's assets is 10%. The company has 250,000 shares outstanding. The company is considering raising $1 million in debt with a required return of 6% and would use the proceeds to repurchase outstanding stock.

-What is the value of Bavarian Brew before restructuring? Assume a corporate tax rate of 34%.

A) $5,000,000
B) $500,000
C) $3,300,000
D) $1,000,000

Answer 2

$3,300,000

Question 3

Bavarian Brew
Bavarian Brew, an unlevered firm, has an expected EBIT of $500,000. The required return on assets for the firm's assets is 10%. The company has 250,000 shares outstanding. The company is considering raising $1 million in debt with a required return of 6% and would use the proceeds to repurchase outstanding stock.

-What is the value of Bavarian Brew after restructuring. Assume no corporate taxes.

A) $3,300,000
B) $5,000,000
C) $500,000
D) $1,000,000

Answer 3

$5,000,000

Question 4

Bavarian Brew
Bavarian Brew, an unlevered firm, has an expected EBIT of $500,000. The required return on assets for the firm's assets is 10%. The company has 250,000 shares outstanding. The company is considering raising $1 million in debt with a required return of 6% and would use the proceeds to repurchase outstanding stock.

-What is the value of Bavarian Brew after restructuring? Assume corporate taxes of 34%.

A) $5,000,000
B) $5,340,000
C) $3,300,000
D) $1,000,000

Question 5

Bavarian Brew
Bavarian Brew, an unlevered firm, has an expected EBIT of $500,000. The required return on assets for the firm's assets is 10%. The company has 250,000 shares outstanding. The company is considering raising $1 million in debt with a required return of 6% and would use the proceeds to repurchase outstanding stock.

-What is the value of Bavarian Brew after the restructuring, if the PV of bankruptcy cost is $750,000? Assume a corporate tax rate of 34%.

A) $5,000,000
B) $5,340,000
C) $4,590,000
D) $4,250,000

Question 6

Miller's Drugstore
Miller's drugstore has an EBIT of $15,000, debt with a market value of $25,000 and a required return on assets of 12%.

-Assuming no taxes, what is Miller's Drugstore's value?

A) $15,000
B) $125,000
C) $25,000
D) $75,000

Question 7

Miller's Drugstore
Miller's drugstore has an EBIT of $15,000, debt with a market value of $25,000 and a required return on assets of 12%.

-Assuming a corporate tax rate of 35%, what is Miller's Drugstore's value?

A) $125,000
B) $25,000
C) $133,750
D) $75,000

Question 8

State Company had determined its earnings before interest and taxes (EBIT) in four possible states of the world. In the Great State, EBIT will be $3,000,000 and in the Good, Normal and Poor States EBIT will be $2,000,000, $1,500,000, and $1,000,000 in that order. If each state has an equal probability of occurring, then what is State Company's expected EBIT?

A) $3,000,000
B) $2,500,000
C) $1,875,000
D) none of the above

Question 9

Which of the following statements is true?

A) The use of debt may lead to financial distress and bankruptcy, thus firms that sell expensive, durable products that may have warranties and ongoing service requirements tend to use less debt.
B) The use of debt may lead to financial distress and bankruptcy, thus firms that sell expensive, durable products that may have warranties and ongoing service requirements tend to use more debt.
C) Companies with a large proportion of tangible assets should be more willing to use debt than firms with mostly intangible assets.
D) Companies with a large proportion of tangible assets should be less willing to use debt than firms with mostly intangible assets.
E) Both (a) and (c)

Question 10

Financial distress can lead to financial and operating "games." Which of the following statements is (are) true?

A) A firm's stockholders may prefer that the firm engage in riskier projects whereas the firm's bondholders may prefer that the firm invest in low-risk projects.
B) The firm may underinvest in projects because the financing must be provided solely by the stockholders since it is unlikely the firm will be able to borrow additional funds.
C) The firm may underinvest in projects because the financing must be provided solely by the bondholders since it is unlikely the firm will be able to issue additional stock.
D) A firm's bondholders may prefer that the firm engage in riskier projects whereas the firm's stockholders may prefer that the firm invest in low-risk projects.
E) Both (a) and (b)