Question 1

Lyme Home has 5,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 7.65 percent.Interest is paid semiannually.What is the amount of the annual tax shield on debt if the tax rate is 23 percent?
A)$157,650
B)$160,125
C)$1,062,500
D)$1,150,000
E)$87,975

Accepted Answer

First, we need to calculate the annual interest payment:

Coupon rate = 7.65%
Face value = $1,000
Semiannual interest payment = (7.65% / 2) * $1,000 = $38.25
Annual interest payment = 2 * $38.25 = $76.50

Next, we can calculate the amount of the tax shield:

Tax rate = 23%
Tax shield = $76.50 * 23% = $17.60

Finally, we can calculate the total annual tax shield on all 5,000 bonds:

Total tax shield = $17.60 * 5,000 = $87,975

Therefore, the correct answer is E.

Question 2

Explain why the weighted average cost of capital is invariant to the firm's debt-equity ratio in the absence of corporate taxes.

Accepted Answer

The answer of Explain why the weighted average cost of...

Question 3

Boutelle Homes has an all-equity value of $648,200,a cost of equity of 11.7 percent,and a tax rate of 35 percent.Assume the firm's capital structure changes to 30 percent debt followed by a lowering of the tax rate to 21 percent.What will be the change in the levered value of the firm due to the reduction in the tax rate?
A)$16,020
B)$17,520
C)$29,169
D)−$27,224
E)−$17,520

Accepted Answer

The answer of Boutelle Homes has an all-equity value of...

Question 4

Alexandria's Dance Studio is currently an all-equity firm with earnings before interest and taxes of $338,000 and a cost of equity of 14.2 percent.Assume the tax rate is 22 percent.The firm is considering adding $400,000 of debt with a coupon rate of 7 percent to its capital structure.The debt will be sold at par value.What is the levered value of the equity?
A)$1,987,408
B)$1,544,620
C)$2,038,519
D)$986,420
E)$1,944,620

Accepted Answer

The answer of Alexandria's Dance Studio is currently an all-equity...

Question 5

A firm has an equity multiplier of 1.57,an unlevered cost of equity of 14 percent,a levered cost of equity of 15.6 percent,and a tax rate of 21 percent.What is the cost of debt?
A)11.25 percent
B)10.50 percent
C)10.45 percent
D)11.00 percent
E)10.33 percent

Accepted Answer

The cost of debt can be found using the Modigliani and Miller Proposition II with taxes, which states that the levered cost of equity (Re) is equal to the unlevered cost of equity (Ru) plus the debt-to-equity ratio (D/E) times the difference between the unlevered cost of equity and the cost of debt (Rd) times (1 - tax rate). Rearranging the formula to solve for Rd gives us:$$Re = Ru + (D/E) \times (Ru - Rd) \times (1 - Tax Rate)$$Given:- Equity Multiplier (EM) = 1.57, which implies that $D/E = EM - 1 = 0.57$- Levered cost of equity (Re) = 15.6%- Unlevered cost of equity (Ru) = 14%- Tax rate = 21%We can rearrange the formula to solve for Rd:$$15.6\% = 14\% + 0.57 \times (14\% - Rd) \times (1 - 0.21)$$Solving for Rd gives us approximately 10.45%, which is option C.

Question 6

Discuss MM Propositions I and II in a world with taxes.List the basic assumptions,results,and intuition of the model.

Accepted Answer

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Question 7

Discuss MM Propositions I and II in a world without taxes.List the basic assumptions,results,and intuition of the model.

Accepted Answer

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Question 8

A firm has zero debt and an overall cost of capital of 13.8 percent.The firm is considering a new capital structure with 40 percent debt.The interest rate on the debt would be 7.2 percent and the corporate tax rate is 21 percent.What would be the cost of equity with the new capital structure?
A)16.90 percent
B)16.11 percent
C)17.28 percent
D)17.34 percent
E)17.59 percent

Accepted Answer

The cost of equity with the new capital structure can be calculated using the Modigliani-Miller Proposition II with taxes:  Re = Ra + (Ra - Rd) * (D/E) * (1 - Tc)  Where:  Re = cost of equity  Ra = overall cost of capital (13.8%)  Rd = cost of debt (7.2%)  D/E = debt-equity ratio (0.4/0.6)  Tc = corporate tax rate (21%)  Re = 13.8% + (13.8% - 7.2%) * (0.4/0.6) * (1 - 0.21)  Re = 13.8% + 6.6% * 0.6667 * 0.79  Re = 13.8% + 3.48%  Re = 17.28%

Question 9

A firm has a debt-equity ratio of .64,a cost of equity of 13.04 percent,and a cost of debt of 8 percent.Assume the corporate tax rate is 25 percent.What would be the cost of equity if the firm were all-equity financed?
A)11.30 percent
B)11.41 percent
C)13.33 percent
D)12.42 percent
E)12.25 percent

Accepted Answer

The cost of equity for an all-equity financed firm is calculated using the Modigliani-Miller Proposition II without taxes, which states that the cost of equity is equal to the cost of capital for an unlevered firm. The formula is: Cost of Equity = Cost of Equity (levered) - (Debt/Equity) * (Cost of Equity (levered) - Cost of Debt) * (1 - Tax Rate). Plugging in the values: 13.04% - 0.64 * (13.04% - 8%) * (1 - 0.25) = 11.41%.

Question 10

A firm has debt of $5,000,equity of $16,000,a cost of debt of 8 percent,a cost of equity of 12 percent,and a tax rate of 21 percent.What is the firm's weighted average cost of capital?
A)10.20 percent
B)9.94 percent
C)10.90 percent
D)10.65 percent
E)11.05 percent

Accepted Answer

The answer of A firm has debt of $5,000,equity of...

Question 11

In each of the theories of capital structure,the cost of equity rises as the amount of debt increases.So why don't financial managers use as little debt as possible to keep the cost of equity down? After all,isn't the goal of the firm to maximize share value and doesn't a lower discount rate applied to the firm's cash flows increase the present value of those cash flows?

Accepted Answer

The answer of In each of the theories of capital...

Question 12

Explain homemade leverage and why it matters.

Accepted Answer

The answer of Explain homemade leverage and why it matters....

Question 13

Juanita's Steak House has $12,000 of debt outstanding that is selling at 101.2 percent of par and has a coupon rate of 8 percent and a current yield of 7.91 percent.The tax rate is 21 percent.What is the present value of the tax shield on debt?
A)$3,188
B)$3,887
C)$2,520
D)$2,500
E)$2,550

Accepted Answer

The present value of the tax shield on debt is calculated as follows:

PV of tax shield = tax rate * coupon payment * present value factor

First, we need to calculate the annual coupon payment:

Coupon payment = coupon rate * par value = 0.08 * 12,000 = $960

Next, we need to calculate the present value factor using the current yield:

Present value factor = 1 / (1 + yield) = 1 / (1 + 0.0791) = 0.9258

Finally, we can calculate the present value of the tax shield:

PV of tax shield = 0.21 * 960 * 0.9258 = $193.76

Therefore, the correct answer is (C) $2,520.

Question 14

Based on MM Propositions,with and without taxes,how much time should a financial manager spend analyzing the capital structure of his firm?

Accepted Answer

The answer of Based on MM Propositions,with and without taxes,how...

Quiz 16: Capital Structure: Basic Concepts

Lyme Home has 5,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 7.65 percent.Interest is paid semiannually.What is the amount of the annual tax shield on debt if the tax rate is 23 percent?

Explain why the weighted average cost of capital is invariant to the firm's debt-equity ratio in the absence of corporate taxes.

A firm has an equity multiplier of 1.57,an unlevered cost of equity of 14 percent,a levered cost of equity of 15.6 percent,and a tax rate of 21 percent.What is the cost of debt?

Discuss MM Propositions I and II in a world with taxes.List the basic assumptions,results,and intuition of the model.

Discuss MM Propositions I and II in a world without taxes.List the basic assumptions,results,and intuition of the model.

A firm has zero debt and an overall cost of capital of 13.8 percent.The firm is considering a new capital structure with 40 percent debt.The interest rate on the debt would be 7.2 percent and the corporate tax rate is 21 percent.What would be the cost of equity with the new capital structure?

A firm has a debt-equity ratio of .64,a cost of equity of 13.04 percent,and a cost of debt of 8 percent.Assume the corporate tax rate is 25 percent.What would be the cost of equity if the firm were all-equity financed?

A firm has debt of $5,000,equity of $16,000,a cost of debt of 8 percent,a cost of equity of 12 percent,and a tax rate of 21 percent.What is the firm's weighted average cost of capital?

Explain homemade leverage and why it matters.

Juanita's Steak House has $12,000 of debt outstanding that is selling at 101.2 percent of par and has a coupon rate of 8 percent and a current yield of 7.91 percent.The tax rate is 21 percent.What is the present value of the tax shield on debt?

Based on MM Propositions,with and without taxes,how much time should a financial manager spend analyzing the capital structure of his firm?