1.An all equity firm has 400,000 shares outstanding. Its management has decided to issue debt and use the receipt to buy back 200,000 shares.The firm will have to make $400,000 in interest payments for the new debt.At what EBIT will the firm be indifferent between its old all equity capital structure and the new leveraged capital structure?

2.FEDUP co expects an EBIT of $10,000 per year indefinitely.The firm currently has no debt, and its cost of equity is 15%.FEDUP can borrow at 10%.If the corporate tax rate is 35%, what is the value of the firm?

3.A firm has the following information for the last two years.Calculate its degree of financial leverage.

This year - sales $1,500,000; operating costs $900,000; net income $150,000; and number of shares outstanding = 50,000

Last year - sales $1,400,000; operating costs $850,000; net income $130,000; and number of shares outstanding = 50,000

4.Allegra Inc has one million shares outstanding.The company is considering the issue of debt of $10 million.The interest rate on this new debt issue will be 8%, and the number of shares after the debt issue will be reduced to 500,000.Given a corporate rate of 35%, what is the EBIT that will cause the firm's earning per share to be indifferent between issuing and not issuing debt?

5.Mrs. Abecrombus has $2000 to invest in one of two possible investments; a levered fir mwiht a D/E ratio of 1 and a share price of $20, and a risk free asset with a return of 10%.If Mrs. Abecrombus prefers a D/E ratio of 2, how can she use homemade leverage to achieve her goal?

6.Async Inc and Sync Corp bot hhave the same EBIT of $5 million and tax rate of 35%.Async is all equity financed with a cost of capital of 13%, whereas Sync has debt of $8 million.What is sync's firm value using the M&M Proposition?

7.You are a business analyst with a big investment bank, and you are evaluating the equity risk, business risk, and financial risk of Abilon's Inc.You went online and found that the industry consensus on Abilon's equity risk is 1.5.You also know that the company's debt equity ratio is 1.What is Abilon;s estimated business and financial risk based on the model BA(1+D/E)?

8.Aceline Corp is currently all equity financed, with a cost of capital of 15% and a firm value of $10 million.The company is considering a $3 million debt issue at an 8% interest rate.The money raised will be used to repurchase shares.The company's marginal tax rate is 35%.According to the M&M Proposition, what is Aceline's WACC after the debt issue?

Multiple Choice

1. Introducing personal taxes into the valuation of firms does not affect the valuation formula as long as

a)Equity distributions are taxed more heavily than interest income at the personal level

b)Equity distributions are taxed less heavily than interest income at the personal level

c)Equity distributions are taxed identically to interest income at the personal level

d)Equity distributions are taxed more heavily at the corporate level than at the personal level

e)Interest income is taxed more heavily at the corporate level than at the personal level

2. According to the static theory of capital structure,

a)The greater the volatility in EBIT, the less a firm should borrow

b)The higher the financial costs, the less a firm should borrow

c)The higher the accumulated losses, the less a firm should borrow

d)The higher the tax rate, the more a firm should borrow

e)All of the above are true

3. According to M&M Proposition I with taxes,

a)The optimal capital structure is 100% debt

b)The optimal capital structure is 50% debt

c)The optimal capital structure is 25% debt

d)The optimal capital structure is 0% debt

e)Capital structure decisions are irrelevant

4. Introducing personal taxes into the valuation of firms does not affect the valuation formula as long as

a)Equity distributions are taxed more heavily than interest income at the personal level

b)Equity distributions are taxed less heavily than interest income at the personal level

c)Equity distributions are taxed identically to interest income at the personal level

d)Equity distributions are taxed more heavily at the corporate level than at the personal level

e)Interest income is taxed more heavily at the corporate level than at the personal level

5.The trade off that defines the static theory of capital structure is

a)Direct bankruptcy costs versus financial distress costs

b)Direct bankruptcy costs versus the value of the firm

c)Financial distress costs versus present value of tax shield on debt

d)Financial distress costs versus the value of the firm

e)Flotation costs of issuing securities versus the value of the firm

Answer rating: 100% (QA)

ANSWER 1 To find the EBIT at which the firm is indifferent between its old all equity capital structure and the new leveraged capital structure we need to determine the point where the two structures ... View the full answer