Question 1

In this problem, we admit only one real-world factor in an otherwise ideal capital market.This real world factor is corporate taxation; specifically that interest payments on debt are deductible while dividend payments are not deductible.Suppose Delaware East, Inc.has until now been an all-equity firm with a market value of $100 mn.Now, the firm decides to increase its leverage by issuing $40 mn.in debt, with the proceeds being used to pay a dividend to shareholders.Assuming that this debt will be a permanent part of the firm's capital structure, and that the firm's tax rate is 34%, and accounting for the deductibility of the interest on the debt, what is the total market value of the firm after the recapitalization?

Accepted Answer

A)  $113.6 mn.
B)  $100 mn.
C)  $73.6 mn.
D)  $13.6 mn.E) B) and D)
F) B) and C)

Question 2

The ______hypothesis is stated as follows: Among long-term assets, the firm should finance long-term tangible assets, such as PP&E, with long-term debt, while other long-term assets, such as investments and intangibles, must be financed with equity.

Accepted Answer

A)  tangible asset
B)  debt-equity
C)  collateral
D)  FisherE) None of the above
F) B) and D)

Question 3

The tradeoff in the traditional tradeoff theory of optimal capital structure is between:

Accepted Answer

A)  agency costs of debt and information asymmetry costs of debt.
B)  the tax benefit of debt and the expected costs of future financial distress.
C)  the tax benefit of debt and agency costs of debt.D) B) and C)
E) All of the above

Question 4

According to the ________hypothesis, short-term assets should be financed with short-term capital and long-term assets with long-term capital.

Accepted Answer

A)  maturity matching
B)  hedging
C)  risk-return
D)  capital assetE) All of the above
F) A) and B) A

Question 5

Compute the present value of the tax shield generated when Smith Company issues $100 mn.in perpetual debt with an 8% coupon rate, and uses the proceeds to retire equity.The corporate tax rate is 34%.

Accepted Answer

A)  $2.72 mn.
B)  $8 mn.
C)  $34 mn.
D)  272 mn.E) A) and B)
F) B) and D) C

Question 6

The current market value of the assets of levered firm ABC, Inc.is $100 million.The annual standard deviation of returns on the assets is 30%.The firm's capital structure consists of equity and pure discount debt for which payment of $80 million is due in 5 years.The risk-free rate is 5%.Using the Black-Scholes Option Pricing Model to calculate the value of the firm's debt.

Accepted Answer

A)  $44
B)  $55
C)  $66
D)  $77E) All of the above
F) A) and B) B

Exam 6: The Leverage Decision

Correct Answer
verified

The ______hypothesis is stated as follows: Among long-term assets, the firm should finance long-term tangible assets, such as PP&E, with long-term debt, while other long-term assets, such as investments and intangibles, must be financed with equity.

Correct Answer
verified

The tradeoff in the traditional tradeoff theory of optimal capital structure is between:

Correct Answer
verified

According to the ________hypothesis, short-term assets should be financed with short-term capital and long-term assets with long-term capital.

Correct Answer
verified
A

Compute the present value of the tax shield generated when Smith Company issues $100 mn.in perpetual debt with an 8% coupon rate, and uses the proceeds to retire equity.The corporate tax rate is 34%.

Correct Answer
verified
C

Correct Answer
verified
B

Exam 6: The Leverage Decision

Correct AnswerverifiedShow Answer

The ______hypothesis is stated as follows: Among long-term assets, the firm should finance long-term tangible assets, such as PP&E, with long-term debt, while other long-term assets, such as investments and intangibles, must be financed with equity.

Correct AnswerverifiedShow Answer

The tradeoff in the traditional tradeoff theory of optimal capital structure is between:

Correct AnswerverifiedShow Answer

According to the ________hypothesis, short-term assets should be financed with short-term capital and long-term assets with long-term capital.

Correct AnswerverifiedA

Compute the present value of the tax shield generated when Smith Company issues $100 mn.in perpetual debt with an 8% coupon rate, and uses the proceeds to retire equity.The corporate tax rate is 34%.

Correct AnswerverifiedC

Correct AnswerverifiedB

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
A

Correct Answer
verified
C

Correct Answer
verified
B