FINA 5320 - Ch. 16, 18 Questions with Correct
Answers
Pineda Gallery 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?
$1,544,620
A general rule for managers to follow is to set the firm's capital structure such that the
firm's:
value is maximized.
Cuellar's has debt with a book value of $285,000 and a market value of $263,000. The
firm's equity has a book value of $418,000 and a market value of $612,000. The tax rate
is 21 percent and the cost of capital is 12.4 percent. What is the market value of this
firm based on MM Proposition I without taxes?
$875,000
MM Proposition I without taxes does not hold when corporate taxes are introduced
because:
levered firms pay less in taxes than identical unlevered firms.
A firm has a debt-equity ratio of .52, a pretax cost of debt of 6.5 percent, and a required
return on assets of 12 percent. Ignoring taxes, what is the cost of equity?
14.86 percent
, Hossain Health has a levered cost of equity of 13.84 percent and an unlevered cost of
capital of 12.5 percent. The company has $5,000 in debt that is selling at par. The
levered value of the firm is $14,600 and the tax rate is 25 percent. What is the pretax
cost of debt?
9.07 percent
Agave Group has an unlevered cost of capital of 11.6 percent, a cost of debt of 7.9
percent, and a tax rate of 23 percent. What is the target debt-equity ratio if the targeted
levered cost of equity is 12.6 percent?
.35
The tax shield on debt is one reason why:
a firm's net cost of debt is generally less than its cost of equity.
Javed Medical Management 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?
$87,975
According to MM Proposition II with no taxes, the:
required return on equity is a linear function of the firm's debt-equity ratio.
A 40 percent owner of Nguyen Medical Group is electing to retire. The other
shareholders in this closely held, all-equity firm have agreed that the firm will borrow
$1.8 million to purchase the retiring owner's 3,000 shares of stock. Ignoring taxes, what
is the total value of this firm?
$4.5 million
Answers
Pineda Gallery 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?
$1,544,620
A general rule for managers to follow is to set the firm's capital structure such that the
firm's:
value is maximized.
Cuellar's has debt with a book value of $285,000 and a market value of $263,000. The
firm's equity has a book value of $418,000 and a market value of $612,000. The tax rate
is 21 percent and the cost of capital is 12.4 percent. What is the market value of this
firm based on MM Proposition I without taxes?
$875,000
MM Proposition I without taxes does not hold when corporate taxes are introduced
because:
levered firms pay less in taxes than identical unlevered firms.
A firm has a debt-equity ratio of .52, a pretax cost of debt of 6.5 percent, and a required
return on assets of 12 percent. Ignoring taxes, what is the cost of equity?
14.86 percent
, Hossain Health has a levered cost of equity of 13.84 percent and an unlevered cost of
capital of 12.5 percent. The company has $5,000 in debt that is selling at par. The
levered value of the firm is $14,600 and the tax rate is 25 percent. What is the pretax
cost of debt?
9.07 percent
Agave Group has an unlevered cost of capital of 11.6 percent, a cost of debt of 7.9
percent, and a tax rate of 23 percent. What is the target debt-equity ratio if the targeted
levered cost of equity is 12.6 percent?
.35
The tax shield on debt is one reason why:
a firm's net cost of debt is generally less than its cost of equity.
Javed Medical Management 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?
$87,975
According to MM Proposition II with no taxes, the:
required return on equity is a linear function of the firm's debt-equity ratio.
A 40 percent owner of Nguyen Medical Group is electing to retire. The other
shareholders in this closely held, all-equity firm have agreed that the firm will borrow
$1.8 million to purchase the retiring owner's 3,000 shares of stock. Ignoring taxes, what
is the total value of this firm?
$4.5 million
