MBA 621 exam 2 Questions & Answers
Verified 100% Correct
Which of the following statements is FALSE?
- The Law of One Price implies that leverage will affect the total value of the firm
under perfect capital market conditions.
- In the absence of taxes or other transaction costs, the total cash flow paid out to all of
a firm's security holders is equal to the total cash flow generated by the firm's assets.
- With perfect capital markets, leverage merely changes the allocation of cash flows
between debt and equity, without altering the total cash flows of the firm.
- In a perfect capital market, the total value of a firm is equal to the market value of the
total cash flows generated by its assets and is not affected by its choice of capital structure.
The Law of One Price implies that leverage will affect the total value of the firm under
perfect capital market conditions.
Consider two firms, With and Without, that have identical assets that generate identical cash
flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price
of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an
interest rate of 5%. According to MM Proposition 1, the stock price for With is closest to:
$6.00
Suppose that Taggart Transcontinental currently has no debt and has an equity cost of capital of
10%. Taggart is considering borrowing funds at a cost of 6% and using these funds to
,repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows
until they achieved a debt-to-value ratio of 20%, then Taggart's levered cost of equity
would be closest to:
11.0%
Which of the following statements is FALSE?
- With no debt, the WACC is equal to the unlevered equity cost of capital.
- With perfect capital markets, a firm's WACC is dependent of its capital structure and is
equal to its equity cost of capital only the firm it is unlevered.
- As the firm borrows at the low cost of capital for debt, its equity cost of capital rises, but
the net effect is that the firm's WACC is unchanged.
- Although debt has a lower cost of capital than equity, leverage does not lower a
firm's WACC.
With perfect capital markets, a firm's WACC is dependent of its capital structure and is equal to
its equity cost of capital only the firm it is unlevered.
Which of the following statements is/are TRUE?
I) In general, the gain to investors from the tax deductibility of interest payments is referred
to as the interest tax shield.
II) The interest tax shield is the additional amount that a firm would have paid in taxes if it
did not have leverage.
III) Because Corporations pay taxes on their profits after interest payments are
deducted, interest expenses reduce the amount of corporate tax firms must pay.
All of the above
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a
corporate tax rate of 21%. The total of Rosewood's net income and interest payments
is closest to:
, Net income + Interest expense = (EBIT - Interest expense)(1 - τC)+ Interest Expense= (450 -
175)(1 - .21)+ 175 = $217.25 + $175 = $392.25
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a
corporate tax rate of 21%. The amount of Rosewood's interest tax shield is closest to:
Interest expense x (τC) = 175x 0.21 = $36.75
37 million
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt
will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the
foreseeable future. The present value of Wyatt's annual interest tax shield is closest to:
$40 million
Which of the following statements is FALSE?
- To determine the benefit of leverage for the value of the firm, we must compute the
present value of the stream of future interest tax shields the firm will receive.
- Because the cash flows of the levered firm are equal to the sum of the cash flows from the
unlevered firm plus the interest tax shield, by the Law of One Price the same must be true
for the present values of these cash flows.
- By increasing the amount paid to debt holders through interest payments, the amount
of the pre-tax cash flows that must be paid as taxes increases.
- When a firm uses debt, the interest tax shield provides a corporate tax benefit each year.
By increasing the amount paid to debt holders through interest payments, the amount of
the pre-tax cash flows that must be paid as taxes increases.
Which of the following statements is FALSE?
- Given a forecast of future interest payments, we can determine the interest tax shield
and compute its present value by discounting it at a rate that corresponds to its risk.
Verified 100% Correct
Which of the following statements is FALSE?
- The Law of One Price implies that leverage will affect the total value of the firm
under perfect capital market conditions.
- In the absence of taxes or other transaction costs, the total cash flow paid out to all of
a firm's security holders is equal to the total cash flow generated by the firm's assets.
- With perfect capital markets, leverage merely changes the allocation of cash flows
between debt and equity, without altering the total cash flows of the firm.
- In a perfect capital market, the total value of a firm is equal to the market value of the
total cash flows generated by its assets and is not affected by its choice of capital structure.
The Law of One Price implies that leverage will affect the total value of the firm under
perfect capital market conditions.
Consider two firms, With and Without, that have identical assets that generate identical cash
flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price
of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an
interest rate of 5%. According to MM Proposition 1, the stock price for With is closest to:
$6.00
Suppose that Taggart Transcontinental currently has no debt and has an equity cost of capital of
10%. Taggart is considering borrowing funds at a cost of 6% and using these funds to
,repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows
until they achieved a debt-to-value ratio of 20%, then Taggart's levered cost of equity
would be closest to:
11.0%
Which of the following statements is FALSE?
- With no debt, the WACC is equal to the unlevered equity cost of capital.
- With perfect capital markets, a firm's WACC is dependent of its capital structure and is
equal to its equity cost of capital only the firm it is unlevered.
- As the firm borrows at the low cost of capital for debt, its equity cost of capital rises, but
the net effect is that the firm's WACC is unchanged.
- Although debt has a lower cost of capital than equity, leverage does not lower a
firm's WACC.
With perfect capital markets, a firm's WACC is dependent of its capital structure and is equal to
its equity cost of capital only the firm it is unlevered.
Which of the following statements is/are TRUE?
I) In general, the gain to investors from the tax deductibility of interest payments is referred
to as the interest tax shield.
II) The interest tax shield is the additional amount that a firm would have paid in taxes if it
did not have leverage.
III) Because Corporations pay taxes on their profits after interest payments are
deducted, interest expenses reduce the amount of corporate tax firms must pay.
All of the above
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a
corporate tax rate of 21%. The total of Rosewood's net income and interest payments
is closest to:
, Net income + Interest expense = (EBIT - Interest expense)(1 - τC)+ Interest Expense= (450 -
175)(1 - .21)+ 175 = $217.25 + $175 = $392.25
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a
corporate tax rate of 21%. The amount of Rosewood's interest tax shield is closest to:
Interest expense x (τC) = 175x 0.21 = $36.75
37 million
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt
will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the
foreseeable future. The present value of Wyatt's annual interest tax shield is closest to:
$40 million
Which of the following statements is FALSE?
- To determine the benefit of leverage for the value of the firm, we must compute the
present value of the stream of future interest tax shields the firm will receive.
- Because the cash flows of the levered firm are equal to the sum of the cash flows from the
unlevered firm plus the interest tax shield, by the Law of One Price the same must be true
for the present values of these cash flows.
- By increasing the amount paid to debt holders through interest payments, the amount
of the pre-tax cash flows that must be paid as taxes increases.
- When a firm uses debt, the interest tax shield provides a corporate tax benefit each year.
By increasing the amount paid to debt holders through interest payments, the amount of
the pre-tax cash flows that must be paid as taxes increases.
Which of the following statements is FALSE?
- Given a forecast of future interest payments, we can determine the interest tax shield
and compute its present value by discounting it at a rate that corresponds to its risk.
