MBA 621 Sample Exam Questions &
Answers Verified 100% Correct
$6.00
Under MM I, the total value of With and Without must be the same.Value(Without) =
1,000,000 × $24 = $24 millionValue(levered equity) = value(With) - debt = $24 M - $12M = $12
MPrice per share = $12M/2M = $6.00
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:
$8.00
$24.00
$6.00
$12.00
11.0%
re = ru +D/E(ru-rd) = 10% +20%/80%(10%-6%) = 11%
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:
8.0%
9.2%
10.0%
11.0%
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 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.
All of above
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.II) Because Corporations pay taxes on their profits after interest payments are
deducted, interest expenses reduce the amount of corporate tax firms must pay. I only
I and II only
II and III only
All of above
$392 million
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 total of Rosewood's net income and interest payments is closest to:
$270 million
$392 million
$290 million
$450 million
$37 million
, Interest expense x (τC) = 175x 0.21 = $36.75
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: $115 million
$90 million
$175 million
$37 million
$40 million
PV Tax shield = (debtinterest ratetax rate)/discount rate = ($1007%40%)/7% = $40 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:
$4.2 million
$7.0 million
$40 million
$60 million
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?
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.
Answers Verified 100% Correct
$6.00
Under MM I, the total value of With and Without must be the same.Value(Without) =
1,000,000 × $24 = $24 millionValue(levered equity) = value(With) - debt = $24 M - $12M = $12
MPrice per share = $12M/2M = $6.00
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:
$8.00
$24.00
$6.00
$12.00
11.0%
re = ru +D/E(ru-rd) = 10% +20%/80%(10%-6%) = 11%
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:
8.0%
9.2%
10.0%
11.0%
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 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.
All of above
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.II) Because Corporations pay taxes on their profits after interest payments are
deducted, interest expenses reduce the amount of corporate tax firms must pay. I only
I and II only
II and III only
All of above
$392 million
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 total of Rosewood's net income and interest payments is closest to:
$270 million
$392 million
$290 million
$450 million
$37 million
, Interest expense x (τC) = 175x 0.21 = $36.75
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: $115 million
$90 million
$175 million
$37 million
$40 million
PV Tax shield = (debtinterest ratetax rate)/discount rate = ($1007%40%)/7% = $40 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:
$4.2 million
$7.0 million
$40 million
$60 million
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?
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.
