Question 1
The main advantage of debt financing for a firm is:
I) no SEC registration is required for bond issue
II) interest expense of a firm is tax deductible
III) unlevered firms have higher value than levered firms
A.I only
B.II only
C.III only
D.I and III only
Question 2
If a firm permanently borrows $100 million at an interest rate of 8%, what is the present value of the interest tax shield? (Assume that the tax rate is 30%)
A.$8.00 million
B.$5.6 million
C.$30 million
D.$26.67 million
E. None of the above
PV of interest tax shield = (0.3)(100) = $30 million
Question 3
In order to calculate the tax shields provided by debt, the tax rate used is the:
A. average corporate tax rate
B. marginal corporate tax rate
C. average of shareholders' tax rates
D. average of bondholders' tax rates
Question 4
The reason that MM Proposition I does not hold good in the presence of corporate taxes is because:
A. Levered firms pay lower taxes when compared with identical unlevered firms
B. Bondholders require higher rates of return compared with stockholders
C. Earnings per share are no longer relevant with taxes
D. Dividends are no longer relevant with taxes
Question 5
Assuming that bonds are sold at a fair price, the benefits from the tax shield go to the:
A. managers of the firm
B. bondholders of the firm
C. stockholders of the firm
D. lawyers of the firm
Question 6
The pecking order theory of capital structure predicts that:
A. If two firms are equally profitable, the more rapidly growing firm will borrow more, other things equal
B. Firms prefer equity to debt financing
C. Risky firms will end up borrowing less
D. Risky firms will end up borrowing more
Question 7
Capital budgeting decisions that include both investment and financing decisions can be analyzed by:
I) Adjusting the present value
II) Adjusting the discount rate
III) Ignoring financing mix
A.I only
B.II only
C.III only
D.I and II only
Question 8
The after-tax weighted average cost of capital is determined by:
A. Multiplying the weighted average after tax cost of debt by the weighted average cost of equity
B. Adding the weighted average before tax cost of debt to the weighted average cost of equity
C. Adding the weighted average after tax cost of debt to the weighted average cost of equity
D. Dividing the weighted average before tax cost of debt to the weighted average cost of equity
Question 9
In calculating the weighted average cost of capital, the values used for D, E and V are:
A. book values
B. liquidating values
C. market values
D. none of the above
Question 10
A firm has a total market value of $10 million and debt has a market value of $4 million. What is the after-tax weighted average cost of capital if the before - tax cost of debt is 10%, the cost of equity is 15% and the tax rate is 35%?
A.13%
B.11.6%
C.8.75%
D. None of the given answers
WACC = 0.4(0.10)(1 - 0.35) + 0.6(0.15) = 11.6%
Question 11
Given the following data for year-1:
Profits after taxes = $20 millions;
Depreciation = $6 millions;
Interest expense = $4 millions;
Investment in fixed assets = $12 millions;
Investment in working capital = $4 millions.
Calculate the free cash flow (FCF) for year-1:
A.$4 millions
B.$6 millions
C.$10 millions
D. none of the above
FCF = 20 + 6 - 12 - 4 = $10 millions
Question 12
Lowering debt-equity ratio of a firm can change:
I) financing proportions
II) cost of equity
III) cost of debt
IV) effective tax rate
A.II and III only
B.I only
C.I, II, and III only
D.I, II, III and IV
Question 13
Floatation costs are incorporated into the APV framework by:
A. Adding them into the all equity value of the project.
B. Subtracting them from all equity value of the project.
C. Incorporating them into the WACC.
D. Disregarding them.
Question 14
Subsidized loans have the effect of:
A. Increasing the NPV of the loan, thereby reducing the APV.
B. Decreasing the NPV of the loan, thereby reducing the APV.
C. Decreasing the NPV of the loan, thereby increasing the APV.
D. Increasing the NPV of the loan, thereby increasing the APV.
Question 15
APV method is most useful in analyzing:
A. large international projects
B. domestic projects
C. small projects
D. none of the above