Question 1

Which of the following statements is FALSE?

Accepted Answer

A)  A biotech firm might be developing drugs with tremendous potential, but it has yet to receive any revenue from these drugs. Such a firm will not have taxable earnings. In that case, a tax-optimal capital structure does not include debt.
B)  No corporate tax benefit arises from incurring interest payments that regularly exceed EBIT.
C)  The optimal level of leverage from a tax saving perspective is the level such that interest equals EBIT.
D)  In general, as a firm's interest expense approaches its expected taxable earnings, the marginal tax advantage of debt increases, limiting the amount of equity the firm should use.E) All of the above
F) C) and D)

Question 2

Which of the following statements is FALSE?

Accepted Answer

A)  Even after adjusting for personal taxes, the value of an unlevered firm exceeds the value of a levered firm, and there is a tax advantage to using debt financing.
B)  In Modigliani and Miller's setting of perfect capital markets, firms could use any combination of debt and equity to finance their investments without changing the value of the firm.
C)  When firms raise new capital from investors, they do so primarily by issuing debt.
D)  In most years aggregate equity issues are negative, meaning that firms are reducing the amount of equity outstanding by buying shares.E) All of the above
F) A) and B)

Question 3

Consider the following formula: τ* = e is: A) the effective personal tax rate on equity. B) the effective tax advantage of debt. C) the effective corporate tax rate on income. D) the effective personal tax rate on interest income." class="answers-bank-image d-inline" rel="preload" > The term τe is:

Accepted Answer

A)  the effective personal tax rate on equity.
B)  the effective tax advantage of debt.
C)  the effective corporate tax rate on income.
D)  the effective personal tax rate on interest income.E) B) and C)
F) A) and C)

Question 4

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
-If Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff as an all equity firm would be closest to:

Accepted Answer

A)  $80 million
B)  $100 million
C)  $73 million
D)  $115 millionE) A) and B)
F) C) and D)

Question 5

KAHR Incorporated will have EBIT this coming year of $45 million. It will also spend $18 million on total capital expenditures and increases in net working capital, and have $9 million in depreciation expenses. KAHR is currently an all-equity firm with a corporate tax rate of 35% and a cost of capital of 10%. If the interest rate on new KAHR debt is 8%, how much should KAHR borrow today if they want to maximize there interest tax shield?

Accepted Answer

Amount to ...

Question 6

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
-If Flagstaff maintains a debt to equity ratio of 1, then Flagstaff's pre-tax WACC is closest to:

Accepted Answer

A)  11.0%
B)  10.5%
C)  10.0%
D)  9.0%E) A) and B)
F) All of the above

Question 7

Which of the following statements is FALSE?

Accepted Answer

A)  In general, the gain to investors from the tax deductibility of interest payments is referred to as the interest tax shield.
B)  The interest tax shield is the additional amount that a firm would have paid in taxes if it did not have leverage.
C)  Because Corporations pay taxes on their profits after interest payments are deducted, interest expenses reduce the amount of corporate tax firms must pay.
D)  As Modigliani and Miller made clear in their original work, capital structure matters in perfect capital markets. Thus, if capital structure does not matter, then it must stem from a market imperfection.E) None of the above
F) A) and D)

Question 8

Use the table for the question(s) below.
Consider the following top federal tax rates in the United States:
Personal Tax Rates
 
-In 2000, assuming an average dividend payout ratio of 50%, the effective tax rate for equity holders was closest to:

Accepted Answer

A)  69%
B)  65%
C)  55%
D)  30%E) A) and B)
F) A) and D)

Question 9

Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ Millions) :
 
-The income that would be available to equity holders in 2006 if Kroger was not levered is closest to:

Accepted Answer

A)  $1,525 million
B)  $2,035 million
C)  $1,500 million
D)  $1,325 millionE) A) and B)
F) A) and C)

Question 10

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
-Assume that investors hold Google stock in retirement accounts that are free from personal taxes. If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently, then the amount that Google needs to borrow is closest to:

Accepted Answer

A)  $14.25 billion
B)  $22.00 billion
C)  $24.50 billion
D)  $40.75 billionE) B) and C)
F) A) and B)

Question 11

Which of the following statements is FALSE?

Accepted Answer

A)  Personal taxes have the potential to offset some of the corporate tax benefits of leverage.
B)  The actual interest tax shield depends on the reduction in the total taxes (both corporate and personal) that are paid.
C)  The amount of money an investor will pay for a security ultimately depends on the benefits the investor will receive-namely, the cash flows the investor will receive before all taxes have been paid.
D)  Just like corporate taxes, personal taxes reduce the cash flows to investors and diminish firm value.E) None of the above
F) A) and C)

Question 12

Use the information for the question(s) below.
KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt. KD has had consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
-After the recapitalization, the total value of KD as a levered firm is closest to:

Accepted Answer

A)  $470 million
B)  $730 million
C)  $670 million
D)  $530 millionE) C) and D)
F) B) and D)

Question 13

Use the following information to answer the question(s) below.
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.
-Assume that five years have passed since Wyatt issued this debt. While tax rates have remained at 40%, interest rates have dropped so that Wyatt's current cost of debt capital is now only 4%. Wyatt's annual interest tax shield is now closest to:

Accepted Answer

A)  $2.8 million
B)  $4.2 million
C)  $40.0 million
D)  $60.0 millionE) A) and B)
F) None of the above

Question 14

Use the table for the question(s) below.
Consider the following top federal tax rates in the United States:
Personal Tax Rates
 
-In 2005, the effective tax rate for debt holders was closest to:

Accepted Answer

A)  58%
B)  35%
C)  40%
D)  65%E) None of the above
F) C) and D)

Question 15

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
-Assume that investors in Google pay a 15% tax rate on income from equity and a 25% tax rate on interest income. If Google were to issue sufficient debt to reduce its taxes by $600 million per year permanently, then the effective tax advantage of this debt would be closest to:

Accepted Answer

A)  10%
B)  15%
C)  25%
D)  30%E) B) and C)
F) None of the above

Question 16

Consider the following formula: VL = VU + L = VU +   The term   represents: A) the value of firm with leverage. B) the present value of the interest tax shield. C) the preset value of the future interest payments. D) the interest tax shield each year." class="answers-bank-image d-inline" rel="preload" > The term L = VU +   The term   represents: A) the value of firm with leverage. B) the present value of the interest tax shield. C) the preset value of the future interest payments. D) the interest tax shield each year." class="answers-bank-image d-inline" rel="preload" > represents:

Accepted Answer

A)  the value of firm with leverage.
B)  the present value of the interest tax shield.
C)  the preset value of the future interest payments.
D)  the interest tax shield each year.E) A) and B)
F) All of the above

Question 17

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
-Assume that investors hold Google stock in retirement accounts that are free from personal taxes. If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently, then the value that would be created is closest to:

Accepted Answer

A)  $14.25 billion
B)  $22.00 billion
C)  $24.50 billion
D)  $40.75 billionE) A) and B)
F) B) and C)

Question 18

Use the following information to answer the question(s) below.
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.
-Which of the following statements is FALSE?

Accepted Answer

A)  The tax deductibility of interest lowers the effective cost of debt financing for the firm.
B)  When a firm uses debt financing, the cost of the interest it must pay is offset to some extent by the tax savings from the interest tax shield.
C)  With tax-deductible interest, the effective after-tax borrowing rate is r(τ
C)  .
D)  The WACC represents the cost of capital for the free cash flow generated by the firm's assets.E) B) and C)
F) None of the above

Question 19

Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in taxes. Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
-Assume that investors hold Google stock in retirement accounts that are free from personal taxes. If Google were to issue sufficient debt to reduce its taxes by $600 million per year permanently, then the amount that Google needs to borrow is closest to:

Accepted Answer

A)  $14.25 billion
B)  $22.00 billion
C)  $24.50 billion
D)  $40.75 billionE) C) and D)
F) B) and D)

Question 20

Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.
-If Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff as a levered firm is closest to:

Accepted Answer

A)  $114 million
B)  $100 million
C)  $111 million
D)  $140 millionE) A) and D)
F) B) and D)

Exam 15: Debt and Taxes

Which of the following statements is FALSE?

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Consider the following formula: V_L = V_U + The term represents:

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Which of the following statements is FALSE?

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Which of the following statements is FALSE?

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Which of the following statements is FALSE?

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Use the table for the question(s) below. Consider the following top federal tax rates in the United States: Personal Tax Rates -In 2005, the effective tax rate for debt holders was closest to:

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Amount to ...
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Consider the following formula: τ* = The term τ_e is:

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Use the table for the question(s) below. Consider the following top federal tax rates in the United States: Personal Tax Rates -In 2000, assuming an average dividend payout ratio of 50%, the effective tax rate for equity holders was closest to:

Correct Answer
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Use the table for the question(s) below. Consider the following income statement for Kroger Inc. (all figures in $ Millions) : -The income that would be available to equity holders in 2006 if Kroger was not levered is closest to:

Correct Answer
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Exam 15: Debt and Taxes

Which of the following statements is FALSE?

Correct AnswerverifiedShow Answer

Consider the following formula: VL = VU + The term represents:

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Which of the following statements is FALSE?

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Which of the following statements is FALSE?

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Which of the following statements is FALSE?

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Use the table for the question(s) below. Consider the following top federal tax rates in the United States: Personal Tax Rates -In 2005, the effective tax rate for debt holders was closest to:

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Consider the following formula: τ* = The term τe is:

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Use the table for the question(s) below. Consider the following top federal tax rates in the United States: Personal Tax Rates -In 2000, assuming an average dividend payout ratio of 50%, the effective tax rate for equity holders was closest to:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Use the table for the question(s) below. Consider the following income statement for Kroger Inc. (all figures in $ Millions) : -The income that would be available to equity holders in 2006 if Kroger was not levered is closest to:

Correct AnswerverifiedShow Answer

Correct Answer
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Consider the following formula: V_L = V_U + The term represents:

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Amount to ...
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Consider the following formula: τ* = The term τ_e is:

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