Chapter 18 Quiz, How Much Should a Firm Borrow?
1.
If a firm permanently borrows $20 million at an interest rate of 8%, what is the present value of the interest tax shield? Assume a 35% tax rate.
A.
$7.00 million
B.
$8.75 million
C.
$16.50 million
D.
$25.00 million
E.
None of the above
2.
In order to calculate the tax shield effect of interest payment, always use:
A.
Average tax rate
B.
Marginal tax rate
C.
State mandated tax rate
D.
None of the above
3.
The positive value to the firm by adding debt to the capital structure in the presence of corporate taxes is:
A.
Due to the extra cash flow going to the investors of the firm rather than the tax authorities
B.
Due to the earnings before interest and taxes being fully taxed at the corporate rate
C.
Because personal tax rates are the same as corporate tax rates
D.
Because shareholders prefer to let financial managers choose the capital structure thus making their value independent of it
4.
The Akron Company is unlevered with assets of $30 million and EBIT of $5 million. If the firm's tax rate is 34%, calculate its after-tax cash flow.
A.
$2.40 million
B.
$3.30 million
C.
$3.96 million
D.
$10.20 million
5.
If Miller is right and AAA corporate bonds yield 15%, what should be the yield on AAA municipal bonds? Assume a 35% corporate tax rate.
A.
9.75%
B.
12.35%
C.
15.00%
D.
23.08%
6.
If companies are unsure whether they will make taxable profits in the future:
A.
Safe, profitable companies will have an incentive to issue more debt than risky, unprofitable companies
B.
The aggregate amount of debt issued will be higher than predicted by Miller's theory of debt and taxes
C.
The equilibrium interest rate on corporate debt will be higher than predicted by Miller
D.
None of the above
7.
The possibility of bankruptcy has a negative effect on the value of the firm because:
A.
Increased bankruptcy risk lowers value
B.
Reorganization is costless but risk is not
C.
A bankruptcy has real costs associated with it
D.
Value enhancing strategies are no longer available
8.
What are some of the possible consequences of financial distress?
A.
Debtholders, who face the prospect of getting only part of their money back, are likely to want the company to take additional risks.
B.
Equity investors would like the company to cut its dividend payments to conserve cash.
C.
Equity investors would like the firm to shift toward riskier lines of business
D.
Equity investors would like the firm to settle up with creditors as fast as possible
9.
The main difference between a positive and negative covenant is (are):
A.
A positive covenant is one you must not do while a negative covenant must be carried out
B.
Actions that you must do regularly versus periodically
C.
A positive covenant is one you must do while a negative covenant is to limit actions the firm can take
D.
No difference as they are both restrictive
10.
The trade-off theory of capital structure predicts that:
A.
Unprofitable firms should borrow more than profitable ones
B.
Safe firms should borrow more than risky ones
C.
Rapidly growing firms should borrow more than mature firms
D.
Increasing leverage increases firm value
11.
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
12.
Financial slack means:
A.
Cash and marketable securities
B.
Readily saleable real assets
C.
Ready access to the debt markets
D.
Ready access to the equity markets
E.
All of the above
13.
The tax incentives to issue debt are highest for profitable companies which are sure to pay taxes in the future.
A.
True
B.
False
14.
The corporate tax shield on interest payments is worth more to some firms than to others.
A.
True
B.
False
15.
Bankruptcy not only has direct costs but also indirect costs.
A.
True
B.
False
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