Corporate Finance Final Practice Exam Questions with Complete Solutions

An unlevered firm has a cost of capital of 14% and earnings before interest and taxes of $150,000. A levered firm with the same operations and assets has both a book value and a face value of debt of $700,000 with a 7% annual coupon. The applicable tax rate is 35%. What is the value of the levered firm? - ANSWER-$941,429 Financial leverage impacts the performance of the firm by: - ANSWER-increasing the volatility of the firm's net income. Gail's Dance Studio is currently an all equity firm that has 80,000 shares of stock outstanding with a market price of $42 a share. The current cost of equity is 12% and the tax rate is 34%. Gail is considering adding $1 million of debt with a coupon rate of 8% to her capital structure. The debt will be sold at par value. What is the levered value of the equity? - ANSWER-$2.7 million Hey Guys!, Inc. has debt with both a face and a market value of $3,000. This debt has a coupon rate of 7% and pays interest annually. The expected earnings before interest and taxes is $1,200, the tax rate is 34%, and the unlevered cost of capital is 12%. What is the firm's cost of equity? - ANSWER-14.14% MM Proposition I with taxes supports the theory that: - ANSWER-there is a positive linear relationship between the amount of debt in a levered firm and its value. MM Proposition II with taxes: - ANSWER-has the same general implications as MM Proposition II without taxes. The Modigliani-Miller Proposition I without taxes states: - ANSWER-a firm cannot change the total value of its outstanding securities by changing its capital structure proportions. The WACC is used to _______ the expected cash flows when the firm has ____________. - ANSWER-discount; debt and equity in the capital structure The increase in risk to equityholders when financial leverage is introduced is evidenced by: - ANSWER-a higher variability of EPS with debt than all equity. The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as: - ANSWER-MM Proposition I with no tax. The reason that MM Proposition I does not hold in the presence of corporate taxation is because: - ANSWER-levered firms pay less taxes compared with identical unlevered firms.