978-0133423822 Chapter 15 Part 4

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15) Zybeck Corp. projects operating income of $4 million next year. The irm’s income tax

rate is 40%. Zybeck presently has 750,000 shares of common stock which have a market

value of $10 per share, no preferred stock, and no debt. The irm is considering two

alternatives to inance a new product: (a) the issuance of $6 million of 10% bonds, or (b)

the issuance of 60,000 new shares of common stock. There are no issuance costs for either

the bonds or the stock. If Zybeck issues common stock this year, what will projected EPS be

next year?

A) $2.10

B) $2.96

C) $2.33

D) $1.67

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

16) Zybeck Corp. projects operating income of $4 million next year. The irm’s income tax

rate is 40%. Zybeck presently has 750,000 shares of common stock which have a market

value of $10 per share, no preferred stock, and no debt. The irm is considering two

alternatives to inance a new product: (a) the issuance of $6 million of 10% bonds, or (b)

the issuance of 60,000 new shares of common stock at $10 per share. If Zybeck issues

common stock this year, what will the irm’s return on equity be next year?

A) 16.7%

B) 18.2%

C) 22.1%

D) 26.4%

E) 29.6%

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

17) Abbot Corp has a debt ratio (debt to assets) of 20%. Management is wondering if its

current capital structure is too conservative. Abbot Corp’s present EBIT is $4.5 million, and

proits available to common shareholders are $2,910,600, with 600,000 shares of common

stock outstanding. If the irm were to instead have a debt ratio of 40%, additional interest

expense would cause proits available to stockholders to decline to $2,851,200, but only

480,000 common shares would be outstanding. What is the diference in EPS at a debt ratio

of 40% versus 20%?

A) $4.85

B) $6.34

C) $1.09

D) $-0.10

Question Status: New question

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

18) Babbit Corp has a debt ratio (debt to assets) of 40%. Management is wondering if its

current capital structure is too conservative. Babbit Corp’s present EBIT is $4.5 million,

and proits available to common shareholders are $2,851,200, with 480,000 shares of

common stock outstanding. If the irm were to instead have a debt ratio of 60%, additional

interest expense would cause proits available to stockholders to decline to $2,791,800, but

only 384,000 common shares would be outstanding. What is the diference in EPS at a debt

ratio of 60% versus 40%?

A) $5.94

B) $1.33

C) $1.09

D) $-0.12

Question Status: New question

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

19) Cabot Corp has a debt ratio (debt to assets) of 60%. Management is wondering if its

current capital structure is too conservative. Cabot Corp’s present EBIT is $4.5 million, and

proits available to common shareholders are $2,791,800, with 384,000 shares of common

stock outstanding. If the irm were to instead have a debt ratio of 80%, additional interest

expense would cause proits available to stockholders to decline to $2,732,400, but only

307,200 common shares would be outstanding. What is the diference in EPS at a debt ratio

of 80% versus 60%?

A) $$1.62

B) $1.33

C) $7.27

D) $-0.15

Question Status: New question

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

Use the following information to answer the following question(s).

Your irm is trying to determine whether it should inance a project requiring $800,000

with new common stock or with debt. The irm is faced with the following inancing

alternatives:

I: Issue new common stock. Sale price of the common stock is expected to be $40 per

share.

II: Issue new bonds with a coupon rate of 12%.

The irm has a marginal tax rate of 34%, the company currently has 40,000 shares of

common stock outstanding, and $90,000 face value of 10% debt outstanding.

20) The indiference level of EBIT is

A) $99,000.

B) $66,600.

C) $333,000.

D) $297,000.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

21) EPS at the indiference level of EBIT is

A) $3.17.

B) $4.80.

C) $5.27.

D) $5.90.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

22) A irm is analyzing two diferent capital structures for inancing a new asset that will

cost $100,000. The efects of the two structures on the irm’s balance sheet are described

below.

Plan A: inance with 50% debt

New asset $100,000 Debt $50,000

Common equity $50,000

Total $100,000

Plan B: inance with 70% debt

New asset $100,000 Debt $70,000

Common equity $30,000

Total $100,000

Based on the information provided, we can conclude that

A) if the irm chooses Plan A, then any changes in the irm’s EBIT will lead to larger

luctuations in the irm’s EPS than if the irm chooses Plan B.

B) if the irm chooses Plan B, then any changes in the irm’s EBIT will lead to larger

luctuations in the irm’s EPS than if the irm chooses Plan A.

C) if the irm chooses Plan A, then any changes in the irm’s EBIT will lead to the same

luctuations in the irm’s EPS as will occur if the irm chooses Plan B.

D) if the irm chooses Plan B, then any changes in the irm’s EBIT will lead to smaller

luctuations in the irm’s EPS than if the irm chooses Plan A.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

23) The level of EBIT that will equate EPS between two diferent inancing plans is called

the

A) indiference point.

B) optimal capital plan.

C) pivot point.

D) tradeof point

Question Status: Revised

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

24) Useful ratios for benchmarking a irm’s capital structure include

A) the Debt ratio.

B) Times Interest Earned ratio.

C) EBITDA coverage ratio.

D) all of the above.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

25) Which of the following factors was most often cited by CFOs as an important inluence

on debt use?

A) Keeping the conidence of customers and suppliers

B) Minimizing bankruptcy costs

C) Maintaining inancial lexibility

D) Benchmarking against similar irms

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

26) The EBIT-EPS indiference point, sometimes called the break-even point, identiies the

optimal range of inancial leverage regardless of the inancing plan chosen by the inancial

manager.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

27) Comparative leverage ratio analysis does not involve the use of industry norms.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

28) High coverage ratios, compared with a standard, imply unused debt capacity.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

29) Benchmarking the company’s capital structure is popular because it is impossible to

know exactly what the company’s optimal capital structure should be.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

30) Rising bankruptcy costs should cause most irms to use less debt and more equity.

Question Status: New question

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

31) Roberts, Inc. is trying to decide how best to inance a proposed $10 million capital

investment. Under Plan I, the project will be inanced entirely with long-term 9% bonds.

The irm currently has no debt or preferred stock. Under Plan II, common stock will be sold

to net the irm $20 a share; presently, 1 million shares are outstanding. The corporate tax

rate for Roberts is 40%.

a. Calculate the indiference level of EBIT associated with the two inancing plans.

b. Which inancing plan would you expect to cause the greatest change in EPS relative to a

change in EBIT? Why?

c. If EBIT is expected to be $3.1 million, which plan will result in a higher EPS?

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

32) Young Enterprises is inanced entirely with 3 million shares of common stock selling for

$20 a share. Capital of $4 million is needed for this year’s capital budget. Additional funds

can be raised with new stock (ignore dilution) or with 13% 10-year bonds. Young’s tax rate

is 40%.

a. Calculate the inancing plan’s EBIT indiference point.

b. Does the “indiference point” calculated in question (a) above truly represent a point

where stockholders are indiferent between stock and debt inancing? Explain your answer.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

33) The MAX Corporation is planning a $4 million expansion this year. The expansion can

be inanced by issuing either common stock or bonds. The new common stock can be sold

for $60 per share. The bonds can be issued with a 12% coupon rate. The irm’s existing

shares of preferred stock pay dividends of $2.00 per share. The company’s combined state

and federal corporate income tax rate is 46%. The company’s balance sheet prior to

expansion is as follows:

MAX Corporation

Current assets $ 2,000,000

Fixed assets 8,000,000

Total assets $10,000,000

Current liabilities $ 1,500,000

Bonds:

(8%, $1,000 par value) 1,000,000

(10%, $1,000 par value) 4,000,000

Preferred stock:

($100 par value) 500,000

Common stock:

($2 par value) 700,000

Retained earnings 2,300,000

Total liabilities and equity $10,000,000

a. Calculate the indiference level of EBIT between the two plans.

b. If EBIT is expected to be $3 million, which plan will result in higher EPS?

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

34) Sunshine Candy Company’s capital structure for the past year of operation is shown

below.

First mortgage bonds at 12% $2,000,000

Debentures at 15% 1,500,000

Common stock (1 million shares) 5,000,000

Retained earnings 500,000

Total $9,000,000

The federal tax rate is 50%. Sunshine Candy Company, home-based in Orlando, wants to

raise an additional $1 million to open new facilities in Tampa and Miami. The irm can

accomplish this via two alternatives: (1) it can sell a new issue of 20-year debentures with

16% interest; or (2) 20,000 new shares of common stock can be sold to the public to net the

candy company $50 per share. A recent study, performed by an outside consulting

organization, projected Sunshine Candy Company’s long-term EBIT level at approximately

$6.8 million. Find the indiference level of EBIT (with regard to EPS) between the

suggested inancing plans.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value

35) Allston-Brighton Corp. has total assets of $10 million, total liabilities of $4 million, of

which $1 million are non-interest bearing. Interest expense was $180,000. Earnings before

interest and taxes were $2.5 million. Depreciation was $1.5 million. Compute the following

ratios: Debt ratio, Interest-bearing debt ratio, Times interest earned ratio, and EBITDA

coverage ratio.

Question Status: Previous edition

Objective: 15.4 Use the basic terms of inancial analysis to analyze a irm’s inancing decisions.

Keywords: EBIT-EPS

Principles: Principle 3: Cash Flows Are the Source of Value