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41) A firm has a debt-equity ratio of .48. Its cost of debt is 7 percent and its WACC is 10.8
percent. What is its cost of equity if there are no taxes or other imperfections?
A) 10.97 percent
B) 13.05 percent
C) 12.62 percent
D) 11.46 percent
E) 13.67 percent
42) A firm has a debt-equity ratio of 1, a cost of equity of 16 percent, and a cost of debt of 8
percent. If there are no taxes or other imperfections, what is its unlevered cost of equity?
A) 8 percent
B) 10 percent
C) 12 percent
D) 14 percent
E) 16 percent
43) A firm has a debt-equity ratio of .55 with a cost of debt of 6.7 percent. If it had no debt, its
cost of equity would be 14.5 percent. What is its levered cost of equity assuming there are no
taxes or other imperfections?
A) 18.96 percent
B) 15.82 percent
C) 17.94 percent
D) 18.79 percent
E) 13.67 percent
44) If a firm is unlevered and has a cost of equity capital of 13.7 percent, what would be the cost
of equity if its debt-equity ratio was revised to .4? The expected cost of debt is 7.4 percent and
there are no taxes.
A) 15.54 percent
B) 15.67 percent
C) 16.09 percent
D) 16.22 percent
E) 16.36 percent
45) Reena Industries has $138,000 of debt outstanding that is selling at par and has a coupon rate
of 7 percent. If the tax rate is 21 percent, what is the present value of the tax shield on debt?
A) $28,412
B) $31,010
C) $28,980
D) $3,284
E) $2,029
46) A firm has debt of $7,000, equity of $12,000, a cost of debt of 7 percent, a cost of equity of
14 percent, and a tax rate of 21 percent. What is the firm's weighted average cost of capital?
A) 8.45 percent
B) 9.90 percent
C) 10.88 percent
D) 12.50 percent
E) 11.27 percent
47) The Winter Wear Company has expected earnings before interest and taxes of $3,800, an
unlevered cost of capital of 15.4 percent and a tax rate of 22 percent. The company also has
$2,600 of debt with a coupon rate of 5.7 percent. The debt is selling at par value. What is the
value of this firm?
A) $15,585
B) $19,819
C) $12,115
D) $12,055
E) $17,700
48) The Dance Studio is currently an all-equity firm that has 22,000 shares of stock outstanding
with a market price of $27 a share. The current cost of equity is 12 percent and the tax rate is 23
percent. The firm is considering adding $225,000 of debt with a coupon rate of 6.25 percent to its
capital structure. The debt will sell at par. What will be the levered value of the equity?
A) $325,500
B) $420,750
C) $521,250
D) $472,750
E) $594,000
49) The Montana Hills Co. has expected earnings before interest and taxes of $17,100, an
unlevered cost of capital of 12.4 percent, and debt with both a book and face value of $25,000.
The debt has an annual 6.2 percent coupon. If the tax rate is 21 percent, what is the value of the
firm?
A) $91,016
B) $137,903
C) $114,194
D) $106,667
E) $146,403
50) Joe's Leisure Time Sports is an unlevered firm with an aftertax net income of $78,400. The
unlevered cost of capital is 11.4 percent and the tax rate is 23 percent. What is the value of this
firm?
A) $447,017
B) $581,818
C) $687,719
D) $613,309
E) $537,900
51) An unlevered firm has a cost of capital of 13.6 percent and earnings before interest and taxes
of $138,000. A levered firm with the same operations and assets has both a book value and a face
value of debt of $520,000 with an annual coupon of 7 percent. The applicable tax rate is 21
percent. What is the value of the levered firm?
A) $996,421
B) $907,679
C) $1,184,929
D) $910,818
E) $1,191,506
52) The Spartan Co. has an unlevered cost of capital of 11.6 percent, a cost of debt of 7.9
percent, and a tax rate of 23 percent. What is the target debt-equity ratio if the targeted levered
cost of equity is 12.6 percent?
A) .44
B) .39
C) .35
D) .56
E) .53
53) Salmon Inc. has debt with both a face and a market value of $227,000. This debt has a
coupon rate of 7 percent and pays interest annually. The expected earnings before interest and
taxes is $87,200, the tax rate is 21 percent, and the unlevered cost of capital is 12 percent. What
is the firm's cost of equity?
A) 13.25 percent
B) 13.89 percent
C) 13.92 percent
D) 14.27 percent
E) 14.14 percent
54) Anderson's Furniture Outlet has an unlevered cost of capital of 10.3 percent, a tax rate of 21
percent, and expected earnings before interest and taxes of $1,900. The company has $4,000 in
bonds outstanding that have an annual coupon of 7 percent. If the bonds are selling at par, what
is the cost of equity?
A) 11.33 percent
B) 9.34 percent
C) 10.72 percent
D) 9.99 percent
E) 11.21 percent
55) Aspen's Distributors has a levered cost of equity of 13.84 percent and an unlevered cost of
capital of 12.5 percent. The company has $5,000 in debt that is selling at par. The levered value
of the firm is $14,600 and the tax rate is 25 percent. What is the pretax cost of debt?
A) 7.92 percent
B) 9.07 percent
C) 8.16 percent
D) 8.84 percent
E) 9.00 percent
56) Rosita's has a cost of equity of 13.76 percent and a pretax cost of debt of 8.5 percent. The
debt-equity ratio is .60 and the tax rate is 21 percent. What is Rosita's unlevered cost of capital?
A) 11.83 percent
B) 12.07 percent
C) 13.97 percent
D) 14.08 percent
E) 14.60 percent
57) An all-equity firm has a cost of capital of 12.8 percent and a tax rate of 23 percent. At the
firm's target debt-equity ratio, the pretax cost of debt is 7.35 percent and the cost of equity is
15.07 percent. What is the target debt-equity ratio?
A) .67
B) .49
C) .51
D) .61
E) .54
58) Wild Flowers Express has a debt-equity ratio of .60. The pretax cost of debt is 9 percent
while the unlevered cost of capital is 14 percent. What is the cost of equity if the tax rate is 23
percent?
A) 7.52 percent
B) 8.78 percent
C) 16.31 percent
D) 16.83 percent
E) 17.30 percent
59) Your firm has a bond issue with a face value of $250,000 outstanding. These bonds have a
coupon rate of 7 percent, pay interest semiannually, and have a current market price equal to 103
percent of face value. What is the amount of the annual tax shield on debt given a tax rate of 21
percent?
A) $3,675
B) $6,309
C) $4,500
D) $47,500
E) $52,500
60) Jasmine's Boutique has 2,000 bonds outstanding with a face value of $1,000 each, a market
value of $1,060 each, and a coupon rate of 9 percent. The interest is paid semiannually. What is
the amount of the annual tax shield on debt if the tax rate is 23 percent?
A) $44,872
B) $460,000
C) $43,884
D) $41,400
E) $487,600
61) Juanita's Steak House has $12,000 of debt outstanding that is selling at 101.2 percent of par
and has a coupon rate of 8 percent and a current yield of 7.91 percent. The tax rate is 21 percent.
What is the present value of the tax shield on debt?
A) $3,188
B) $3,887
C) $2,520
D) $2,500
E) $2,550
62) A firm has debt of $5,000, equity of $16,000, a cost of debt of 8 percent, a cost of equity of
12 percent, and a tax rate of 21 percent. What is the firm's weighted average cost of capital?
A) 10.20 percent
B) 9.94 percent
C) 10.90 percent
D) 10.65 percent
E) 11.05 percent
63) A firm has zero debt and an overall cost of capital of 13.8 percent. The firm is considering a
new capital structure with 40 percent debt. The interest rate on the debt would be 7.2 percent and
the corporate tax rate is 21 percent. What would be the cost of equity with the new capital
structure?
A) 16.90 percent
B) 16.11 percent
C) 17.28 percent
D) 17.34 percent
E) 17.59 percent
64) A firm has a debt-equity ratio of .64, a cost of equity of 13.04 percent, and a cost of debt of 8
percent. Assume the corporate tax rate is 25 percent. What would be the cost of equity if the firm
were all-equity financed?
A) 11.30 percent
B) 11.41 percent
C) 13.33 percent
D) 12.42 percent
E) 12.25 percent
65) A firm has an equity multiplier of 1.57, an unlevered cost of equity of 14 percent, a levered
cost of equity of 15.6 percent, and a tax rate of 21 percent. What is the cost of debt?
A) 11.25 percent
B) 10.50 percent
C) 10.45 percent
D) 11.00 percent
E) 10.33 percent
66) Lyme Home has 5,000 bonds outstanding with a face value of $1,000 each and a coupon rate
of 7.65 percent. Interest is paid semiannually. What is the amount of the annual tax shield on
debt if the tax rate is 23 percent?
A) $157,650
B) $160,125
C) $1,062,500
D) $1,150,000
E) $87,975
67) Alexandria's Dance Studio is currently an all-equity firm with earnings before interest and
taxes of $338,000 and a cost of equity of 14.2 percent. Assume the tax rate is 22 percent. The
firm is considering adding $400,000 of debt with a coupon rate of 7 percent to its capital
structure. The debt will be sold at par value. What is the levered value of the equity?
A) $1,987,408
B) $1,544,620
C) $2,038,519
D) $986,420
E) $1,944,620
68) Boutelle Homes has an all-equity value of $648,200, a cost of equity of 11.7 percent, and a
tax rate of 35 percent. Assume the firm's capital structure changes to 30 percent debt followed by
a lowering of the tax rate to 21 percent. What will be the change in the levered value of the firm
due to the reduction in the tax rate?
A) $16,020
B) $17,520
C) $29,169
D) −$27,224
E) −$17,520
69) Explain homemade leverage and why it matters.
70) Explain why the weighted average cost of capital is invariant to the firm's debt-equity ratio in
the absence of corporate taxes.
71) Discuss MM Propositions I and II in a world without taxes. List the basic assumptions,
results, and intuition of the model.
72) In each of the theories of capital structure, the cost of equity rises as the amount of debt
increases. So why don't financial managers use as little debt as possible to keep the cost of equity
down? After all, isn't the goal of the firm to maximize share value and doesn't a lower discount
rate applied to the firm's cash flows increase the present value of those cash flows?
73) Based on MM Propositions, with and without taxes, how much time should a financial
manager spend analyzing the capital structure of his firm?
74) Discuss MM Propositions I and II in a world with taxes. List the basic assumptions, results,
and intuition of the model.
