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41)
Which of the following statements is false?
41)
A)
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.
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)
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.
42)
Consider the following formula:
* =
(1 -i) - (1 -c)(1 -e)
(1 -i)
The term * is
42)
A)
the effective tax advantage of debt.
B)
the effective personal tax rate on equity.
C)
the effective personal tax rate on interest income.
D)
the effective corporate tax rate on income.
Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ Millions):
Year 2006 2005 2004
Total Sales 60,553 56,434 53,791
Cost of goods sold 45,565 42,140 39,637
Selling, general & admin expenses 11,688 12,191 11,575
Depreciation 1,265 1,256 1,209
Operating Income 2,035 847 1,370
Other Income 0 0 0
EBIT 2,035 847 1,370
Interest expense 510 557 604
Earnings before tax 1,525 290 766
Taxes (35%) 534 102 268
Net Income 991 189 498
43)
The total amount available to payout to all the investors in Kroger in 2006 is closest to:
43)
A)
$1,525 million
B)
$1,500 million
C)
$2,035 million
D)
$990 million
Use the information for the question(s) below.
LCMS Industries has $70 million in debt outstanding. The firm will pay only interest on this debt (the debt is perpetual).
LCMS' marginal tax rate is 35% and the firm pays a rate of 8% interest on its debt.
44)
Assuming that the risk is the same as the loan, the present value of LCMS' interest tax shield is
closest to:
44)
A)
$45.5 million
B)
$24.5 million
C)
$35.0 million
D)
$20.0 million
Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
45)
The total of Rosewood's net income and interest payments is closest to:
45)
A)
$450 million
B)
$355 million
C)
$270 million
D)
$290 million
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.
46)
If Flagstaff maintains a debt to equity ratio of 1, then Flagstaff's pre-tax WACC is closest to:
46)
A)
10.5%
B)
9.0%
C)
11.0%
D)
10.0%
47)
Which of the following statements is false?
47)
A)
To determine the true tax benefit of leverage, we need to evaluate the combined effect of both
corporate and personal taxes.
B)
In the United States and many other countries, capital gains from equity have historically
been taxed more heavily than interest income.
C)
Personal taxes have an indirect effect on the firm's weighted average cost of capital.
D)
A personal tax disadvantage for debt causes the WACC to decline more slowly with leverage
than it otherwise would.
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.
48)
After the recapitalization, the value of a share of KD's stock is closest to:
48)
A)
$22.00
B)
$22.35
C)
$22.65
D)
$23.50
Use the information for the question(s) below.
Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%.
49)
The amount of Rosewood's interest tax shield is closest to:
49)
A)
$60 million
B)
$290 million
C)
$115 million
D)
$175 million
Use the table for the question(s) below.
Consider the following top federal tax rates in the United States:
Personal Tax Rates
Year
Corporate
Tax Rate
Interest
Income Dividends
Capital
Gains
2000 35% 40% 40% 20%
2005 35% 35% 15% 15%
50)
In 2000, assuming an average dividend payout ratio of 50%, the effective tax rate for equity holders
was closest to:
50)
A)
69%
B)
30%
C)
65%
D)
55%
51)
In 2005, the effective tax rate for debt holders was closest to:
51)
A)
35%
B)
40%
C)
65%
D)
58%
52)
Which of the following statements is false?
52)
A)
The reduction in the WACC increases with the amount of debt financing.
B)
The higher the firm's leverage, the more the firm exploits the tax advantage of debt, and the
lower its WACC.
C)
Because the firm's free cash flow is computed without considering the firm's leverage, we
account for the benefit of the interest tax shield by calculating the WACC using the before tax
cost of debt.
D)
Corporate taxes lower the effective cost of debt financing, which translates into a reduction in
the weighted average cost of capital.
53)
Consider the following formula:
rwacc =E
E + D rE+D
E + D rD-D
E + D rDc
The terms E
E + D rE+D
E + D rD represent
53)
A)
the before tax wacc.
B)
the reduction due to the interest tax shield.
C)
the reduction due to equity financing.
D)
the after tax wacc.
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.
54)
If Flagstaff currently maintains a .5 debt to equity ratio, then Flagstaff's after-tax WACC is closest
to:
54)
A)
10.25%
B)
9.50%
C)
8.75%
D)
10.00%
55)
If Flagstaff currently maintains a debt to equity ratio of 1, then the value of Flagstaff's interest tax
shield is closest to:
55)
A)
$11 million
B)
$18 million
C)
$24 million
D)
$10 million
56)
Which of the following statements is false?
56)
A)
The interest tax shield is the additional amount that a firm would have paid in taxes if it did
not have leverage.
B)
Because Corporations pay taxes on their profits after interest payments are deducted, interest
expenses reduce the amount of corporate tax firms must pay.
C)
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.
D)
In general, the gain to investors from the tax deductibility of interest payments is referred to
as the interest tax shield.
57)
Consider the following formula:
rwacc =E
E + D rE+D
E + D rD-D
E + D rDc
The term D
E + D rDc represents
57)
A)
the present value of the interest tax shield.
B)
the preset value of the future interest payments.
C)
the interest tax shield each year.
D)
the reduction due to the interest tax shield.
58)
Which of the following statements is false?
58)
A)
Personal taxes have the potential to offset some of the corporate tax benefits of leverage.
B)
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.
C)
The actual interest tax shield depends on the reduction in the total taxes (both corporate and
personal) that are paid.
D)
Just like corporate taxes, personal taxes reduce the cash flows to investors and diminish firm
value.
Use the table for the question(s) below.
Consider the following top federal tax rates in the United States:
Personal Tax Rates
Year
Corporate
Tax Rate
Interest
Income Dividends
Capital
Gains
2000 35% 40% 40% 20%
2005 35% 35% 15% 15%
59)
In 2005, assuming an average dividend payout ratio of 50%, the effective tax rate for equity holders
was closest to:
59)
A)
45%
B)
55%
C)
30%
D)
50%
Use the information for the question(s) below.
Shepard Industries expects free cash flow of $10 million each year. Shepard's corporate tax rate is 35%, and its unlevered cost
of equity is 10%. The firm also has outstanding debt of $40 million and it expects to maintain amount of debt permanently.
60)
The value of Shepard Industries without leverage is closest to:
60)
A)
$50 million
B)
$100 million
C)
$114 million
D)
$64 million
61)
Which of the following statements is false?
61)
A)
Once investors know the recap will occur, the share price will rise immediately to a level that
reflects the value of the interest tax shield that the firm will receive from its recapitalization.
B)
When securities are fairly priced, the original shareholders of a firm capture the full benefit of
the interest tax shield from an increase in leverage.
C)
We can analyze the recapitalization using the market value balance sheet; it states that the
total market value of a firm's securities must equal the total market value of the firm's assets.
D)
In the presence of corporate taxes, we do not include the interest tax shield as one of the firm's
assets on its market value balance sheet.
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.
62)
If Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff as an all equity
firm would be closest to:
62)
A)
$80 million
B)
$73 million
C)
$100 million
D)
$115 million
Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and Free Cash Flow of $27 million.
FBNA's marginal corporate tax rate is 40%.
63)
FBNA's EBIT is closest to:
63)
A)
$45 million
B)
$40 Million
C)
$43 million
D)
$60 million
Use the table for the question(s) below.
Consider the following top federal tax rates in the United States:
Personal Tax Rates
Year
Corporate
Tax Rate
Interest
Income Dividends
Capital
Gains
2000 35% 40% 40% 20%
2005 35% 35% 15% 15%
64)
In 2005, assuming an average dividend payout ratio of 50%, the effective tax advantage for debt (
*) was closest to:
64)
A)
15%
B)
18%
C)
24%
D)
35%
65)
In 2000, assuming an average dividend payout ratio of 50%, the effective tax advantage for debt (t*)
was closest to:
65)
A)
24%
B)
30%
C)
18%
D)
40%
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.
66)
If Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff as a levered firm
is closest to:
66)
A)
$100 million
B)
$111 million
C)
$114 million
D)
$140 million
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
67)
With its current leverage, WELS Corporation will have net income net year of 2.6 million. If WELS corporate
tax rate is 35% and it pays 8% interest on its debt, how much additional debt can WELS issue this year and still
receive the benefit of the interest tax shield next year?
68)
MJ Enterprises has 50 million shares outstanding with a market price of $25 per share and no debt. MJ has had
consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $500 million on a
permanent basis through a leveraged recapitalization in which they would use the borrowed funds to
repurchase outstanding shares. Calculate MJ's share price following announcement of the recapitalization plan.
Use the table for the question(s) below.
Consider the following income statement for Kroger Inc. (all figures in $ Millions):
Year 2006 2005 2004
Total Sales 60,553 56,434 53,791
Cost of goods sold 45,565 42,140 39,637
Selling, general & admin expenses 11,688 12,191 11,575
Depreciation 1,265 1,256 1,209
Operating Income 2,035 847 1,370
Other Income 0 0 0
EBIT 2,035 847 1,370
Interest expense 510 557 604
Earnings before tax 1,525 290 766
Taxes (35%) 534 102 268
Net Income 991 189 498
69)
Calculate the interest tax shield, the total amount available to payout to all the investors, and the income that
would be available to equity holders if Kroger was not levered all for the year 2004.
70)
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?
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.
71)
If Flagstaff currently maintains a .8 debt to equity ratio, then calculate the value of Flagstaff's interest tax shield.
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.
72)
Assume the following tax schedule:
Personal Tax Rates
Year
Corporate
Tax Rate
Interest
Income Dividends
Capital
Gains
2000 35% 40% 40% 20%
2005 35% 35% 15% 15%
Considering the effect of personal taxes, calculate the PV of the interest tax shield provided by KD's
recapitalization in 2005.
73)
The Grant Corporation is considering permanently adding $500 million of debt to its capital structure. Grant's
corporate tax rate is 35% and investors pay a tax rate of 40% on their interest income and 20% on their income
from capital gains and dividends. Calculate the present value of the interest tax shield provided by this new
debt.
74)
Your firm currently has $250 million in debt outstanding with an 8% interest rate. The terms of the loan require
the firm to repay $50 million of the balance each year. Suppose that the marginal corporate tax rate is 35% and
that the interest tax shields have the same risk as the loan. What is the present value of the interest tax shields
from this debt?
75)
Raceway Products has a market debt-to-equity ratio of .60, a corporate tax rate of 40%, and pays 8% interest on
its debt. The interest tax shield on Raceway's debt lowers its WACC by what amount?
Answer Key
Testname: C15
Answer Key
Testname: C15
36
Answer Key
Testname: C15
37
