49) Bankruptcy:
A) occurs when total equity is negative.
B) is a legal proceeding.
C) occurs when a company cannot meet its financial obligations.
D) refers to a loss of value for debt holders.
E) is an inexpensive means of reorganizing a company.
50) A company is technically insolvent when:
A) it has a negative book value.
B) its total debt exceeds its total equity.
C) it is unable to meet its financial obligations.
D) it files for bankruptcy protection.
E) the market value of its stock is less than its book value.
51) Which one of the following statements related to Chapter 7 bankruptcy is correct?
A) A company in Chapter 7 bankruptcy is reorganizing its operations such that it can return to
being a viable concern.
B) Under a Chapter 7 bankruptcy, a trustee will assume control of the company’s assets until
those assets can be liquidated.
C) Chapter 7 bankruptcies are always involuntary on the part of the firm.
D) Under a Chapter 7 bankruptcy, the claims of creditors are paid prior to the administrative
costs of the bankruptcy.
E) Chapter 7 bankruptcy allows a firm to restructure its equity such that new shares of stock can
be issued.
52) Which one of the following will generally have the highest priority when assets are
distributed in a bankruptcy proceeding?
A) Consumer claims
B) Dividend payment to preferred shareholders
C) Company contribution to the employees’ retirement account
D) Payment to an unsecured creditor
E) Payment of employees’ wages
53) Which one of these statements related to Chapter 11 bankruptcy is correct?
A) Prepacks apply only to Chapter 7, not Chapter 11, bankruptcies.
B) Senior management must be replaced prior to exiting a Chapter 11 bankruptcy.
C) A company can only file for Chapter 11 after it becomes totally insolvent.
D) Companies sometimes file for Chapter 11 in an attempt to gain a competitive advantage.
E) Chapter 11 involves the total liquidation of the bankrupt firm.
54) The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:
A) permits creditors to file a prepack immediately after a firm files for bankruptcy protection.
B) prevents creditors from submitting any reorganization plans.
C) prevents companies from filing for bankruptcy protection more than once.
D) permits key employee retention plans only if the affected employee(s) has another job offer.
E) allows the payment of bonuses to all key employees to entice those employees to remain in
the company’s employ.
55) Katlin Markets is debating between a levered and an unlevered capital structure. The all-
equity capital structure would consist of 60,000 shares of stock. The debt and equity option
would consist of 45,000 shares of stock plus $250,000 of debt with an interest rate of 7.25
percent. What is the break-even level of earnings before interest and taxes between these two
options? Ignore taxes.
A) $50,500
B) $68,200
C) $81,400
D) $66,667
E) $72,500
56) Holly’s is currently an all-equity firm that has 7,200 shares of stock outstanding at a market
price of $41 a share. The firm has decided to leverage its operations by issuing $60,000 of debt at
an interest rate of 7.6 percent. This new debt will be used to repurchase shares of the outstanding
stock. The restructuring is expected to increase the earnings per share. What is the minimum
level of earnings before interest and taxes that the firm is expecting? Ignore taxes.
A) $22,435
B) $19,516
C) $26,400
D) $17,141
E) $25,020
57) Paradise Travels is an all-equity firm that has 9,000 shares of stock outstanding at a market
price of $27 a share. Management has decided to issue $25,000 worth of debt and use the funds
to repurchase shares of the outstanding stock. The interest rate on the debt will be 7.3 percent.
What are the earnings per share at the break-even level of earnings before interest and taxes?
Ignore taxes.
A) $2.28
B) $1.97
C) $1.67
D) $2.12
E) $1.92
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58) Miller’s Dry Goods is an all-equity firm with 40,000 shares of stock outstanding at a market
price of $50 a share. The company’s earnings before interest and taxes are $160,000. Miller’s has
decided to add leverage to its financial operations by issuing $200,000 of debt at 7 percent
interest and using the proceeds to repurchase shares of stock. Jen owns 500 shares of Miller’s
stock and can loan out funds at 7 percent interest. How many shares of Miller’s stock must Jen
sell to offset the leverage that Miller’s is assuming? (Assume Jen loans out all of the funds she
receives from the sale of stock. Ignore taxes.)
A) 125 shares
B) 100 shares
C) 50 shares
D) 25 shares
E) 75 shares
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59) Theo currently owns 700 shares of JKL, which is an all-equity firm with 320,000 shares of
stock outstanding at a market price of $25 a share. The company’s earnings before interest and
taxes are $160,000. JKL has decided to issue $500,000 of debt at 7.5 percent interest and use the
proceeds to repurchase shares of stock. How many shares of JKL stock must Theo sell to unlever
his position if he can loan out funds at 7.5 percent interest? (Assume partial shares can be sold.)
A) 38.50
B) 42.50
C) 50.00
D) 43.75
E) 46.67
30
60) Naylor’s is an all-equity firm with 48,000 shares of stock outstanding at a market price of
$25 a share. The company has earnings before interest and taxes of $87,000. Naylor’s has
decided to issue $400,000 of debt at 7.3 percent and use the proceeds to repurchase shares.
Currently, Angela owns 600 shares of Naylor’s stock. How many shares of this stock will she
continue to own if she unlevers this position? Assume she can loan out funds at 7.3 percent
interest. Ignore taxes.
A) 200
B) 333
C) 400
D) 425
E) 267
61) Eastern Markets has no debt outstanding and a total market value of $346,500. Earnings
before interest and taxes, EBIT, are projected to be $14,000 if economic conditions are normal.
If there is strong expansion in the economy, then EBIT will be 13 percent higher. If there is a
recession, then EBIT will be 32 percent lower. The firm is considering a debt issue of $16,000
with an interest rate of 6.8 percent. The proceeds will be used to repurchase shares of stock.
There are currently 4,500 shares outstanding. Ignore taxes. What will be the percentage change
in EPS if the economy enters a recessionary period?
A) −35 percent
B) −41 percent
C) −32 percent
D) −28 percent
E) −30 percent
62) North Side Inc. has no debt outstanding and a total market value of $168,000. Earnings
before interest and taxes, EBIT, are projected to be $18,000 if economic conditions are normal.
If there is strong expansion in the economy, then EBIT will be 22 percent higher. If there is a
recession, then EBIT will be 35 percent lower. The company is considering a $50,000 debt issue
with an interest rate of 7.4 percent. The proceeds will be used to repurchase shares of stock.
There are currently 5,000 shares outstanding and the tax rate is 21 percent. What will be the
percentage change in EPS if the economy has a strong expansion?
A) 28.80 percent
B) 31.26 percent
C) 27.69 percent
D) 25.45 percent
E) 22.00 percent
63) Galaxy Products is comparing two different capital structures, an all-equity plan (Plan I) and
a levered plan (Plan II). Under Plan I, the company would have 112,000 shares of stock
outstanding. Under Plan II, there would be 75,000 shares of stock outstanding and $600,000 in
debt. The interest rate on the debt is 6.7 percent and there are no taxes. What is the break-even
EBIT?
A) $87,879
B) $121,686
C) $101,111
D) $133,333
E) $91,414
64) ABC and XYZ are identical firms in all respects except for their capital structures. ABC is
all-equity financed with $530,000 in stock. XYZ has the same total value but uses both stock and
perpetual debt; its stock is worth $310,000 and the interest rate on its debt is 7.9 percent. Both
firms expect EBIT to be $62,222. Ignore taxes. The cost of equity for ABC is ________ percent
and for XYZ it is ________ percent.
A) 11.74; 9.82
B) 11.74; 12.48
C) 11.74; 14.47
D) 12.09; 9.82
E) 12.09; 12.48
65) Lamont Corp. is debt-free and has a weighted average cost of capital of 12.7 percent. The
current market value of the equity is $2.3 million and there are no taxes. According to M&M
Proposition I, what will be the value of the company if it changes to a debt-equity ratio of .85?
A) $18,110,236
B) $1,955,000
C) $15,393,701
D) $2,705,882
E) $2,300,000
66) Ignoring taxes, Pewter & Glass has a weighted average cost of capital of 10.82 percent. The
company can borrow at 7.4 percent. What is the cost of equity if the debt-equity ratio is .68?
A) 12.87%
B) 13.15%
C) 11.09%
D) 15.85%
E) 12.49%
67) The Jean Outlet is an all-equity firm that has 64,000 shares of stock outstanding. The
company has decided to borrow $120,000 to repurchase 1,500 shares of its stock from the estate
of a deceased shareholder. What is the total value of the firm if you ignore taxes?
A) $5,340,000
B) $4,638,000
C) $5,068,700
D) $4,950,000
E) $5,120,000
68) Noelle owns 12 percent of The Toy Factory. She has decided to retire and wants to sell all of
her shares in this closely held, all-equity firm. The other shareholders have agreed to have the
company borrow the $248,000 needed to repurchase her shares of stock. What is the total market
value of the company? Ignore taxes.
A) $2,066,667
B) $2,489,111
C) $2,608,515
D) $2,414,141
E) $2,333,333
69) Winter’s Toyland has a debt-equity ratio of .57. The pretax cost of debt is 8.2 percent and the
required return on assets is 14.7 percent. What is the company’s cost of equity if you ignore
taxes?
A) 14.70 percent
B) 19.74 percent
C) 15.29 percent
D) 17.46 percent
E) 18.41 percent
70) Roy’s Welding has a cost of equity of 14.1 percent and a pretax cost of debt of 7.7 percent.
The required return on the assets is 13.2 percent. What is the debt-equity ratio based on M&M II
with no taxes?
A) .164
B) .217
C) .408
D) .108
E) .583