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Exam 15: Capital Structure

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Question 51

Multiple Choice

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El Capitan Foods has a capital structure of 40% debt and 60% equity, its tax rate is 35%, and its beta (leveraged) is 1.25. Based on the Hamada equation, what would the firm's beta be if it used no debt, i.e., what is its unlevered beta, bU?

A) 0.71
B) 0.75
C) 0.79
D) 0.83
E) 0.87

F) A) and B)
G) C) and E)

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Question 52

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Other things held constant, the lower a firm's tax rate, the more logical it is for the firm to use debt.

A) True
B) False

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Question 53

Multiple Choice

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Your firm's debt ratio is only 5.00%, but the new CFO thinks that more debt should be employed. She wants to sell bonds and use the proceeds to buy back and retire common shares so the percentage of common equity in the capital structure (wc) = 1 - wd. Other things held constant, and based on the data below, if the firm increases the percentage of debt in its capital structure (wd) to 60.0%, by how much would the ROE change, i.e., what is ROENew - ROEOld?

The trade-off theory states that capital structure decisions involve a tradeoff between the costs and benefits of debt financing.

Firm A is very aggressive in its use of debt to leverage up its earnings for common stockholders, whereas Firm NA is not aggressive and uses no debt. The two firms' operations are identical--they have the same total investor-supplied capital, sales, operating costs, and EBIT. Thus, they differ only in their use of financial leverage (wd) . Based on the following data, how much higher or lower is A's ROE than that of NA, i.e., what is ROEA - ROENA?

You work for the CEO of a new company that plans to manufacture and sell a new type of laptop computer. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $600,000. Other data for the firm are shown below. How much higher or lower will the firm's expected EPS be if it uses some debt rather than only equity, i.e., what is EPSL - EPSU?

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Business risk is affected by a firm's operations. Which of the following is NOT directly associated with (or does not directly contribute to) business risk?