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Corporate Finance

1 An unlevered firm operates in perfect capital markets except that there are both corporate and personal taxes. The corporate tax rate is 25%, the personal tax rate on income from stock is 20%, and the personal tax rate on interest income from debt is 30%. If the firm borrows $10 million at 4% interest and uses the proceeds to retire stock, the value of the firm will ________.

decrease by about $143,000

increase by about $143,000

not change at all

increase by about 14.3%

2 When calculating the present value of debt tax shields ________.

discount the annual tax savings using the firm's weighted average cost of capital because that reflects the firm's overall risk

discount the annual tax savings using the firm's cost of debt because the tax savings are as risky as the debt is

discount the annual tax savings using the risk-free rate because in perfect markets the firm's cost of debt equals the risk-free rate

discount the annual tax savings using the firm's cost of equity because the benefits of the tax shield go to shareholders

Question 3 In surveys of CFOs, which of the following was NOT an important factor they considered when making capital structure decisions?

the information that a financing choice would convey to investors

the volatility of the firm's earnings and cash flows

the impact that a financing choice would have on the firm's credit rating

the tax savings that would result from using debt

4 ________ leverage measures the effect of fixed ________ costs on the relationship between EBIT and EPS.

Operating; operating

Financial; operating

Operating; financial

Financial; financial

5 According to the pecking order theory, to avoid having to finance new investments by selling equity at a discount, firms will ________.

engage in asset substitution

signal that they believe in the stock and thereby persuade investors to buy stock at full market value

finance new investments with debt if at all possible

maintain financial slack

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