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Multiple Choice Quiz
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If a firm permanently borrows $20 million at an interest rate of 8%, what is the present value of the interest tax shield? Assume a 35% tax rate.
A)$7.00 million
B)$8.75 million
C)$16.50 million
D)$25.00 million
In order to calculate the tax shield effect of interest payments, always use:
A)Average tax rate
B)Marginal tax rate
C)State mandated tax rate
D)None of the above
The positive value to the firm by adding debt to the capital structure in the presence of corporate taxes is:
A)Due to the extra cash flow going to the investors of the firm rather than the tax authorities.
B)Due to the earnings before interest and taxes being fully taxed at the corporate rate.
C)Because personal tax rates are the same as corporate tax rates.
D)Because shareholders prefer to let financial managers choose the capital structure thus making their value independent of it.
The Akron Company is unlevered with assets of $30 million and EBIT of $5 million. If the firm's tax rate is 34%, calculate its after-tax cash flow.
A)$2.40 million
B)$3.30 million
C)$3.96 million
D)$10.20 million
Suppose you know the following: Corporate tax rate = 35%; Personal tax rate on equity income = 20%; and Personal tax rate on interest income = 10%. What is the relative tax advantage of debt over equity?
D)Cannot be determined
According to MM with taxes:
A)Firms should prefer to raise money via debt
B)Firms should prefer to raise money via equity
C)Firms are indifferent between raising money via debt or equity
D)None of the above
The possibility of bankruptcy has a negative effect on the value of the firm because:
A)Increased bankruptcy risk lowers project cash flows
B)Reorganization is costless but risk is not
C)A bankruptcy has real costs associated with it
D)Value enhancing strategies are no longer available
The trade-off theory of capital structure predicts that:
A)Unprofitable firms should borrow more than profitable ones
B)Safe firms should borrow more than risky ones
C)Rapidly growing firms should borrow more than mature firms
D)Increasing leverage increases firm value
The pecking order theory of capital structure predicts that:
A)If two firms are equally profitable, the more rapidly growing firm will borrow more, other things equal
B)Firms prefer equity to debt financing
C)Risky firms will end up borrowing less
D)Risky firms will end up borrowing more
Financial slack means:
A)Readily saleable real assets
B)Ready access to the debt markets
C)Having cash
D)All of the above
Which theory implies that highly profitable companies will have lower debt ratios?
A)Trade off theory
B)Pecking order theory
C)MM without taxes
D)MM with taxes
Pecking order relies on asymmetric information. According to this theory, who is assumed to have more information about the companies' prospects, risks, and values?
D)Pension funds
An example of an indirect bankruptcy cost is which of the following?
A)Attorney fees
B)Court costs
C)Reluctance to do business with the company
D)Severance packages for employees
The trade off theory states that firms saddled with extra heavy debt should do which of the following?
A)Issue stock
B)Constrain dividends
C)Sell off assets to raise cash
D)All of the above
Pecking order theory is based on which of the following?
A)Asymmetric information
B)Current financial data
C)The New York Stock Exchange
D)The Board of Directors

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