Question :
ABC Corporation
ABC Corporation has a capital structure that consists of : 1325738
ABC Corporation
ABC Corporation has a capital structure that consists of $20 million in debt and $40 million in equity. The debt has a coupon rate of 10%, while the industry return on equity is 15%. ABC Corporation is unsure of the state of the economy in the next year. The tax rate facing the company is 40%.
State of the EconomyBADGOODGREAT
EBIT$2,000,000$5,000,000$10,000,000
Probability0.400.400.20
71.Refer to ABC Corporation. Given the information in the table, what is the expected earnings per share if the company has 1 million shares outstanding?
a.$1.44
b.$1.56
c.$1.68
d.$1.78
72.Refer to ABC Corporation. The company is considering the issue of $10 million in new debt at a rate of 10%. The funds from the new debt will be used to retire $10 million in equity. Currently, there are 1 million shares outstanding trading at $40 per share. Assuming the stock price will remain the same, what is the expected earnings per share in the next year if the company goes through with the re-capitalization?
a.$1.32
b.$1.56
c.$1.68
d.$1.76
73.Which statement is FALSE concerning capital structure?
a.Firms with large amounts of tangible assets tend to use a lot of debt in their capital structures.
b.When corporate profits are taxed at the corporate and personal level, the benefits of leverage are greatly reduced.
c.Modern trade off theory predicts that a firm’s optimal debt level is set by trading off the tax benefits of leverage against the agency costs of increased debt.
d.Debt is used more frequently abroad (such as Germany and England) as international laws tend to favor debtors.
Exhibit 12-1
An all-equity firm has 80,000 shares outstanding worth $20 each. The firm is considering a project requiring an investment of $500,000 and has an NPV of $30,000. The company is also considering financing this project with a new issue of equity.
74.Refer to Exhibit 12-1. What is the price at which the firm needs to issue the new shares so that the existing shareholders are indifferent to whether the firm takes on the project with this equity financing or does not take on the project?
a.$18.44
b.$18.87
c.$19.71
d.$20.00
75.Refer to Exhibit 12-1. What is the price at which the firm needs to issue the new shares so that the existing shareholders capture the full benefit associated with the new project?
a.$20.48
b.$20.38
c.$20.15
d.$20.07
76.Which of the following statements is true?
a.The use of debt may lead to financial distress and bankruptcy, thus firms that sell expensive, durable products that may have warranties and ongoing service requirements tend to use less debt.
b.The use of debt may lead to financial distress and bankruptcy, thus firms that sell expensive, durable products that may have warranties and ongoing service requirements tend to use more debt.
c.Companies with a large proportion of tangible assets should be more willing to use debt than firms with mostly intangible assets.
d.Companies with a large proportion of tangible assets should be less willing to use debt than firms with mostly intangible assets.
e.Both (a) and (c)
77.Financial distress can be particularly dangerous to firms that produce R&D-intensive goods and services because:
a.Most of the expenses incurred in production are sunk costs.
b.It is unlikely to be able to fund future R&D expenditures if it is in financial distress meaning that it is probably not going to be able to produce cutting-edge products in the future.
c.Intangible assets such as patents and trademarks are unlikely to survive the bankruptcy or financial distress intact.
d.all of the above
e.both (a) and (b)
78.Financial distress can lead to financial and operating “games.” Which of the following statements is (are) true?
a.A firm’s stockholders may prefer that the firm engage in riskier projects whereas the firm’s bondholders may prefer that the firm invest in low-risk projects.
b.The firm may underinvest in projects because the financing must be provided solely by the stockholders since it is unlikely the firm will be able to borrow additional funds.
c.The firm may underinvest in projects because the financing must be provided solely by the bondholders since it is unlikely the firm will be able to issue additional stock.
d.A firm’s bondholders may prefer that the firm engage in riskier projects whereas the firm’s stockholders may prefer that the firm invest in low-risk projects.
e.Both (a) and (b)
79.The agency costs of (outside) equity can result in:
a.a benefit to society in the sense that the firm can raise external equity thus generating additional funds that can be invested.
b.a cost to society because the market value of corporate assets is reduced.
c.entrepreneurs paying less than 100% of the cost of consuming perquisites.
d.all of these
e.none of these
80.One method of preventing or reducing the chance that corporate management will harm the bondholders to the benefit of the stockholders is to:
a.require that key executives own a certain percentage of the firm’s outstanding stock
b.require that key executives own a certain percentage of the firm’s outstanding bonds
c.write detailed covenants into bond contracts.
d.all of the above are acceptable methods
