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Exam 26: Analysis of Capital Structure Theory

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Question 21

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(The following data apply to Problems 23 through 25. The problems MUST be kept together.) The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%. Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. -Assume that the firm's gain from leverage according to the Miller model is $126,667. If the effective personal tax rate on stock income is TS = 20%, what is the implied personal tax rate on debt income?

A) 16.4%
B) 18.2%
C) 20.2%
D) 22.5%
E) 25.0%

F) B) and D)
G) A) and B)

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Question 22

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Your firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000. It is growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is the value of your firm's tax shield, i.e., how much value does the use of debt add?

A) $92,571
B) $102,857
C) $113,143
D) $124,457
E) $136,903

F) All of the above
G) C) and E)

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Question 23

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MM showed that in a world without taxes, a firm's value is not affected by its capital structure.

Which of the following statements concerning capital structure theory is NOT CORRECT?

MM showed that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

Firm L has debt with a market value of $200,000 and a yield of 9%. The firm's equity has a market value of $300,000, its earnings are growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what would Firm L's total value be if it had no debt?

(The following data apply to Problems 23 through 25. The problems MUST be kept together.) The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30%. Kimberly uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. -What is the value of the firm according to MM with corporate taxes?

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

(The following data apply to Problems 26 through 28. The problems MUST be kept together.) Gomez computer systems has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Gomez must reinvest 20% of its EBIT in net operating assets. Gomez has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%. -According to the MM extension with growth, what is Gomez's value of equity?