FINC620 Equity Financing Over Debt Financing

FINC620 Equity Financing Over Debt Financing

The interest tax shield is a key reason why:

1. the required rate of return on assets rises when debt is added to the capital structure.
2. the value of an unlevered firm is equal to the value of a levered firm.
3. the net cost of debt to a firm is generally less than the cost of equity.
4. the cost of debt is equal to the cost of equity for a levered firm.
5. firms prefer equity financing over debt financing.

Question 2

Rosita’s has a cost of equity of 13.8% and a pre-tax cost of debt of 8.5%. The debt-equity ratio is .60 and the tax rate is .34. What is Rosita’s unlevered cost of capital?

8. 8.83%
9. 12.30%
10. 13.97%
11. 14.08%
12. 14.60%

Question 3

Juanita’s Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of 8%. The tax rate is 34%. What is the present value of the tax shield?

1. $2,823
2. $2,887
3. $4,080
4. $4,500
5. $4,633

Question 4

The Backwoods Lumber Co. has a debt-equity ratio of .80. The firm’s required return on assets is 12% and its cost of equity is 15.68%. What is the pre-tax cost of debt based on MM Proposition II with no taxes?

6. 6.76%
7. 7.00%
8. 7.25%
9. 7.40%
10. 7.50%

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