Week11_TutorialAnswers

Week11_TutorialAnswers - SCHOOL OF BANKING AND FINANCE...

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FINS 1613 Tutorial Answers 1 SCHOOL OF BANKING AND FINANCE FINS1613 BUSINESS FINANCE Semester 2, 2008 TUTORIAL ANSWERS WEEK 11 – Capital Structure: Theory and Evidence Multiple-choice Questions 1. The corporate tax rate is 37%. The MaPol Company has a 100 million dollars debenture issue outstanding with a coupon rate of 6.84% per annum. Face value of one debenture is $10 000 and investors require a 7% return on debentures with similar credit rating. What is the present value of the tax shield? a. $6 840 000 b. $25 300 800 c. $37 000 000 d. $30 160 000 e. $7 000 000 Answer is c. PV tax shield = D*Tc = $100M x 0.37 = $37M 2. Less Debt, Inc., just revised its capital structure such that the firm’s debt-equity ratio decreased from .80 to .40. Those individual investors who prefer the old capital structure: a. should sell half of their equity holdings and invest in cash b. should sell half of their equity holdings and loan out the net proceeds of the sale c. should loan out funds equivalent to the amount invested in Less Debt d. can replicate that structure by increasing their use of homemade leverage e. can replicate that structure by reducing their debt and doubling their investment in the firm Answer is d. Firm is unelevering so to apply homemade leverage, the investor would lever up by borrowing in the same proportion.
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FINS 1613 Tutorial Answers 2 3. Which of the following statements about capital structure theory is most correct? a. Signaling theory suggests firms should in normal time maintain reserve borrowing capacity thay can be ised if an especially good investment opportunity comes along. b. In general, an increase in the corporate tax rate would cause firms to use less debt in their capital structures. c. According to the trade-off theory, an increase in the costs of bankruptcy would lead firms to reduce the amount of debt in their capital structures. d. Statements a and c are correct.
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Week11_TutorialAnswers - SCHOOL OF BANKING AND FINANCE...

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