MGT3470
Spring 2014
MIDTERM EXAM 3
1. Roger's Trucking is currently an all equity firm that has 24,000 shares of stock outstanding at a market price of $50 a
share. The firm has decided to leverage its operations by issuing $280,000 of debt at an interest rate of 8 percent. This
new debt will be used to repurchase shares of the outstanding stock. The restructuring is expected to increase the
earnings per share. What is the minimum level of earnings before interest and taxes that Roger's is expecting? Ignore
taxes.
A. $72,500
B. $77,778
C. $86,667
D. $96,000
E. $101,333
2. Angela's Quilt Shop is currently an all equity firm that has 5,000 shares of stock outstanding at a market price of $32 a
share. Company management has decided to issue $100,000 worth of debt and use the funds to repurchase shares of
the outstanding stock. The interest rate on the debt will be 7.5 percent. What are the earnings per share at the breakeven level of earnings before interest and taxes? Ignore taxes.
A. $2.34
B. $2.40
C. $2.44
D. $2.47
E. $2.51
3. Parker & Thomas, Inc., (P&T) currently is an all equity firm with 20,000 shares of stock outstanding at a market price
of $40 a share. The company's earnings before interest and taxes are $50,000. The firm's dividend payout ratio is 100
percent. P&T has decided to add leverage to its financial operations by issuing $400,000 of debt at a 9 percent interest
rate. This $400,000 will be used to repurchase shares of stock. You own 2,500 shares of P&T stock. You lend funds at a 9
percent rate of interest. How many of your shares of stock in P&T must you sell to offset the leverage that the firm is
assuming? Assume that you loan out all of the funds you receive from the sale of your stock.
A. 500 shares
B. 750 shares
C. 1,000 shares
D. 1,250 shares
E. 1,500 shares
4 The Fabric Mill has debt with both a face and a market value of $6,500. This debt has a coupon rate of 8 percent and
pays interest annually. The expected earnings before interest and taxes are $1,400, the tax rate is 35 percent, and the
unlevered cost of capital is 14 percent. What is the firm's cost of equity? (hint : VU= ?; VL= ?; E= ?...)
A. 17.90 percent
B. 18.56 percent
C. 22.40 percent
D. 23.59 percent
E. 25.14 percent
5. Jensen Boat Works is an all equity firm that has 340,000 shares of stock outstanding. The company is in the process
(not yet) of borrowing $4 million at 8 percent interest to repurchase 80,000 shares of the outstanding stock. What is the
value of this firm if you ignore taxes?
A. $15.8 million
B. $16.4 million
C. $17.0 million
D. $17.5 million
E. $18.1 million
6. Hanover Tech is currently an all equity firm that has 130,000 shares of stock outstanding with a market price of $36 a
share. The current cost of equity is 14 percent and the tax rate is 35 percent. The firm is considering adding $1.5 million
of debt with a coupon rate of 7 percent to its capital structure. The debt will be sold at par value. What is the levered
value of the equity?
A. $3.180m
B. $3.520m
C. $3.705m
D. $4.875m
E. $5.205m
7. Your firm has a debt-equity ratio of .60. Your pre-tax cost of debt is 9 percent and your required return on assets is 14
percent. What is your cost of equity if you ignore taxes?
A. 16.4 percent
B. 16.7 percent
C. 17.0 percent
D. 17.3 percent
E. 17.5 percent
8. Trudy's Pizza is an unlevered firm with an after-tax net income of $47,000. The unlevered cost of capital is 7.5 percent
and the tax rate is 35 percent. What is the value of this firm?
A. $219,333
B. $328,333
C. $407,334
D. $626,667
E. $733,333
9. Castle Home Builders has an unlevered cost of capital of 12 percent, a cost of debt of 9 percent, and a tax rate of 34
percent. What is the target debt-equity ratio if the targeted cost of equity is 14 percent?
A. .94
B. .96
C. .99
D. 1.01
E. 1.04
10. Victoria Dry Goods has expected earnings before interest and taxes of $14,600, an unlevered cost of capital of 15
percent, and a tax rate of 35 percent. The company also has $3,500 of debt that carries a 6 percent coupon. The debt is
selling at par value. What is the value of this firm?
A. $63,267
B. $64,184
C. $64,492
D. $65,211
E. $66,267
11. Jemison Foods has 6,500 bonds outstanding with a face value of $1,000 each and a coupon rate of 8 percent. The
interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 35 percent?
A. $81,250
B. $129,750
C. $182,000
D. $2,275,000
E. $1,820,000
12 ABC, Inc. has 25,000 shares of stock outstanding at a market price of $20. The firm has $500,000 in outstanding debt.
Earnings for next year are projected at $100,000. The firm plans on spending $120,000 on capital projects next. The firm
also maintains a constant debt-equity ratio. What is the projected dividend amount per share if the firm follows a
residual dividend policy?
A. $0
B. $.20
C. $.60
D. $1.20
E. $1.60
13. The Rose Bush has a cost of equity of 14.5 percent and a pre-tax cost of debt of 9 percent. The debt-equity ratio is
.70 and the tax rate is .35. What is The Rose Bush's unlevered cost of capital?
A. 11.84 percent
B. 12.78 percent
C. 14.29 percent
D. 13.42 percent
E. 15.08 percent
14. Your firm has earnings before interest and taxes of $210,000. Both the book and the market value of debt is
$500,000. Your unlevered cost of equity is 9 percent while your cost of debt is 7 percent. The tax rate is 35 percent.
What is your weighted average cost of capital?
A. 8.07 percent
B. 8.19 percent
C. 8.31 percent
D. 8.54 percent
E. 8.67 percent
15. . Kurt's Adventures has a debt-equity ratio of 3. Earnings for next year are estimated at $30,000. Capital spending is
estimated at $100,000 for next year. If the company follows a residual dividend policy, what is the estimated dividend
payout ratio?
A. 0%
B. 17%
C. 33%
D. 48%
E. 67%