The security market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio.

Question

Question 1

The interest tax shield is a key reason why:

A. the required rate of return on assets rises when debt is added to the capital structure.

B. the value of an unlevered firm is equal to the value of a levered firm.

C. the net cost of debt to a firm is generally less than the cost of equity.

D. the cost of debt is equal to the cost of equity for a levered firm.

E. 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?

A. 8.83%

B. 12.30%

C. 13.97%

D. 14.08%

E. 14.60%

138 = RU + (RU – .085) × .60 × (1 − .34); .17166 = 1.396RU; RU = .12297 = 12.30 %

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?

A. \$2,823

B. \$2,887

C. \$4,080

D. \$4,500

E. \$4,633

Present value of the tax shield = .34×\$12,000 = \$4,080

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?

A. 6.76%

B. 7.00%

C. 7.25%

D. 7.40%

E. 7.50%

.1568 = .12 + (.12 – Rd)´.80; Rd= .074 = 7.40%

Question 5

The combination of the efficient set of portfolios with a riskless lending and borrowing rate results in:

A. the capital market line which shows that all investors will only invest in the riskless asset.

B. the capital market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio.

C. the security market line which shows that all investors will invest in the riskless asset only.

D. the security market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio.

E. None of these.