Part 8 (ch15) Questions T/F & Multiple Choice

Mark T (True) or F (False) in each of the following sentences.

1 Holding stocks over bonds can provide a tax advantage due to the deferral of capital gains taxes until the asset is sold, which effectively lowers the capital gains tax rate.

2 Unlevered beta measures the risk of a company’s stock against that of the broader market, including the impact of a company’s capital structure and leverage, while levered beta measures the market risk of a company without the impact of debt.

3 The interest tax shield with permanent debt implies that a company with a permanent level of debt will receive a consistent tax benefit due to the deductibility of interest expenses.

4 The effective tax advantage of debt can be calculated by multiplying the firm’s interest expense by the corporate tax rate.

5 The Optimal Capital Structure with Taxes refers to the best mix of debt and equity financing that maximizes a company’s market value while minimizing its cost of capital, taking into account the tax benefits of debt financing.

6 The tax advantage of debt arises from the fact that interest payments are reducing the overall tax burden on the firm.

7 The Modigliani-Miller theorem with taxes states that the value of a levered firm is equal to the value of an unlevered firm plus the present value of the tax shield from debt

8 A firm’s cost of debt typically decreases as its credit rating improves, reflecting the reduced risk of default associated with higher credit ratings.

9 The tax shield from debt is equivalent to the amount of debt multiplied by the corporate tax rate.

10 The weighted average cost of capital (WACC) decreases as the proportion of debt in a firm’s capital structure increases due to the tax shield provided by debt financing.

11 The cost of equity typically increases as a firm’s leverage ratio increases due to the higher risk perceived by equity investors.

12 Equity financing always provides a tax shield similar to debt financing.

13 Debt financing can lead to financial distress if a company cannot meet its debt obligations.

14 The tax shield from debt financing is only applicable if the company is profitable and pays taxes.

15 The Modigliani-Miller theorem without taxes states that the value of a firm is dependent on its capital structure.

16 Tax-deductible interest on debt can make borrowing a more attractive option for companies.

17 Interest payments on debt are not tax-deductible for corporations.

18 An increase in the corporate tax rate generally increases the value of the interest tax shield.

19 In the presence of corporate taxes, the value of a levered firm is higher than the value of an unlevered firm due to the tax shield provided by debt.

20 Personal taxes have no impact on the value of a firm’s debt and equity.

21 Retained earnings do not provide a tax shield similar to that provided by debt financing.

22 Preferred stock dividends provide the same tax benefits as interest on debt.

23 Firms with higher marginal tax rates benefit more from the interest tax shield than firms with lower marginal tax rates.

24 The corporate tax shield from debt financing is irrelevant in determining a firm’s capital structure.

25 Issuing new equity shares will generally increase a firm’s interest tax shield.

26 Debt financing can result in restrictive covenants that limit a company’s operational flexibility.

27 All companies, regardless of their profitability, can equally benefit from the tax shield provided by debt.

28 A high debt ratio can increase a company’s financial risk and affect its stock price volatility.

29 Companies in highly cyclical industries might use less debt to avoid financial distress during downturns.

30 The value of a firm’s tax shield is independent of the corporate tax rate.