Question

Need only Answer

11.) Assume that a firm’s earnings per share (EPS) are expected to be $1.35 next year and that analysts have determined that an appropriate forward-looking multiple is 20 times the projected earnings. What should the stock price be?

a. $11.35

b. $20.00

c. $27.00

d. $28.75

12.) ________ is measured by the proportional amount of debt in the firm’s capital structure.

a. Relative risk

b. Business risk

c. Operating risk

d. Financial risk

13.) Creative Industries Inc. is looking to finance a new project with either debt or equity. The firm anticipates that its breakeven EPS-EBIT point is when EBIT reaches $3,000,000. If the projected EBIT are $3,500,000 for the foreseeable future, then to maximize EPS the firm should issue ______.

a. equity.

b. debt

c. preferred shares

d. a dual class of equity

14.) If a firm has a positive debt-equity ratio, and a positive tax rate, then levered beta for the firm must be ________ the unlevered beta for the firm.

a. less than

b. greater than

c. equal to

d. can not definitively answer this question

15.) Plastic Products Inc. has a levered beta of 1.30, a debt-equity ratio of 0.50, and a tax rate of 40%. What is the value of the firm’s unlevered beta?

a. 0.70

b. 1.00

c. 1.30

d. 1.60

16.)________ took place in financial markets during the Great Recession because large financial institutions took excess risks to realize abnormal positive returns in the housing market while they were simultaneously protected from abnormal losses by being “too-big-to-fail.”

a. Disintermediation

b. Deregulation

c. Corporate tax reform

d. Moral hazard

Answer 1

Answer 11 is c.

EPS = $1.35
P/E Ratio = 20 times

P/E Ratio = Stock Price / EPS
20 = Stock Price / $1.35
Stock Price = $27.00

Answer 12 is d.

Financial Risk is measured by the proportional amount of debt in the firm’s capital structure.

Answer 13 is b.

Creative Industries Inc. wants to finance its new project with either equity or debt. The firm expect an EBIT of $3,500,000 and breakeven EPS-EBIT point of $3,000,000.

The firm can achieve maximum EPS when the project is financed by debt only.

Answer 14 is b.

If a firm has a positive debt-equity ratio, and a positive tax rate, then levered beta for the firm must be greater than the unlevered beta for the firm.

Levered Beta = Unlevered Beta * [1 + (1-tax)*(D/E)]

If tax rate is positive and debt-equity ratio is also positive, then [1 + (1-tax)*(D/E)] is greater than 1.
We implies that levered beta is higher than unlevered beta.

Answer 15 is b.

Unlevered Beta = Levered Beta / [1 + (1-tax)*(D/E)]
Unlevered Beta = 1.30 / [1 + (1-0.40)*0.50]
Unlevered Beta = 1.00

Answer 16 is d.

Moral Hazard took place in financial markets during the Great Recession because large financial institutions took excess risks to realize abnormal positive returns in the housing market while they were simultaneously protected from abnormal losses by being “too-big-to-fail.”