Tax and Gearing Essay

714 Words Mar 16th, 2013 3 Pages
W22Extra: Tax and Gearing: More Questions

Multiple Choice

1) Which of the following statements is false?
A) In general, the gain to investors from the tax deductibility of interest payments is referred to as the interest tax shield.
B) The interest tax shield is the additional amount that a firm would have paid in taxes if it did not have leverage.
C) Because Corporations pay taxes on their profits after interest payments are deducted, interest expenses reduce the amount of corporate tax firms must pay.
D) As Modigliani and Miller made clear in their original work, capital structure matters in perfect capital markets. Thus, if capital structure does not matter, then it must stem from a market imperfection.
As Modigliani and
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FBNA's marginal corporate tax rate is 40%.

6) Establish FBNA's EBIT
A) £43 million
B) £40 Million
C) £45 million
D) £60 million

EBIT = NI + Taxes + Interest expense
FCF = NI + Interest expense => 27 = 24 + interest expense = 3
(EBIT - Interest Expense)(1 - 0.4) = NI
(EBIT - 3)(0.6) = 24 (EBIT – 3) = 24/0.6 = 40
EBIT = 40 + 3 = $43

7) IF FBNA increases leverage so that its interest expense rises by £1 million, then the amount its profit for shareholders will change is closest to:
A) -£400,000
B) -£600,000
C) £400,000
D) £600,000

(EBIT - Interest Expense - chg IE)(1 - 0.4) = NI + chg NI
(- chg IE)(0.6) = chg NI
-1m (.6) = -600,000
Or, -$1m (1 - .4) = -$600,000

8) IF FBNA increases leverage so that its interest expense rises by £1 million, then the amount its Free Cash flow will change is closest to:
A) -£600,000
B) -£400,000
C) £600,000
D) £400,000

FCF = NI + Interest expense chg FCF = chg NI + chg Interest expense
= - 600,000 + 1m = +400,000
Or, $1m (0.4) = $400,000

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LCMS Industries has £70 million in debt outstanding. The firm will pay only interest on this debt (the debt is perpetual). LCMS' marginal tax rate is 35% and the firm pays a rate of 8% interest on its debt.

9) LCMS' annual interest tax shield

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