A Firm Is Analyzing Two Possible Capital Structures-30 and 50

question 161

Multiple Choice

A firm is analyzing two possible capital structures-30 and 50 percent debt ratios. The firm has total assets of $5,000,000 and common stock valued at $50 per share. The firm has a marginal tax rate of 40 percent on ordinary income. If the interest rate on debt is 7 percent and 9 percent for the 30 percent and the 50 percent debt ratios, respectively, the amount of interest on the debt under each of the capital structures being considered would be ________.

• A) 30 percent debt ratio: $105,000 and 50 percent debt ratio: $225,000
• B) 30 percent debt ratio: $245,000 and 50 percent debt ratio: $225,000
• C) 30 percent debt ratio: $105,000 and 50 percent debt ratio: $250,000
• D) 30 percent debt ratio: $135,000 and 50 percent debt ratio: $175,000

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Definitions:

Profitable Level

A point at which revenues exceed costs, resulting in financial gain for businesses or economic activities.

Market Price

The current price at which an asset or service can be bought or sold, determined by the supply and demand dynamics in the open market.

Shut Down

A short-run decision by a firm to cease production when market conditions make continued operation unprofitable.

Market Price

The existing trade value at which an asset or service can be acquired or disposed of.