According to theory, the value of a firm is maximized by: Issuing no debt Issuing the maximum amount of debt absorbed by the market place Increasing debt until the marginal tax benefit of debt is offset by distress costs Keeping the debt equity mix at 50/50

According to theory, the value of a firm is maximized by: Issuing no debt Issuing the maximum amount of debt absorbed by the market place Increasing debt until the marginal tax benefit of debt is offset by distress costs Keeping the debt equity mix at 50/50

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter17: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 1P

See similar textbooks

Related questions

Q: One advantage of using leverage is that it allows the original owners of the firm to maintain their…

A: Financial leverage of a company suggests that the company has debt along with equity in its capital…

Q: Which one of the following statements is correct if the pecking order theory holds? a. Firms with…

A: According to the pecking order theory, managers prefer to fund investment options using the firm's…

Q: The existence of asymmetric (insider) information makes it desirable for firms to:…

A: The term Asymmetric Information means the unbalanced information between the two parties in a…

Q: Explain what this statement means: "One type of leverage affects both EBIT and EPS. The other type…

A: Since you have asked multiple questions, we will solve the first question for you. IF you want any…

Q: 4. If a higher ROE is desirable, why don't companies take on large amounts of debt? a. Additional…

A: The return on equity is used to evaluate the profit earned on an investment considering the profit…

Q: A firm has zero debt and an overall cost of capital of 12.5 percent. The firm is considering a new…

A: Answer - Cost of Equity = Cost of Capital + ( % Debt / % balance)(Cost of Capital- cost of debt)…

Q: Regarding the trade-off theory, a firm would reach its optimal capital structure if the tax savings…

A: Capital Structure is the break-up of total amount of funds raised by entity to finance its…

Q: Which of the following statements are incorrect regarding how much debt a company should borrow?…

A: The company has two types of capital Debt capital and equity capital. Interest on Debt capital…

Q: Explain Why you agree or disagree with the following statements. The answer should not be more than…

A: Agree or disagree with the following statements is as under-

Q: Answer as either true or false and provide a reason for why. When a company pays dividends, its…

A: Since you have asked multiple questions, we will solve the first question for you. If you want any…

Q: The MM irrelevance capital structure theory proved that a firm’s value is unaffected by its capital…

A: The MM irrelevance capital structure theory states that a firm’s valuation is unaffected by its…

Q: Consider the following statements: The Trade-off theory of capital structure cannot explain the…

A: The Trade-off theory of capital structure cannot explain the following: I. Why profitable firms have…

Q: Which of the following would likely encourage a firm to increase the debt in its capital structure?…

A: There are two correct options for the question. a) Increase in corporate tax rate would mean that by…

Q: 9. A firm is considering actions which will raise its debt ratio. It is anticipated that these…

A: financial ratio analysis are considered to be an important or investor in order to make decisions…

Q: The disadvantages of debt to the corporation include all but which of the following? Group of…

A: The company can raise funds through different sources of finance such as debt funds, equity funds,…

Q: A company will prefer debt in its capital structure, if (tick the most appropriate alternative) (a)…

A: Any capital structure is composed of debt and equity. Both have their own pros and cons which affect…

Q: For a typical firm, assumes that all rates are after taxes and that the firm operates at its target…

A: Given, cost of equity > after tax cost of debt > WACC.

Q: The difference between the market value of the firm and the amount of money invested in the firm is…

A: An investor takes into consideration the market value of the company to decide whether investment…

Q: If the financial market is frictionless, the cost of equity is higher than the cost of debt in all…

A: A financial market is a place where people may exchange low-cost financial securities and…

Q: A limitation of the Degree of Financial Leverage formula is that we assume the cost of debt…

A: Answer 1. FALSE The limitation of the degree of financial leverage formula is the risk rises and…

Q: Suppose your firm’s credit rating is B-, and outlook is negative, not easy to raise finance through…

A: Equity and debts are the two sources of financing available in capital markets. It is generally…

Q: Finance Which one of the following statements is not correct? a) Market timing theory argues that…

A: The wrong statement is b) According to static trade-off theory agency costs of equity increase when…

Q: Which one of the following is NOT an implication of market efficiency for corporate finance?

A: Since you have posted multiple independent questions in the same request, we will solve the first…

Q: Concerning the EBIT-EPS indifference analysis, which of the following statements is accurate? If…

A: EBIT-EPS analysis is the financial tool used to evaluated different alternatives of project…

Q: Please explain if a company has already taken too much debt (exceeded the amount that they can…

A: A used buyout happens when an association buys one more association with the assistance of acquired…

Q: key benefits associated with refunding debt are the reduction in the firm's debt ratio and the…

A: The debt ratio is ratio that dictates that how much company has taken the debt out of its total…

Q: In a world with corporate taxes but no possibility of financial distress, the value of the firm is…

A: financial distress is the cost that occurs when promises to the creditors are broken these cost…

Q: Which of the following is a disadvantage of long-term debt as a means of company financing? Group…

A: Funds are very important and necessary for smooth running of a business organization. A business has…

Q: Which of the following makes this a true statement? In this slightly more realistic world with…

A: We derive a firm's value by discounting its future cash flows. We use weighted average cost of…

Q: Explain Why you agree or disagree with the following statements. The answer should not be more than…

A: Introduction: Capital structure is nothing but the debt and securities that are included in the…

Q: According to the capital structure trade-off model: O a. The optimal capital structure minimizes the…

A: Capital structure refers to the mix of source from where the long term funds required in a business…

Q: Consider the following statements about a firm: I. The debt beta of a firm is usually quite low. If…

A: Weighted Average Cost of Capital is referred to as the common method for determining the required…

Q: If the present value of a firm's marginal financial distress costs are equal to the present value of…

A: Financial distress costs means the firm cannot pay its debt or firms have insufficient cashflow.…

Q: Identify the corect statement: O H EBIT is expected to be below the indifference point, the firm…

A: EBIT - EPS indifferent point is the EBIT level at which EPS is same

Q: The optimal capital structure for firms in stable industries can reasonably contain ________________…

A: Option A: More Debt - If debt will be more then Fixed charges of Interest will be more. Stable…

Q: Which of the followings proposes that there is a tradeoff between level of borrowing and benefit of…

A: As per company policy in case of multiple questions it is possible to solve only one question.

Q: interaction effects make it difficult for a firm to adjust its capital structure based on prevailing…

A: There are two ways of finance of firms one is debt and other is equity Cost of debt is low and has…

Q: If the present value of a firm’s marginal financial distress costs are less than the present value…

A: Capital Structure refers to arrangement of sources of finance from which capital of firm is finance.…

Q: Which of the following is most consistent with using debt to reduce agency costs or conflicts?…

A: Statement number 4 is consistent with using debt to reduce agency costs or conflicts.

Q: Generally speaking, the cost of debt is cheaper than the cost of equity. Does it imply that a firm…

A: Cost of debt is the charge which a fir must pay to the bond holder for borrowing the money. This…

Q: firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is…

A: Weighted average cost of capital = (weight of Debt * Cost of debt) + (weight of Equity * Cost of…

Q: What is the blend of long-term financial sources used to finance the firm which may include debt,…

A: Debt is cheaper source of finance but increases volatility.

Q: 9.Which of the following are true according to the Modigliani and Miller propositions? i.In a world…

A: Merton Miller as well as Franco Modigliani had conceptualized as well as developed this theorem as…

Q: Although the exact relationship between a firm's degree of financial leverage and its beta is…

A: Beta is a measure of volatility or systematic risk higher the beta higher will be the risk. The beta…

Question

According to theory, the value of a firm is maximized by:
1. Issuing no debt
2. Issuing the maximum amount of debt absorbed by the market place
3. Increasing debt until the marginal tax benefit of debt is offset by distress costs

Keeping the debt equity mix at 50/50

Expert Solution

This question has been solved!

Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.

SEE SOLUTION Check out a sample Q&A here

Step 1

VIEW

Step 2

VIEW

Step by step

Solved in 2 steps

SEE SOLUTION Check out a sample Q&A here

Knowledge Booster

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.

Similar questions

What happens to ROE for Firm U and Firm L if EBIT falls to $1,600? What happens if EBIT falls to $1,200? What is the after-tax cost of debt? What does this imply about the impact of leverage on risk and return?
Which of the following is a disadvantage of long-term debt as a means of company financing? Group of answer choices Debtholders have preferential status in the event of a company being wound up. Tax relief is available on interest payments. Debt is often quicker to arrange compared to equity. The amount and timing of interest payments is predictable, making budgeting easier.
For each statement indicate whether it is true or false and briefly explain why. a) In a perfect capital market with no corporate taxes, as a firm takes on more and more debt its weighted average cost of capital remains unchanged while its required return on equity rises. b) If a firm issues riskfree debt the risk of the firm’s equity will not change. So, risk-free debt allows the firm to get the benefit of a low cost of debt without raising its cost of equity. c) In the context of firms’ capital structure decisions, the theory predicts that the value of a firm’s equity will rise in direct proportion to the level of debt in its capital structure.
Suppose your firm’s credit rating is B-, and outlook is negative, not easy to raise finance through debt from the capital market. According to the capital structure theories we examined, benefits by having debt since the interest expense is deductible for tax purposes, creating an interest tax shield. The interest tax shield, on the other hand, increases in value the higher the coupon rate on the debt and the higher the tax rate. Shouldn't the firm then choose to raise as much debt as possible or pay as high a coupon rate as possible given the low credit rating? As CFO, what kinds of concerns you have to issue as much debt as possible, and high coupon rate increase the benefits of tax shields? (300 words limit with bulletin points to answer the above questions)
If the present value of a firm's marginal financial distress costs are equal to the present value of its marginal tax shieid, the companySelect one:a.has too much debt in its capital structureb.should increase the amount of debt in ts capital structurec. has an optimal capital structured.shouid reduce the amount of equity in its capital structuree:none of the abovt
Bolton Company substantially increased its allowance for bad debt. Which of the following effects will occur? Question options: It will reduce the current ratio. It will increase the acid test ratio. It will increase working capital. It will reduce its dividend payout ratio.
The disadvantages of debt to the corporation include all but which of the following? Group of answer choices A. Indenture agreements may place burdensome restrictions on the firm. B. Interest and principal payments must be met regardless of performance results. C. Debt may have to be paid back with "cheaper" dollars because of inflation. D. Too much debt may depress the firm's stock price.
The "Pure Modigliani and Miller Result" establishes, under restrictive assumptions, that the firm's stock price will be maximized if it uses virtually 100 percent debt. Which of the following real-world conditions does the most to limit real world corporate debt-to-assets ratios to far less than 100 percent? Group of answer choices Interest rates increase as the debt-to-assets ratio rises. At high levels of debt revenues decline. Dividends are relevant in the real world. There are brokerage costs. Investors can't really borrow at the same rate as corporations.
According to MM propositions, which of the following statements best describes the consequence of increasing debt-to-value ratio for a firm? Group of answer choices The weighted average cost of capital can decrease. The weighted average cost of capital can increase. The cost of equity capital can decrease. The weighted average cost of capital must not stay constant.
There are advantages and disadvantages of debt financing in contrast to equity financing. Which of the following is less likely to represent an advantage of debt financing? a. The cost of debt should be lower than the cost of equity for most companies due to the lower risk to the lender and the tax deductibility of interest b. The repayment of debt capital may affect the liquidity of the company c. If the return on assets exceeds the cost of debt, then this will result in a higher return on shareholders’ funds as compared to the return on assets d. The increase in borrowings will not normally affect the voting control of the current shareholders as compared to the issue of shares e. Fixed interest rate loans will result in the variability in the market value of such loans over time which will normally be less than the variability in the value of the equity of the company
According to Modigliani and Miller Proposition II: A. WACC curve is flat and hence no optimal capital structure exists B. WACC curve is upward slopping , indicating the equity financing exclusively being the optimal capital structure of a company C. WACC curve is downward slopping, hence the perfect capital structure is 100% debt D. An optimal capital structure exists as it is the balance between the tax benefit and the bankruptcy costs
In a world with corporate taxes but no possibility of financial distress, the value of the firm is maximized when the: Firm uses the maximum amount of debt in its capital structure. Firm uses a debt-equity ratio of 1.0. Firm uses no debt in its capital structure. Corporate tax rate approaches 100%.