Although the major benefit of debt financing is easy to observethe tax shield-many of the indirect costs of debt financing can be quite subtle and difficult to observe. Describe some of these costs. Select from the drop-down menus.) O A. Overinvestment: Highly leveraged firms run the risk of bankruptcy and so cannot write long tem employment contracts and offer job security. O B. Overinvestment: Not investing in positive NPV projects OC. Overinvestment: Investing in negative NPV projects. O D. Overinvestment: Paying out dividends instead of investing in positive NPV projects. Select from the drop-down menus.) O A. Underinvestment: Not investing in positive NPV projects O B. Underinvestment: Paying out dividends instead f investing positive NPV projects. OC. Underinvestment: Highly leveraged firms run the risk of bankruptcy and so cannot write long term employment contracts and offer job security. O D. Underinvestment: Investing in negative NPV projects. Select from the drop-down menus.) O A. Cashing out: Highly leveraged firms run the risk of bankruptcy and so cannot write long tem employment contracts and offer job security. OR Cochinn r

Although the major benefit of debt financing is easy to observethe tax shield-many of the indirect costs of debt financing can be quite subtle and difficult to observe. Describe some of these costs. Select from the drop-down menus.) O A. Overinvestment: Highly leveraged firms run the risk of bankruptcy and so cannot write long tem employment contracts and offer job security. O B. Overinvestment: Not investing in positive NPV projects OC. Overinvestment: Investing in negative NPV projects. O D. Overinvestment: Paying out dividends instead of investing in positive NPV projects. Select from the drop-down menus.) O A. Underinvestment: Not investing in positive NPV projects O B. Underinvestment: Paying out dividends instead f investing positive NPV projects. OC. Underinvestment: Highly leveraged firms run the risk of bankruptcy and so cannot write long term employment contracts and offer job security. O D. Underinvestment: Investing in negative NPV projects. Select from the drop-down menus.) O A. Cashing out: Highly leveraged firms run the risk of bankruptcy and so cannot write long tem employment contracts and offer job security. OR Cochinn r

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter21: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 3MC: David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing....

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David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: Now assume that Firms L and U are both subject to a 25% corporate tax rate. Using the data given in part b, repeat the analysis called for in parts b(1) and b(2) using assumptions from the MM model with taxes.
Why do companies often prefer debt financing to other forms of financing for capitalinvestments?a. Actually, they don't prefer debt financing. They usually try to use retainedearnings for capital investments.b. Because bond holders are happy to just break even on their bonds.c. Because the MARR all but guarantees the projects will return yields greater thanthe interest on the loans.d. Because debt interest is tax deductible, reducing significantly the actual cost ofborrowing money for projects.
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.
An analyst at a company notes that its cost of debt is far below that of equity. He concludes that it is important for the firm to maintain the ability to increase its borrowing because if it cannot borrow, it will be forced to use more expensive equity to finance some projects. This might lead it to reject some projects that would have seemed attractive if evaluated at the lower cost of debt. How do you balance the amount of equity and debt? Explain the significance of maintaining the ability to increase borrowing capacity for a company with a lower cost of debt compared to equity. How does this impact project evaluation and investment decisions, and what role does the concept of cost of capital play in such considerations?
Which of the following statements is FALSE? As debt increases, the risk associated with bankruptcy and agency costs is reduced. Debt is often the least costly form of financing for a firm. Firms should probably use some debt in their capital structure. Different firms are subject to different levels of risk.
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
Which of the following makes this a true statement? In this slightly more realistic world with corporate taxes, managers can: Multiple Choice maximize the firm's value by taking on as much equity as possible. maximize the firm's value by taking on as much debt as possible. minimize the firm's value by taking on as much debt as possible. maximize the firm's value by financing only with debt.
Please help solve and show work. As a firm takes on more debt, its probability of bankruptcy ___ . Other factors held constant, a firm whose earnings are relatively volatile faces a ____ chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use ____ debt than a more stable firm. When bankruptcy costs become more important, they ____ the tax benefits of debt. Blue Ram Brewing Company currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm’s unlevered beta is 1.05, and its cost of equity is 12.40%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.40%. The risk-free rate of interest (rRFrRF) is 4%, and the market risk premium (RPMRPM) is 8%. Blue Ram’s marginal tax rate is 25%. Blue Ram is examining how different levels of debt will affect its costs of debt and…
Under Modigliani and Miller's assumption of perfect capital markets, which of the following is NOT CORRECT? A) The proper WACC equation under perfect capital markets is the "pre-tax" WACC B) Taxes are irrelevant C) Reducing the debt ratio can cause the cost of debt and the cost of equity to decline, even as the WACC stays the same. D) The WACC does not change as the weights of debt and equity change E) Bankruptcy costs reduce the amount bondholders receive when bankruptcy occurs
If we drop the assumption that there are no information and transaction costs, in addition to dropping the no-tax assumption, then the Modigliani and Miller model suggests: Companies will not always increase their use of debt. Capital structure has no impact on companies’ value Capital structure has impact on companies’ cost of capital Companies will always increase their use of debt.
Which of the following statements is CORRECT? Group of answer choices Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes. If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject. Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt. Higher flotation costs tend to reduce the cost of equity capital.
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