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.

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.

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter21: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 1MC: David Lyons, CEO of Lyons Solar Technologies, is concerned about his firm’s 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.
David Lyons, CEO of Lyons Solar Technologies, is concerned about his firm’s 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: Who were Modigliani and Miller (MM), and what assumptions are embedded in the MM and Miller models?
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: e. Suppose the expected free cash flow for Year 1 is 250,000 but it is expected to grow faster than 7% during the next 3 years: FCF2 = 290,000 and FCF3 = 320,000, after which it will grow at a constant rate of 7%. The expected interest expense at Year 1 is 128,000, but it is expected to grow over the next couple of years before the capital structure becomes constant: Interest expense at Year 2 will be 152,000, at Year 3 it will be 192,000 and it will grow at 7% thereafter. What is the estimated horizon unlevered value of operations (i.e., the value at Year 3 immediately after the FCF at Year 3)? What is the current unlevered value of operations? What is the horizon value of the tax shield at Year 3? What is the current value of the tax shield? What is the current total value? The tax rate and unlevered cost of equity remain at 25% and 14%, respectively.
Which of the following is most consistent with using debt to reduce agency costs or conflicts? Question 11 options: Increasing debt reduces a firm’s business risk The interest paid on debt reduces taxable income and income taxes The interest paid on debt reduces cash that management of a firm might otherwise waste or use poorly The issuance of debt helps firms increase their credit rating
Which of the following is CORRECT? Select one: a. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation. b. When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation. c. Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of common stock as measured by the CAPM. d. Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a company's WACC. e. All of the above are correct. Which of the following is CORRECT? Select one: a. If the NPV of a project is negative, the IRR for the project must also be negative. b. A project's MIRR can never exceed its IRR. c. If a project with normal cash flows has an IRR less than WACC, the project must have a positive NPV. d. If Project 1's IRR exceeds Project 2's IRR, then 1 must…
You are the controller of a firm whose CEO believes that debt should always be used to finance long-term expenditures because interest is tax deductible. List and describe other benefits to debt financing. Also, list and describe risks to using debt.
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
Agency costs of debt arise any time there is a conflict between lender interests and borrower interests. Assuming that agency costs of debt are high at a company relative to the rest of the market, other things being equal, which of the following would you expect to observe with the company's borrowing? It will be able to borrow less than other companies. AND It will have to pay lower interest rates on its loans than otherwise companies. It will have to pay lower interest rates on its loans than otherwise similar companies. It will have to pay lower interest rates on its loans than otherwise similar companies. AND It will face more "covenants" than otherwise similar companies. NONE. it will face more "covenants" than otherwise similar companies. It will be able to borrow less than other companies. It will be able to borrow less than other companies. It will face more "covenants" than otherwise similar companies.
All of the following are likely to result in the use of less debt in a company's capital structure EXCEPT A. desire to maintain a high credit rating. B. desire to maintain financial flexibility. C. insufficient internal funds. D. a decrease in a company's marginal tax rate.
Which of the following statements is NOT CORRECT? A. Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks associated with using short-term financing B. A company may hold a relatively large amount of cash and marketable securities if it is uncertain about its volume of sales, profits, and cash flows during the coming year C. The cash budget is useful to help estimate future financing needs, especially the need for short-term working capital loans. D. If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10, net 30 to net 60.
Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant? a. An increase in the corporate tax rate. b. An increase in the personal tax rate. c. The Federal Reserve tightens interest rates in an effort to fight inflation. d. The company's stock price hits a new low. e. An increase in costs incurred when filing for bankruptcy. Explain your answer
. The relationship between a firm's capital structure and other company attributes 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 1.15, and its cost of equity is 11.55%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 11.55%. The risk-free rate of interest (rRFrRF) is 3.5%, and the market risk premium (RPMRPM) is 7%. Blue Ram’s marginal tax rate is 25%. Blue Ram is examining how different levels of…