Which of the following statements is correct? a. As Modigliani and Miller made clear in their original work, capital structure does not matter in perfect capital markets. Thus, if capital structure does matter, then it must stem from a market imperfection. b. Because corporations pay taxes on their profits after interest payments are deducted, interest expenses increase the amount of corporate tax firms must pay. c. To determine the loss due the leverage for the value of the firm, we must compute the present value of the stream of future interest tax shields the firm will receive minus the stream of future dividends. d. By increasing the amount paid to debt holders through interest payments, the amount of the pre-tax cash flows that must be paid as taxes increases. e. In general, the gain to lenders from the tax deductibility of interest payments is referred to as the interest tax benefit.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Which of the following statements is correct?
a. As Modigliani and Miller made clear in their original work, capital structure does not matter in perfect capital markets. Thus, if capital structure does matter, then it must stem from a market imperfection.
b. Because corporations pay taxes on their profits after interest payments are deducted, interest expenses increase the amount of corporate tax firms must pay.
c. To determine the loss due the leverage for the value of the firm, we must compute the present value of the stream of future interest tax shields the firm will receive minus the stream of future dividends.
d. By increasing the amount paid to debt holders through interest payments, the amount of the pre-tax cash flows that must be paid as taxes increases.
e. In general, the gain to lenders from the tax deductibility of interest payments is referred to as the interest tax benefit.
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