Which of the following statements is CORRECT? * In most cases, increasing a company's debt ratio raises the marginal cost of both debt and equity funding. However, this action could also reduce the company's WACC. Since debt funding is less costly than equity financing, rising a company's debt ratio would often lower its WACC. Since the use of financial leverage has no impact on a firm's beta coefficient, leverage has no effect on the cost of equity. Since debt funding increases a company's financial risk, raising its debt ratio will often increase its WACC. In most situations, rising a company's leverage ratio reduces the marginal cost of both debt and equity funding. However, this behavior could increase the company's WACC.

Which of the following statements is CORRECT? * In most cases, increasing a company's debt ratio raises the marginal cost of both debt and equity funding. However, this action could also reduce the company's WACC. Since debt funding is less costly than equity financing, rising a company's debt ratio would often lower its WACC. Since the use of financial leverage has no impact on a firm's beta coefficient, leverage has no effect on the cost of equity. Since debt funding increases a company's financial risk, raising its debt ratio will often increase its WACC. In most situations, rising a company's leverage ratio reduces the marginal cost of both debt and equity funding. However, this behavior could increase the company's WACC.

Financial Reporting, Financial Statement Analysis and Valuation

8th Edition

ISBN:9781285190907

Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Chapter5: Risk Analysis

Section: Chapter Questions

Problem 2QE

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Similar questions

Which of the following is a valid reason for a firm not to use as much debt as it can raise? Group of answer choices The use of more debt is expected to result in an increase in the firmʹs cost of capital when everything is considered More debt will increase the firmʹs riskiness All of them are valid reasons for a firm to use less debt than might be available The use of more debt is expected to result in a lower price/earnings ratio
Which statement is most correct? * A. Since debt financing raises the firm’s financial risk, increasing debt ratio will increase WACC. B. Since debt financing is cheaper than equity financing, increasing debt ratio will reduce WACC. C. Increasing a firm’s debt ratio will typically reduce the marginal costs of both debt and equity financing; however, it still may raise the firm’s WACC. D. Statements a and c are correct. E. None of the above
Regarding the EPS fallacy, which of the following statements is correct: a. When a company issues debt and uses all the proceeds to buy back equity and as a result EPS rises, the fact that some analysts associate the rise of EPS to an improvement in the company's performance is called the EPS fallacy. b. All given statements are correct. c. One of the reasons behind the EPS fallacy is not to take into account that when EPS rises mechanically due to a leveraged recapitalisation, the cost of equity also rises in the same proportion and the share price does not change (assume no taxes and perfect capital markets world). d. Suppose companies A and B have identical cash flows but different capital structures. Suppose further that EPS(A) > EPS(B). We cannot conclude that A has a better performance than B.
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.
Which of the following about optimal capital structure is incorrect? Optimal capital structure is the mixed of debt and equity capital that minimizes the firm’s weighted average cost of capital A company that follows the pecking order theory will use external financing thru debt after exhausting all the possible financing thru equity The management empire-building theory views high interest payments as to prevent management from unreasonable spending A company can take advantage of its high corporate tax rate as tax shield, under the trade-off theory
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 one of the following statements is correct if the pecking order theory holds?a. Firms with the highest debt ratios can be expected to have the lowest profits owing to the lesser availability of internal financeb. Firms will be keen to undertake equity issues as this signals to investors that managers believe the firm is undervaluedc. Firms will raise funds via equity issues in preference to debt issuesd. Firms will raise funds via external finance in preference to internal financee. None of the above
If the financial market is frictionless, the cost of equity is higher than the cost of debt in all firms. Therefore, in this circumstance, firms must finance their projects by issuing debt rather than equity. Is it right?
Which of the following statements is correct?(a) The quickest way to determine whether the firmhas too much debt is to calculate the Timesinterest-earned ratio.(b) The best rule of thumb for determining the firm’sliquidity is to calculate the current ratio.(c) From an investor’s point of view, the price-toearnings ratio is a good indicator of whether ornot a firm is generating an acceptable return tothe investor.(d) The operating margin is determined by subtracting all operating and non-operating expensesfrom the gross margin.
Does decreasing net margin percentages and slightly increasing financial leverage have an effect on Return on Equity (ROE)?. If Yes, What should a company do to solve such problem.
Diol Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. To estimate how much its debt would cost at different debt levels, the company’s treasury staff has consulted with investment bankers and, on the basis of those discussions, has created the following table: Structure Market Debt-to-Value Ratio (Wd) Market Equity-to-Value Ratio (Ws) Bond Rating Pre-tax Cost of Debt (rd) A 0.0 1.0 AA 9.0% B 0.2 0.8 BBB 10.5% C 0.5 0.5 BB 11.6% D 0.6 0.4 C 12.7% E 0.75 0.25 D 14.0% Diol uses the CAPM to estimate its cost of common equity, rs. The company estimates that the risk-free rate is 7%; the market risk is 13%, and the company’s tax rate is 20%. Diol estimates that if it had no debt, its “unlevered” beta, bU, would be 1.3. What is the…
Which of the following statements is most correct? Group of answer choices The optimal capital structure maximizes the WACC. None of these. Increasing the amount of debt in a firm's capital structure is likely to increase the cost of both debt and equity financing. If the after-tax cost of equity financing exceeds the after-tax cost of debt financing, firms are always able to reduce their WACC by increasing the amount of debt in their capital structure.