Why do companies often prefer debt financing to other forms of financing for capital investments? a. Actually, they don't prefer debt financing. They usually try to use retained earnings 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 than the interest on the loans. d. Because debt interest is tax deductible, reducing significantly the actual cost of borrowing money for projects.

Why do companies often prefer debt financing to other forms of financing for capital investments? a. Actually, they don't prefer debt financing. They usually try to use retained earnings 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 than the interest on the loans. d. Because debt interest is tax deductible, reducing significantly the actual cost of borrowing money for projects.

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter21: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 4MC: 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: d. Suppose that Firms U and L have the same input values as in Part c except for debt of 980,000. Also, both firms have total net operating capital of 2,000,000 and both firms are expected to grow at a constant rate of 7%. (Assume that the EBIT in part c is expected at t = 1.) Use the compressed adjusted present value (APV) model to estimate the value of U and L. Also estimate the levered cost of equity and the weighted average cost of capital.
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
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 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 incorrect about the Pecking Order Theory? A.Firms with high ratios of fixed assets to total assets tend to have higher debt ratios.This evidence exclusively supports the pecking order theory B.When external finance is required,firms issue debt first and equity as a last resort C.Most profitable firms borrow less not because they have lower target debt ratios but beause they don't need external finance D.Firms prefer internal finance since funds can be raised without sending adverse signals
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.
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.
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
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.
Which of the following is most correct about the cost of capital? The cost of debt reflects the interest rates on debt capital before taking into account the tax effects. Cost of capital is affected by the required rates of return of each of the source of capital, regardless of the capital structure. The capital asset pricing model is the most widely used model to estimate the cost of common equity. To minimize the cost of capital, firms should borrow more than their capacity because increasing the lower cost of debt yields the lowest cost of capital, thus, enhances shareholder value.
Which of the following statement is incorrect about the Peking Order Theory? A.Firms with high ratios of fixed assets tend to have higher debt ratio.The evidence exclusively supports the peking order theory B.When exernal finance is required,firms issue debt first and equity as a last resort C.Most profitable firms borrow less not because they have lower target debt but because they don't need external finance D.Firms prefer internal finance since funds can be raised without sending advers signals
In certain scenerios, some companies may choose to finance with a bank loan specifically because of the deductibility of interest. It could lower their taxable income enough (assuming it is not a corporation at the current 21% flat rate) to put them in a lower tax bracket. This means they could end up paying less money after interest and taxes are paid. It is interesting that bank interest could be utilized as a cash flow strategy! Do you think this is something many finance managers may consider?