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Why do most analysts recommend against having a capital structure of zero debt?

Cornerstones of Financial Accounting

4th Edition

ISBN:9781337690881

Author:Jay Rich, Jeff Jones

Publisher:Jay Rich, Jeff Jones

ChapterA2: Investments

Section: Chapter Questions

Problem 8DQ: How does the equity method discourage the manipulation of net income by investors?

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Similar questions

“Having zero debt in the firm’s capital structure is not an ideal scenario.” Do you agree withthis statement? Explain
Critically discuss over-investment and under-investment problems due to debt usage. What kinds of capital structures could prevent such problems?
What is the biggest disadvantage to be considered when exploring the option of equity financing versus debt financing?
In determining the optimal weighted average cost of capital, an MNC can never have too much debt. Group of answer choices True False
What is a good capital structure? Are low debt ratios always favorable?
Which of the following statements relating to working capital financing is not correct? A. A conservative policy uses long-term debt to finance non-current assets. B. Short-term debt is cheaper than long-term debt. C. An aggressive policy uses long-term debt to finance fluctuating current assets. D. Long-term debt is less risky that short-term debt.
What are the advantages and disadvantages ofusing short-term debt as a source of financing?
Assume that the risk-free rate increases, but the market risk premium remains constant. What impact would this have on the cost of debt? What impact would it have on the cost of equity? How should the capital structure weights are used to calculate the WACC be determined?
Why are the bonds treated as a conservative investment? Do you think the treasury bills are risk-free assets?
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
Why do we use the market value of debt and equity to estimate WACC instead of the book value?
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.