Foundations Of Finance
10th Edition
ISBN: 9780134897264
Author: KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher: Pearson,
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Textbook Question
Chapter 12, Problem 7SP
(Capital structure theory) Which of the following statements most appropriately describes how agency costs affect a firm’s choice of capital structure? Explain.
- a. When firm owners borrow money, they have an incentive to engage in excessive risk taking (that is, investing in very risky projects) since they are managing someone else’s money.
- b. When firms have very limited investment opportunities and little debt financing combined with healthy profits that provide them with
free cash flow , their management team might squander the firm’s earnings on questionable investments.
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Chapter 12 Solutions
Foundations Of Finance
Ch. 12 - Prob. 1RQCh. 12 - Prob. 3RQCh. 12 - Prob. 4RQCh. 12 - Prob. 5RQCh. 12 - Prob. 1SPCh. 12 - Prob. 2SPCh. 12 - Prob. 3SPCh. 12 - Prob. 4SPCh. 12 - Prob. 5SPCh. 12 - (Capital structure theory) Match each of the...
Ch. 12 - (Capital structure theory) Which of the following...Ch. 12 - Prob. 8SPCh. 12 - Prob. 9SPCh. 12 - (Assessing leverage use) Financial data for three...Ch. 12 - Prob. 1.1MCCh. 12 - Prob. 1.2MCCh. 12 - Prob. 1.3MCCh. 12 - Prob. 1.4MCCh. 12 - Prob. 2.1MCCh. 12 - Prob. 2.2MCCh. 12 - Prob. 2.3MCCh. 12 - Prob. 3.1MCCh. 12 - Prob. 3.2MCCh. 12 - Prob. 3.3MC
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Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.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 ratioarrow_forward1. Shareholders are impacted by the amount of debt a firm has. Explain why they are impacted. Then describe at least one reason more debt in the capital structure may benefit shareholders and one reason why more debt in the capital structure may harm shareholders. 2.Capital budgeting refers to the techniques to evaluate project and a firm undertake only those projects which add value to the firm and earn more than required rate of return of the investors. Thus, the change in capital structure affects the capital budgeting of a firm.arrow_forwardMany businesses finance their investment activities internally. Should internal financing affect the efficiency with which the interest rate performs its functions? No, investment is profitable if the expected rate of return is greater than the rate of interest regardless of the source of funds. Yes, investment is profitable if the expected rate of return is greater than the rate of interest regardless of the source of funds. O No, because internal financing relies on a different profit calculation. Yes, because firms are usually more anxious about what happens to money that they do not have to pay back.arrow_forward
- When establishing their optimal capital structure, firms should strive to minimize the amount of debt financing used minimize the weighted average cost of capital none of the choices maximize the marginal cost of capitalarrow_forwardWhich of the following statements is false? A. Net incomes are not cash flows. Financial Managers should focus on the cash flows when making capital budgeting decisions. B. Incremental earnings are the amount by which the firm's earnings are expected to change as a result of the investment decision. C. To the extend that overhead costs are fixed and will be incurred in any case, they are not incremental to the project and should be excluded in the capital budgeting analysis. D. Depreciation is not a cash expense paid by the firm. E. None of the above.arrow_forwardFor firms that have debt on their balance sheets, interest expense is commonly seen as an expense on the firm's income statement. In capital budgeting, however, we ignore interest expense. Why? Group of answer choices A) Because the cost of debt is already included in the WACC, and including interest expense in the calculation of cash flows would then be "double counting" it. B) Capital budgeting is done from the perspective of the common stockholders, so it ignores interest expense (Wrong Choice) C) Like depreciation, interest expense is a "non-cash" expense D) Because firms ignore the pleas of banks and bondholders to pay their interest. This is why Silicon Valley Bank failed.arrow_forward
- The size of capital investments and the difficulty in reversing them once they are made make capital - budgeting decisions very important to the firm. O True O Falsearrow_forwardWhich statement about capital structure is the most correct? a. The more the company borrows, the lower will be the after-tax WACC. This increases the present value of the firm free cash flows which represents the value of the levered firm. Therefore, a firm should always seek to borrow as much debt as possible. b. The more the company borrows, the higher will be its tax shields, therefore a company will always prefer to issue debt than equity. c. Because the cost of debt is cheaper than the cost of equity, a company should use as much debt as possible to finance their projects d. Lenders rank ahead of shareholders when the company goes bankrupt. This increased risk for shareholders means the cost of equity is higher than the cost of debt. e. A company should always try to reduce its debt because of the high bankruptcy risk associated with debt. A company should aim to have 100% equity financing if it is possible.arrow_forwardAccording to the M&M propositions WITH and WITHOUT taxes, should a financial manager spend time analysing a firm’s capital structure? What is the optimal capital structure with and without tax? Discuss.arrow_forward
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