Pearson eText Foundations of Finance -- Instant Access (Pearson+)
10th Edition
ISBN: 9780135639382
Author: Arthur Keown, John Martin
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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1. Which of the following statements most appropriately describe how agency cost affect the firms choice 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 money.b. When firm have very limited investment opportunities and little debt financing combine with wealth profit that provide them with free cash flow, their management team might squander the firms' earnings on questionable investments.
2. What is the primary weakness of using EBIT-EPS analysis as a financing tool.
3. Why might firms who's sale level change drastically overtime, choose to use debt only sparingly in their capital structure
4. What does the term independence hypothesis means as it applies to capital structure theory
5. Explain how industry norms might be used by the finance manager in the design of the company's financing mix
note: if you can provide the source of the info,…
3. Which of the following statements is false about the agency costs of free cash flow (FCF)?
Managers of firms with high FCFs may make negative NPV
investments
The free cash flow problem is more severe for firms with high cash flows but many profitable investment
opportunities
The free cash flow problem is more severe for firms with high debt in their capital
structure
Managers have incentives to grow firms more than optimal to increase their power and resources under
their control
Managers have incentives to grow firms more than optimal to increase their compensation and promotion
prospects
See below for some statements on how financial managers can create value for their firms.
Which of the following statement(s) is (are) FALSE?
Select one or more alternatives:
Managers can create value for the firm's stakeholders through improving its ESG performance. The "ESG"
in ESG investing stands for environmental, social and governance.
Capital markets are less efficient than goods markets; this is why the primary source of creating value is
through clever financing decisions.
If capital markets are inefficient at times, financial managers could create value through financing decisions.
Managers can create value for the firm's stakeholders through improving its ESG performance. The "ESG"
in ESG investing stands for environmental, sustainability and governance.
Chapter 12 Solutions
Pearson eText Foundations of Finance -- Instant Access (Pearson+)
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
- Several factors affect a firm’s need for external funds. Evaluate the effect of each following factor and place a check next to each factor that is likely to increase a firm’s need for external capital—that is, its AFN (additional funds needed). Check all that apply. The firm increases its dividend payout ratio. The firm switches its supplier for the majority of its raw materials. The new supplier offers less favorable credit terms and thus reduces the trade credit available to the firm, resulting in a reduction in accounts payable. The firm improves its production system and increases its profit margin. Accounts payable and accrued liabilities represent obligations that the firm must pay off. Assuming everything else holds constant, if they increase, the firm’s AFN will_________ .arrow_forwardSee below for some statements on how financial managers can create value for their firms. Which of the following statement(s) is (are) TRUE? Select one or more alternatives: If capital markets are inefficient at times, financial managers could create value through financing decisions. Capital markets are less efficient than goods markets; this is why the primary source of creating value is through clever financing decisions. Managers can create value for a firm's stakeholders through improving its ESG performance. The "ESG" in ESG investing stands for environmental, social and governance. Managers can create value for a firm's stakeholders through improving its ESG performance. The "ESG" in ESG investing stands for environmental, sustainability and governance.arrow_forwardWhen a firm has businesses with different risk profiles, different investments can have different costs of equity and capital. What is the relationship between the firm’s cost of equity and capital and its projects’ costs of equity and capital?arrow_forward
- Many 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_forwardAnalyze why, despite employing various investment appraisal techniques, large investment projects in big corporations may fail to deliver their estimated cash flows. Critically assess how a failed capital project may affect key stakeholders and shareholder value, and also shape the future strategy of investment capital.arrow_forwardWhich 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 theoryarrow_forward
- 1. 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_forwardA negative effect of the increase in debt in the capital structure to control the agency problem can be: Select one: O a. the excessive payment of corporate taxes due to the high interest on the debt. O b. the excessive investment of managers in projects even with a low NPV. O c. resulting in very high risk aversion in management, leading to little or almost no investment in capital projects, even with positive NPVS. This would cause stagnation or little growth of the firm. O d. a wrong signal that the firm is spreading the firm's risk among more shareholders.arrow_forwardB) Analyze why, despite employing various investment appraisal techniques, large investment projects in big corporations may fail to deliver their estimated cash flows. Critically assess how a failed capital project may affect key stakeholders and shareholder value, and also shape the future strategy of investment capital.arrow_forward
- 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_forwardAccording to the capital structure trade-off model: O a. The optimal capital structure minimizes the company's weighted average cost of capital. O b. There is no optimal capital structure, but instead there is a hierarchy of sources of capital. O c. There is no optimal capital structure, and companies should aim to maximize debt financing, since they thereby minimize their tax payments. O d. The optimal capital structure minimizes the company's market value. O e. The optimal capital structure minimizes the company's cost of equity.arrow_forwardExplain why finance theory, combined with well-diversifiedinvestors and “homemade hedging,” might suggest that riskmanagement should not add much value to a company.arrow_forward
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