Corporate Finance
12th Edition
ISBN: 9781259918940
Author: Ross, Stephen A.
Publisher: Mcgraw-hill Education,
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Question
Chapter 16, Problem 3CQ
Summary Introduction
To determine: Whether the given information is true or false.
Statement:
In the real world when there are no taxes, no expenses of fiscal distress, and no transaction cost reasonable borrowing will not raise the necessary return on a company’s equity.
Introduction:
Modigliani-Miller theory:
Professors Modigliani and Miller made a research on capital structure theory very intensely. From the analysis, it is found that they formed a capital structure irrelevant proposal.
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Students have asked these similar questions
Is this statement true or false? Please explain in detail
As debt-financing is usually cheaper than equity financing, debt-financing will lower risk for transnational company.
Consider the trade-off theory of capital structure and the market timing theory in answering this question. A company can borrow at a favourable rate due to low interest rates but chooses not to do so due to the increased financial risk. Instead, it issues equity, despite the market not valuing its equity in excess of the company’s internal valuation.
Required:
Discuss which of the two abovementioned theories prevailed and provide a motivation for your answer.
4. Which of the following is false about the risk-shifting problem?
Risk-shifting leads to a transfer of value from debt-holders to equity
holders
Risk-shifting leads prospective lenders to pay less for debt and require higher interest
payments
Risk-shifting arises when shareholders choose negative NPV projects with higher
risk
Risk-shifting is an example of an agency cost of
debt
Risk-shifting is greater in firms with low
leverage
Chapter 16 Solutions
Corporate Finance
Ch. 16 - MM Assumptions List the three assumptions that lie...Ch. 16 - Prob. 2CQCh. 16 - Prob. 3CQCh. 16 - MM Propositions What is the quirk in the tax code...Ch. 16 - Prob. 5CQCh. 16 - Prob. 6CQCh. 16 - Optimal Capital Structure Is there an easily...Ch. 16 - Financial Leverage Why is the use of debt...Ch. 16 - Homemade Leverage What is homemade leverage?Ch. 16 - Capital Structure Goal What is the basic goal of...
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Similar questions
- 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 abovearrow_forward2. If the value of the financial sector is in terms of reducing the individual risk in the economy, how could you measure the value of the financial sector without using information on loan payments (broadly construed to include any interest payment necessary to measure an interest rate or any payment that looks like a return on an investmemt)? If we think of the amount of individual risk remaining after individuals buy portfolios is a measure of the ineffectiveness of the financial sector [or its imperfections], what do you think accounts for these imperfections?arrow_forwardIn the conflicts between equity holders and bond holders, 1).Why would equity investors want to forego good project with positive NPV (“debt overhang”) and rather take risky projects with negative NPV? (“risk shifting”) 2).What is an example of “asset stripping” from equity holders in case of high financial distress?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_forwardFirms will take investments only when expected risks are remunerated by expected profit. * a. Incremental cash flows b. Efficient capital markets c. Risk-return trade-off d. All risks are not equalarrow_forwardHow many statements below are correct about the Modigliani-Miller theorem? i. The theorem is not an exact description of reality. ii. The theorem provides a benchmark to understand how the capital structure could affect WACC. iii. The theorem implies that firms have benefited from financing with debt due to a higher required rate of return on debt compared with equity. iv. The value of the firm is not affected by its capital structure under any assumptions.arrow_forward
- Critique this statement: “The use of debt financing lowers the net income of the firm, and hence debt financing should be used only as a last resort.”arrow_forwardWhich of the following statements is correct? A. Investors appreciate illiquid assets in their portfolios as they can easily sell them off to cover margin calls. B. Liquid assets can quickly be converted into cash without changing prices too much. O C. Corporate bonds are among the most liquid financial assets as they trade at a very high frequency. D. Liquid assets tend to be cheaper as investors are not willing to pay for their liquidity benefits.arrow_forwardWhich of the below statements does the MM Proposition I predict? A. In a perfect market, the value of a firm is independent of its capital structure B.In a perfect market, the discount rate depends on the capital structure C.In a perfect market, the value of a firm decreases in leverage D.In a perfect market, the NPY of investments depends on the existing debt/equity mixarrow_forward
- Debt financing is likely to appeal most strongly to organizations that have predictable profits and cash-flow patterns. Question 22 options: True Falsearrow_forwardDebt allows an economy to appear very large but debt also creates more ____ in an economy. Inevitability Surety Certainty Risk Businessarrow_forwardWhich of the following statements is correct? A firm has a greater likelihood of needing an unexpected loan when its cash flows are relatively constant over time. The cost of borrowing affects the target cash balance of a firm. Management's desire to maintain a low cash balance has no effect on the borrowing needs of a firm. The target cash balance increases as the interest rate rises. The target cash balance decreases as the order costs increase.arrow_forward
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