Loose Leaf for Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
11th Edition
ISBN: 9781259709685
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe
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
Indicate whether each of the following statements is true or false. Support your answers with the relevant explanations.
a) Modigliani and Miller’s Proposition II assumes that increased borrowing does not affect the interest rate on the firm’s debt. (Explain your reasoning.)
b) Under the conditions of perfect capital markets, the cost of capital of a company financed fully by equity is expected to be equal to that of the same company but financed with 50% equity and 50% debt. (Explain your reasoning.)
c) The higher the systematic risk of a company’s stock, the higher the value of its beta. The higher the beta, the higher the return required by the investors. (Explain your reasoning.)
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 above
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
Chapter 16 Solutions
Loose Leaf for Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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...
Ch. 16 - Prob. 1QPCh. 16 - EBIT, Taxes, and Leverage Repeat p arts (a) and...Ch. 16 - ROE and Leverage Suppose the company in Problem 1...Ch. 16 - Break-Even EBIT Franklin Corporation is comparing...Ch. 16 - Prob. 5QPCh. 16 - Break-Even EBIT and Leverage Kolby Corp. is...Ch. 16 - Leverage and Stock Value Ignoring taxes in Problem...Ch. 16 - Homemade Leverage Star, Inc., a prominent consumer...Ch. 16 - Homemade Leverage and WACC ABC Co. and XYZ Co. are...Ch. 16 - MM Scarlett Corp. uses no debt. The weighted...Ch. 16 - Prob. 11QPCh. 16 - Calculating WACC Weston Industries has a...Ch. 16 - Prob. 13QPCh. 16 - MM and Taxes Bruce Co. expects its EBIT to be...Ch. 16 - MM and Taxes In Problem 14, what is the cost of...Ch. 16 - MM Proposition I Levered, Inc., and Unlevered,...Ch. 16 - MM Tool Manufacturing bas an expected EBIT of...Ch. 16 - Firm Value Cavo Corporation expects an EBIT of...Ch. 16 - MM Proposition I with Taxes The Dart Company is...Ch. 16 - MM Proposition I without Taxes Alpha Corporation...Ch. 16 - Cost of Capital Acetate, Inc., has equity with a...Ch. 16 - Homemade Leverage The Veblen Company and the...Ch. 16 - MM Propositions Locomotive Corporation is planning...Ch. 16 - Stock Value and Leverage Green Manufacturing,...Ch. 16 - Prob. 25QPCh. 16 - Prob. 26QPCh. 16 - Prob. 27QPCh. 16 - Prob. 28QPCh. 16 - Prob. 29QPCh. 16 - Prob. 30QPCh. 16 - STEPHENSON REAL ESTATE RECAPITALIZATION Stephenson...Ch. 16 - Prob. 2MCCh. 16 - Prob. 3MCCh. 16 - Prob. 4MCCh. 16 - Prob. 5MC
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- 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.arrow_forwardWhich of the following statements is FALSE? A. Equity cost of capital is normally higher then cost of debt, thus cost of debt can be examined in isolation. B. No matter if a firm is unlevered or levered, there is no difference in the market value of the firms total securities and market value of the firm’s assets. C. Introducing debt increases the risk even though it may be cheap and consequently increases firms equity cost of capital. D. Cost of Capital of equity and Leverage can be explicitly explained by first proposition that Modigliani and Miller introduced.arrow_forwardFor each statement indicate whether it is true or false and briefly explain why. a) In a perfect capital market with no corporate taxes, as a firm takes on more and more debt its weighted average cost of capital remains unchanged while its required return on equity rises. b) If a firm issues riskfree debt the risk of the firm’s equity will not change. So, risk-free debt allows the firm to get the benefit of a low cost of debt without raising its cost of equity. c) In the context of firms’ capital structure decisions, the theory predicts that the value of a firm’s equity will rise in direct proportion to the level of debt in its capital structure.arrow_forward
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