Fundamentals of Corporate Finance
11th Edition
ISBN: 9780077861704
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Bradford D Jordan Professor
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 16, Problem 3CRCT
Optimal Capital Structure [LO1] Is there an easily identifiable debt–equity ratio that will maximize the value of a firm? Why or why not?
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D3)
The pecking-order theory of capital structure implies that firms will always prefer to issue debt over equity. Explain why firms might be reluctant to issue equity and what will happen to the stock price if a firm issues equity.
According to Modigliani & Miller M Proposition II (MM Il), as a firm's debt-equity ratio decreases, what happens to the required rate of return on equity? Briefly explain including the key aspect of MM II.
QUESTION
Generally speaking, the cost of debt is cheaper than the cost of equity. Does it imply that a firm should increase its debt-to-equity ratio to as high as possible such that its corporate cost of capital can be minimized?
Chapter 16 Solutions
Fundamentals of Corporate Finance
Ch. 16.1 - Why should financial managers choose the capital...Ch. 16.1 - What is the relationship between the WACC and the...Ch. 16.1 - What is an optimal capital structure?Ch. 16.2 - Prob. 16.2ACQCh. 16.2 - Prob. 16.2BCQCh. 16.2 - Prob. 16.2CCQCh. 16.3 - What does MM Proposition I state?Ch. 16.3 - What are the three determinants of a firms cost of...Ch. 16.3 - Prob. 16.3CCQCh. 16.4 - What is the relationship between the value of an...
Ch. 16.4 - If we consider only the effect of taxes, what is...Ch. 16.5 - Prob. 16.5ACQCh. 16.5 - What are indirect bankruptcy costs?Ch. 16.6 - Can you describe the trade-off that defines the...Ch. 16.6 - What are the important factors in making capital...Ch. 16.7 - Prob. 16.7ACQCh. 16.7 - What is the difference between a marketed claim...Ch. 16.7 - What does the extended pie model say about the...Ch. 16.8 - Prob. 16.8ACQCh. 16.8 - Why might firms prefer not to issue new equity?Ch. 16.8 - Prob. 16.8CCQCh. 16.9 - Do U.S. corporations rely heavily on debt...Ch. 16.9 - What regularities do we observe in capital...Ch. 16.10 - Prob. 16.10ACQCh. 16.10 - Prob. 16.10BCQCh. 16 - Maximizing what will maximize shareholder value?Ch. 16 - What is most closely related to a firms use of...Ch. 16 - Give an example of a direct cost of bankruptcy.Ch. 16 - Prob. 16.7CTFCh. 16 - Prob. 1CRCTCh. 16 - Prob. 2CRCTCh. 16 - Optimal Capital Structure [LO1] Is there an easily...Ch. 16 - Observed Capital Structures [LO1] Refer to the...Ch. 16 - Financial Leverage [LO1] Why is the use of debt...Ch. 16 - Homemade Leverage [LO1] What is homemade leverage?Ch. 16 - Prob. 7CRCTCh. 16 - Prob. 8CRCTCh. 16 - Prob. 9CRCTCh. 16 - Prob. 10CRCTCh. 16 - Prob. 1QPCh. 16 - Prob. 2QPCh. 16 - Prob. 3QPCh. 16 - Prob. 4QPCh. 16 - MM and Stock Value [LO1] In Problem 4, use MM...Ch. 16 - Prob. 6QPCh. 16 - Prob. 7QPCh. 16 - Prob. 8QPCh. 16 - Homemade Leverage and WACC [LO1] ABC Co. and XYZ...Ch. 16 - Prob. 10QPCh. 16 - MM and Taxes [LO2] In the previous question,...Ch. 16 - Calculating WACC [LO1] Twice Shy Industries has a...Ch. 16 - Calculating WACC [LO1] Braxton Corp. has no debt...Ch. 16 - MM and Taxes [LO2] Meyer Co. expects its EBIT to...Ch. 16 - Prob. 15QPCh. 16 - MM [LO2] Tool Manufacturing has an expected EBIT...Ch. 16 - Prob. 17QPCh. 16 - Homemade Leverage [LO1] The Day Company and the...Ch. 16 - Weighted Average Cost of Capital [LO1] In a world...Ch. 16 - Cost of Equity and Leverage [LO1] Assuming a world...Ch. 16 - Business and Financial Risk [LO1] Assume a firms...Ch. 16 - Stockholder Risk [LO1] Suppose a firms business...Ch. 16 - Prob. 1MCh. 16 - Prob. 2MCh. 16 - Prob. 3MCh. 16 - Stephenson Real Estate Recapitalization Stephenson...Ch. 16 - Stephenson Real Estate Recapitalization Stephenson...
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- 27. What are the advantages of the arbitrage pricing theory over the capital asset pricing model?arrow_forward6. What is the Cost of Equity for CS3? 7. The weighted average cost of capital for CS1 is 8. The weighted average cost of capital for CS3 is 9. What is the weight of equity in the optimal capital structure 10. What is the weighted average cost of capital on the optimal capital structure?arrow_forwardWhich of the following statements is most correct? Group of answer choices The optimal capital structure maximizes the WACC. None of these. Increasing the amount of debt in a firm's capital structure is likely to increase the cost of both debt and equity financing. If the after-tax cost of equity financing exceeds the after-tax cost of debt financing, firms are always able to reduce their WACC by increasing the amount of debt in their capital structure.arrow_forward
- H2. Do all firms have the potential to be aggressive rapid-growth firms? Why or why not?arrow_forwardMultinational Finance & investment Q2 b) Do you agree with the following statement? And explain why. “The Capital Asset Pricing Model [CAPM] assumes that the stock market is dominated by welldiversified investors who are concerned with specific risk. “arrow_forwardQuestion #5. When calculating the weighted average cost of capital (WACC), should we use marketvalues or balance sheet values as the weights of debt and equity? Explain your responsearrow_forward
- Which 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_forwardQ.What is the advantage of an ETF relative to open-end and closed-end investment company? ____ A) Intraday pricing of its shares B) Tax shelter protection C) Lower portfolio turnovers D) All of the abovearrow_forward41) Balancing the advantages and disadvantages of using debt and equity when determining a firm’s optimal capital structure is referred to as: Question 41 options: Tax theory Trade off theory Signaling theory Pecking order theory1arrow_forward
- 11.Explain why a firm needs to understand their allocation of debtfinancing to equity (the amount the owner used to fund thebusiness). Discuss how this allocation can impact their Total DebtRatio. Can having too much debt bring down profit margins? Why orWhy Not?arrow_forwardD3) Finance Please explain negative growth equity markets and share valuation.arrow_forward16) Consider the following statements: The traditional view of capital structure with no taxation or bankruptcy costs is: I. At low levels of debt there is a gain to the firm from taking on more debt II. There is an optimal capital structure III. The weighted average cost of capital is unaffected by the debt-equity ratio Which of the following is correct? a. I, II and III b. I and II only c. I and III only d. II and III only e. I only. 17) In relation to the efficient markets hypothesis, consider the following observations: I. Mutual fund managers do not on average make superior returns. II. In any year approximately 50 percent of all pension funds outperform the market. III. It is possible to make superior returns by buying or selling stocks after the announcement of an abnormal rise in earnings. IV. Managers who trade in their own stocks make superior returns. Which of the following statements is TRUE? a. I does not provide evidence against semi-strong form efficiency, but II does…arrow_forward
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Financial leverage explained; Author: The Finance story teller;https://www.youtube.com/watch?v=GESzfA9odgE;License: Standard YouTube License, CC-BY