PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Chapter 18, Problem 25PS
Leverage targets Some corporations’ debt–equity targets are expressed not as a debt ratio but as a target debt rating on the firm’s outstanding bonds. What are the pros and cons of setting a target rating rather than a target ratio?
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Students have asked these similar questions
Which of the following is an advantage of debt financing?
a. Excessive debt increases the risk of equity holders and therefore depresses share price.
b. The obligation is generally fixed in terms of interest and principal payments.
c. Interest and principal obligations must be paid regardless of the economic position of the firm.
d. Debt agreements contain covenants.
Select all that are true with respect to the cost of debt.
Group of answer choices
it is the return the firm needs to earn overall to satisfy all investors
It is the rate the debt holders demand given the risk they face as debt holders
Can be estimated using CAPM
Cannot be estimated using CAPM because CAPM is used for estimating the cost of equity
Is always equal to the YTM on a company's existing bonds
Is lower than the YTM on a company's existing debt if there is default risk
Can be proxied by the YTM on a company's existing debt if the debt is risk free
Flag question: Question 7
Case study: Debt vs. Equity Holders
Companies obtain their funds from two sources: debt and equity. The providers of these funds are protected in different ways. Debtholders have specific contracts with the company, and if the company defaults they have recourse ahead of shareholders.Shareholders are the bearers of residual risk and in return for the uncertainty this creates, equity finance is more expensive than debtfinance- reflecting the risk premium and risk appetite of the shareholders. But, because the shareholders come last and it is not clear what they are entitled to, they operate in conditions of an incomplete contract.Question:If the shareholders’ position is not protected by a contract-unlike the provider of debt- how is it in fact made viable? Discuss.
Chapter 18 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 18 - Prob. 1PSCh. 18 - Tax shields Compute the present value of interest...Ch. 18 - Tax shields Here are book and market value balance...Ch. 18 - Tax shields Look back at the Johnson Johnson...Ch. 18 - Prob. 5PSCh. 18 - Tax shields The firm cant use interest tax shields...Ch. 18 - Prob. 7PSCh. 18 - Tax shields The trouble with MMs argument is that...Ch. 18 - Bankruptcy costs On February 29, 2019, when PDQ...Ch. 18 - Financial distress This question tests your...
Ch. 18 - Prob. 12PSCh. 18 - Agency costs Let us go back to Circular Files...Ch. 18 - Agency costs The Salad Oil Storage (SOS) Company...Ch. 18 - Agency costs The possible payoffs from Ms....Ch. 18 - Prob. 17PSCh. 18 - Prob. 18PSCh. 18 - Prob. 20PSCh. 18 - Pecking-order theory Fill in the blanks: According...Ch. 18 - Financial slack For what kinds of companies is...Ch. 18 - Financial slack True or false? a. Financial slack...Ch. 18 - Debt ratios Rajan and Zingales identified four...Ch. 18 - Leverage targets Some corporations debtequity...Ch. 18 - Prob. 26PSCh. 18 - Trade-off theory The trade-off theory relies on...
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- Identify the following as either an advantage (A) or a disadvantage (D) of bond financing for a company. A company earns a higher return with borrowed funds than it pays in interest.arrow_forwardFor purposes of measuring a firm’s leverage, should preferred stock be classified as debt orequity? Does it matter whether the classification is being made (a) by the firm’s management,(b) by creditors, or (c) by equity investors?arrow_forwardLeverage and the Capital Structure. Why is the use of debt financing referred to as financial “leverage?” What is the basic goal of financial management with regard to the capital structure? Is there an easily identifiable debt-equity ratio that will maximize the value of a firm? Why or why not?arrow_forward
- 1. From the scenario, Identify what is the Market value of the firm's equity, the market value of the firm's debt, the cost of equity (required rate of return), cost of debt (yield to maturity on existing debt) and the corporate tax rate.arrow_forwardA profitability measure of ROE is affected by the level of a firm’s debt. Thus,an investor must consider the debt-equity ratio to evaluate the firm’sprofitability. The debt-equity ratio determines a firm’s financial leverage whichindicates how much of assets the firm is able to deploy for each monetary unitof stockholders’ equity.1) Explain how the financial leverage effect can be defined as the differencebetween ROE and ROA. 2) Explain how the financial leverage effect is affected by the debt ratio and theinterest rate.arrow_forwardWhat is the acceptable level of a company's indebtedness according to the financial leverage indicator a. The level based on the willingness of banks to provide loans b. Until the debt financing resource are cheaper than equity shareholder fund c. Under condition that the employed debt financing resources are increasing profitability of equity shareholder fund d. The level based on the willingness of shareholders to provide registered capitalarrow_forward
- Identify the following as either an advantage (A) or a disadvantage (D) of bond financing for a company. A company earns a lower return with borrowed funds than it pays in interest.arrow_forwardFinancial risk refers to the: Multiple Choice possibility that interest rates will increase. risk of owning equity securities. the risk that the share price may not reflect all known information general business risk of the firm. risk faced by equity holders of firms with debt.arrow_forwardYou are working for a mid-sized company that is looking to estimate its cost of debt. The company has never had an issuance in the bond market. What would be the best proxy to estimate its cost of debt? A. Cost of its bank debt B. Cost of its equity C. Cost of debt from companies of a similar market capitalization D. Cost of debt in the corporate bond marketarrow_forward
- Which of the following is not a potential source of financial leverage? Group of answer choices Accounts payable. Long-term debt. Interest payable. Common stock.arrow_forwardWhat are the charateristics of Debt financing and Equity fianancing? If a company wanted to maximize EPS (Earning per Share), which form of financing might they likely consider, debt or equity? Explain.arrow_forward1. When the effective cost of debt is greater its the nominal cost,a. the initial net measurement of the bond is more than the face value.b. The net proceeds is more than the face value.c. The entity records a discount on the bond payable.d. The interest expense is less than the interest payments.2. Which of these statement are true? [S1] The dividend decision generally involves the same factors as the earnings retention decision. [S2] Under the Dividend Relevance Theory, dividends are valued more than capital gains.3. The cost of retained earnings is less than the cost of ordinary shares because ofa. the issuance cost.b. the trust fund doctrine.c. agency costs of free cash flow.d. the taxation on earnings.4. GHI Corp., a new and relatively unknown entity, has issued 5-year bonds with an interest rate of 30%. These may also be traded in by the holder for 5 ordinary shares for every P1,000 face value of the bond. GHI added this feature so that once it has better profits, it can entice…arrow_forward
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