93.
Which of the following statements is correct?
94.
Which of the following statements is correct?
95.
Why does allowing for the existence of corporate taxation cause firms to prefer the
maximum amount of debt possible?
96.
A firm faces a 30 percent tax rate and has $200m in assets, currently financed entirely
with equity. Equity is worth $10 per share, and book value of equity is equal to market
value of equity. Also, let’s assume that the firm’s expected EBIT is $10m. The firm is
considering switching to a 25 percent debt capital structure, and has determined that they
would have to pay a 10 percent yield on perpetual debt. What will be the firm’s new ROE if
they switch to the proposed capital structure?
97.
A firm faces a 30 percent tax rate and has $500m in assets, currently financed entirely
with equity. Equity is worth $100 per share, and book value of equity is equal to market
value of equity. Also, let’s assume that the firm’s expected EBIT is $70m. The firm is
considering switching to an 18 percent debt capital structure, and has determined that
they would have to pay an 8 percent yield on perpetual debt. How much will ROE change if
they switch to the proposed capital structure?
98.
A firm faces a 30 percent tax rate and has $500m in assets, currently financed entirely
with equity. Equity is worth $100 per share, and book value of equity is equal to market
value of equity. Also, let’s assume that the firm’s expected EBIT is $60m. The firm is
considering switching to a 25 percent debt capital structure, and has determined that they
would have to pay a 10 percent yield on perpetual debt. How much will ROE change if they
switch to the proposed capital structure?
99.
Which of the following statements is correct?
100.
The Modigliani-Miller (M&M) theorem states that:
101.
If an investor wanted to reduce the risk of a levered stock in their portfolio, how could they
go about doing so while still retaining shares in the company?
102.
Why is debt often referred to as leverage in finance?
103.
An all-equity financed firm has $450 in assets and the stock price is $45. If the firm
restructures with 20 percent debt which creates interest expense of $10 per year and the
firm’s tax rate is 40 percent, what is the break-even EBIT?
104.
An all-equity financed firm has $350 in assets and the stock price is $10. If the firm
restructures with 20 percent debt which creates interest expense of $14 per year and the
firm’s tax rate is 40 percent, what is the break-even EBIT?
105.
An all-equity financed firm has $650 in assets and the stock price is $20. If the firm
restructures with 40 percent debt which creates interest expense of $17 per year and the
firm’s tax rate is 40 percent, what is the break-even EBIT?
106.
An all-equity financed firm has $500 in assets and the stock price is $20. If the firm
restructures with 15 percent debt which creates interest expense of $30 per year and the
firm’s tax rate is 40 percent, what is the break-even EBIT?
Essay Questions
107.
Which strategy—active or passive capital structure management—would make the
process of changing the firm’s capital structure a longer-term proposition? Why?
108.
Why does the optimal capital structure shift from “debt doesn’t matter” to “the more debt,
the better” when we add corporate taxation to our assumptions?
109.
Explain why, in a world with both corporate taxes and the chance of bankruptcy, a small
firm with volatile EBIT is unlikely to have much debt?
110.
Explain why utility firms tend to have fairly high debt ratios.
111.
In M&M’s perfect world, will the debt holders ever bear any of the risk of the firm?
112.
State the order claimants will be paid according to the absolute priority rule in a Chapter 7
bankruptcy.
113.
Differentiate between active and passive changes to capital structure.
114.
What two main factors come into play when a firm is deciding to change its funding mix
with regard to their capital structure?
115.
Explain how the firm apportions risk and return amongst stockholders and bondholders in
a “perfect world.”
116.
Describe “The More Debt, The Better” statement with regard to the optimal capital
structure.
117.
Why, in finance, do we refer to using debt within a firm’s capital structure as leverage?
118.
Define the Modigliani-Miller (M&M) theorem and list the four features of their “perfect
world.”
119.
Explain how Irving Fisher’s separation principle addresses the question of what will
happen to a firm’s WACC in M&Ms perfect world as the capital structure changes.
120.
Explain how passive capital structure management works.