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Valuation: Measuring and Managing the Value of Companies, Sixth Edition
Chapter 29 Capital Structure, Dividends, and Share Repurchases
Solutions
1. Optimal capital structure is that which maximizes the value of the firm. According to a widely used
analysis, on a graph where the horizontal axis is leverage and the vertical axis is the value of the
firm, the value of the firm will rise as leverage increases from zero to a particular value and then
2. Having less debt allows more freedom and allows the firm to take on riskier projects. Companies
3. The factors used in credit ratings fall into two general categories: coverage and size. Coverage refers
to the extent the firm has its interest costs and other fixed costs covered by revenue and cash flows.
4. Acceptable coverage ratios vary by industry. Telecom companies can have lower coverage than steel
5. There are four general steps in establishing an effective capital structure: (1) project and test the
6. Leverage should be lower for companies with lower returns, higher growth potential and risk, and
highly specific assets and capabilities. Most start-ups have these characteristics. They often operate
7. The pecking-order theory says a firm will first use internal financing (retained earnings), then debt
financing, and then equity financing. One of the reasons for firms having this ordering is the signal
sent by each choice. The theory predicts that a highly profitable firm will use less debt because of
the available internal financing; however, this prediction is contrary to what is usually observed. It is
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8. This statement is a fallacy. The initial borrowing costs for a firm that issues convertible debt will be
