Question 1

Calculate the required return on the company stock.

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Question 2

Calculate the required return risk premium on the common stock before the refinancing.

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Question 3

When large firms file for bankruptcy:

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When large firms file for bankruptcy, their purpose is usually to restructure the business and return it to profitability, while also resolving outstanding debts with creditors. This often involves a reorganization of the firm's assets, liabilities, and operations, as well as negotiations with creditors and other stakeholders. The goal is to create a viable plan for the future of the firm, rather than simply liquidating its assets and shutting down the business.

Question 4

When taxes are considered,the value of a levered firm equals the value of the:

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Question 5

What can be promised by loan covenants? What cannot be ensured by loan covenants?

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Question 6

Although the value of an additional interest tax shield may be positive,firms may restrict borrowing if:

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Question 7

Equity Inc.is currently an all-equity financed firm.It has 10,000 shares outstanding that sell for $20 each.The firm has an operating income of $30,000 and pays no taxes.The firm contemplates a restructuring that would issue $50,000 in 8% debt,which will be used to repurchase stock.Assuming that individuals have the same borrowing opportunities as corporations,explain how an investor can undo the leverage that is proposed by Equity Inc.Under these conditions,what is the value of restructuring to a firm?

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Question 8

A firm's business risk depends upon:

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A firm's business risk is fundamentally determined by the nature and riskiness of its assets and operations. The use of debt and other forms of financing can affect the overall financial risk of the firm, but not its underlying business risk. The other options, such as the ability to undo leverage and the costs of financial distress, are more related to financial risk and are not direct determinants of business risk.

Question 9

Calculate the required return on the debt.

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Question 10

Calculate the return and risk premium on the common stock after the refinancing.

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Question 11

Determine the expected return on equity for a firm with a WACC of 12%,$500,000 in 9% debt,$800,000 in equity.Both debt and equity are shown at market values,and the firm pays no taxes.How can the expected return on equity be reduced?

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Question 12

Explain the pecking-order theory of capital structure.How will this affect the "optimal" capital structure for a firm?

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Question 13

What is the change in value for a firm with $1 million in equity,$1 million in permanent debt at a 10% interest rate,and a 35% tax rate if MM I is modified to recognize corporate taxes?

Accepted Answer

The value of the firm will increase by the amount of tax shield provided by the debt. In this case, the annual tax shield provided by the debt is $100,000 (i.e. 0.35 x 0.1 x $1 million). Therefore, the increase in firm value due to the tax shield is $100,000 / 0.10, which is $1 million. So the firm value increases by $350,000 (i.e. $1 million - $650,000).

Question 14

Discuss how agency problems can develop between shareholders and bondholders when the firm is experiencing financial distress.

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Question 15

Discuss the trade-off theory of capital structure,including the determination of an optimal debt level.

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Question 16

Is there a rule for finding optimal capital structure?

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Question 17

How do corporate income taxes modify MM's leverage irrelevance proposition? D. Future interest tax shields are usually valued by discounting at the borrowing rate r_debt. In the special case of permanent debt, PV tax shield = T_c (r_debt x D)/r_debt = T_cD Of course interest tax shields are valuable only for companies that are making profits and paying taxes.

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Question 18

What is the goal of the capital structure decision? What is the financial manager trying to do?

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Question 19

What's the pecking order theory?

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Question 20

Explain MM Proposition II under conditions of corporate taxes and risk-free debt.How does the analysis change when debt can be risky?

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Quiz 16: Debt and Payout Policy