Exam 15: Cap Structure

operationally similar companies, HD and LD, have identical amounts of assets, operating income (EBIT), tax rates, and business risk Company HD, however, has a much higher debt ratio than LD Company HD's basic earning power ratio (BEP) exceeds its cost of debt (rd) Which of the following statements is CORRECT?

Which of the following statements is CORRECT, holding other things constant?

Which of these items will not generally be affected by an increase in the debt ratio?

Whenever a firm borrows money, it is using financial leverage.

Merriwether Building has operating income of $20 million, a tax rate of 40%, and no debt It pays out all of its net income as dividends and has a zero growth rate The current stock price is $40 per share, and it has 2.5 million shares of stock outstanding If it moves to a capital structure that has 40% debt and 60% equity (based on market values), its investment bankers believe its weighted average cost of capital would be 10% What would its stock price be if it changes to the new capital structure?

trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

Firms U and L both have a basic earning power ratio of 20% and each has the same amount of assetsFirm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity Firm L's debt has a before-tax cost of 8% Both firms have positive net income Which of the following statements is CORRECT?