Exam 17: Capital Structure: Limits to the Use of Debt

The pecking order states how financing should be raised. In order to avoid asymmetric information problems and misinterpretation of whether management is sending a signals on security overvaluation the firm's first rule is to:

When small companies issue large stock offerings, we can expect owner managers to:

Suppose a Miller equilibrium exists with corporate tax rate of 30% and personal tax rate on income from bonds of 35%. What is the personal tax rate on income from stocks?

Issuing debt instead of new equity in a closely held firm more likely:

Studies have found that firms with high proportions of intangible assets are likely to use ____________ debt compared with firms with low proportions of intangible assets.

Given the following information, leverage will add how much value to the unlevered firm per dollar of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 20% Personal tax rate on income from stocks: 0%

One of the indirect costs to bankruptcy is the incentive toward underinvestment. Following this strategy may result in:

The Aggie Company has EBIT of $70,000 and market value debt of $100,000 outstanding with a 9% coupon rate. The cost of equity for an all equity firm would be 14%. Aggie has a 35% corporate tax rate. Investors face a 20% tax rate on debt receipts and a 15% rate on equity. Determine the value of Aggie.

Given realistic estimates of the probability and cost of bankruptcy, the future costs of a possible bankruptcy are borne by:

What three factors are important to consider in determining a target debt to equity ratio?

When graphing firm value against debt levels, the debt level that maximizes the value of the firm is the level where:

The TrunkLine Company will earn $60 if it does well. The debtholders are promised payments of $35 if the firm does well. If the firm does poorly the repayment will be $20 because of the dead weight cost of bankruptcy, expected earnings will be $30. The probability of the firm performing poorly or well is 50%. If bondholders are fully aware of these costs what will they pay for the debt? The interest rate on the bonds is 10%.

Establishing a capital structure for a firm is not simple. Although financial theory guides the process, there is no simple formula. List and explain four main items that one should consider in determining the capital structure.