Exam 13: Capital Structure Concepts

A survey of Fortune 500 firms indicate that they prefer internal financing (retained earnings) to external financing. This preference is known as ____.

Investors' required returns and the cost of equity capital ____ as the relative amount of debt used to finance the firm ____.

When a corporation must get external financing, the first place to look for funds is with debt. There are various reasons for this preference. List the reasons why debt is generally issued first.

Feldspar Inc. is considering the capital structure for a new division. Management has been given the following cost information: Based on this information, what capital structure (debt/asset ratio) should management accept? Assume the marginal tax rate is 40%.

In considering a firm's capital structure, the firm should increase its ____ which will maximize its value.

Biotec has estimated the costs of debt and equity capital for various proportions of debt in its capital structure: If Biotec pays a current dividend of $1.00 and expects dividends to grow at a constant rate of 7%, what is Biotec's stock price if it obtains its optimal capital structure?

Calculate the market value of a firm with total assets of $105 million and $50 million of 10% perpetual debt in the capital structure. The firm's cost of equity is 14% on the $55 million in equity in the capital structure. The perpetual EBIT is expected to be $9 million and the marginal tax rate is 40%.

Calculate the market value of Lotle Group, a firm with total assets of $80 million and $30 million of perpetual debt in its capital structure. The firm's cost of equity is 14% and the cost of debt is 9%. Lotle expects annual, perpetual net operating income (EBIT) of $9 million and a marginal tax rate of 40%.

There are many benefits to a leveraged buy-out. However, the benefits from LBOs come with significant costs. Explain the down-side of LBOs.

Modigliani and Miller show that the value of a firm is ____ capital structure given perfect capital markets and no corporate income taxes.

The market value of a levered firm can be represented by the following equation: Market value of levered firm = Market value of unlevered firm ____ Present value of tax shield ____ Present value of financial distress costs ____ Present value of agency costs

All of the following factors influence a firm's business risk except:

The amount of debt in a firm's optimal capital structure is often referred to as the firm's:

What is the market value of Barings, a firm with total assets of $100 million and $30 million in perpetual debt in its capital structure. Barings' cost of equity is 15% and its cost of debt is 10%. Expected perpetual net operating income (EBIT) will be $17 million and the marginal tax rate is 40%.

Technico has determined that its optimal capital structure is 40% debt, at which point its weighted cost of capital, k_a, is 13.7%. Due to financial problems, the firm has decided to raise the proportion of debt to 50%, which will increase its weighted cost of capital to 14.4%. What is the effect on the stock price of Technico? The current dividend is $1.60 and the long-term growth rate of dividends is expected to be 8.5%.

Operating leverage involves the use of

There are many factors that influence a firm's business risk. List them.

The tax deductibility of the interest payments on corporate debt is known as:

Triad Labs has total assets of $120 million and $40 million of debt in its capital structure. Its current cost of equity is 13% and its cost of debt is 8.5%. Triad is considering increasing its debt to $70 million and purchasing its own stock with proceeds from the sale of $30 million in debt with a cost of 9.5%, reducing equity to $50 million. The cost of equity will increase to 14.5%. Net operating income (EBIT) will remain at $12 million. If Triad has a marginal tax rate of 40%, should the firm increase its debt? Assume that both debt and EBIT are perpetual.

What is optimal capital structure?