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

Brad's Robotics Incorporated will earn $60 in one year if it does well. The debtholders are promised payments of $40 in one year if the firm does well. If the firm does poorly,expected earnings in one year will be $10 and the repayment will be $5 because of the dead weight cost of bankruptcy. The probability of the firm performing poorly or well is 40%. If bondholders are fully aware of these costs what will they pay for the debt? The interest rate on the bonds is 7%.

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

The explicit costs,such as the legal expenses,associated with corporate default are classified as _____ costs.

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: 50% Personal tax rate on income from stocks: 10%

What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?

Covenants restricting the use of leasing and additional borrowings primarily protect:

The optimal capital structure will tend to include more debt for firms with:

The value of a firm is maximized when the:

When firms issue more debt,the tax shield on debt _____,the agency costs on debt (i.e.,costs of financial distress) _____,and the agency costs on equity _____.

When shareholders pursue selfish strategies such as taking large risks or paying excessive dividends,these will result in:

Which of the following is true?

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

The TrunkLine Company will earn $60 in one year if it does well. The debtholders are promised payments of $35 in one year if the firm does well. If the firm does poorly,expected earnings in one year will be $30 and the repayment will be $20 because of the dead weight cost of bankruptcy. 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%.

One of the indirect costs of bankruptcy is the incentive for managers to take large risks. When following this strategy:

The value of a firm in financial distress is diminished if the firm:

Corporations in the U.S. tend to:

Holly Berry Incorporated will earn $40 in one year if it does well. The debtholders are promised payments of $25 in one year if the firm does well. If the firm does poorly,expected earnings in one year will be $20 and the repayment will be $15 because of the dead weight cost of bankruptcy. 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 8%.

The TrunkLine Company debtholders are promised payments of $35 if the firm does well,but will receive only $20 if the firm does poorly. Bondholders are willing to pay $25. The promised return to the bondholders is approximately:

The MM theory with taxes implies that firms should issue maximum debt. In practice,this is not true because:

In a Miller equilibrium,what type of investments do high tax bracket investors tend to hold?