Exam 16: Capital Structure

Which of the statements below is FALSE?

Although the work of Modigliani and Miller produced a near-100% debt mix for firms in a world of taxes, the actual debt-to-equity ratio for most firms falls far short of 100% debt financing.

The Pecking Order Hypothesis suggests that less profitable companies will need more external funding and will first seek debt financing in an asymmetric world, avoiding the equity market.

Refer to the scenario above. What would the unleveraged and leveraged EPSs look like if EBIT were only $1,200?

Which of the statements below is TRUE?

A large public firm cannot issue which of the following types of securities?

Describe the Pecking Order Hypothesis.

The original Modigliani and Miller proposition I states that the value of a firm depends on its capital structure.

Investors Al and Bea lend $100,000 to each new idea. Al's history is that he selects low-risk projects or ideas that hit 50% of the time. Bea's history is that she takes on high-risk projects that hit 20% of the time. What rate of return must each successful project pay Al and Bea for them to break even?

The initial decision of what products and services to produce has a much ________ on the profitability of the firm when compared to the ________.

________ capital structure refers to a combination of debt and equity that maximizes the value of the firm.

The Modigliani-Miller model of capital structure begins with the simple assumption that the investing decision and financing decision of a firm are inseparable.

Financial leverage is the degree to which a firm or individual utilizes ________.

Using debt financing to replace equity financing always leads to greater EPS for the firm.

All markets are open to all borrowers.

Donat Corp. is a small company looking at two possible capital structures. Currently, the firm is an all-equity firm with $600,000 in assets and 100,000 shares outstanding. The market value of each share is $6.00. The CEO of Donat is thinking of leveraging the firm by selling $300,000 of debt financing and retiring 50,000 shares, leaving 50,000 shares outstanding. The cost of debt is 5% annually, and the current corporate tax rate for Donat is 30%. The CEO believes that Donat will earn $50,000 per year before interest and taxes. Which of the statements below is TRUE?

The ability to add debt financing to the current borrowing of the firm and be able to make interest and principal repayments on time is known as the firm's debt-to-equity ratio.

In the Modigliani & Miller model of capital structure, with no corporate taxes, as a firm increases the D/V ratio, the cost of equity also increases.

M&M's Proposition II suggests that in a world of no taxes and no bankruptcy, ________.

Two different individuals or companies can go to the same bank and request exactly the same amount of funding for their projects and yet can be required to pay different costs for their funds. Why? Can we find a parallel situation in the bond and equity markets? Explain.