Exam 16: Capital Structure

With the background ideas of using the cheapest source first and the impact of asymmetric information, what does the Pecking Order Hypothesis predict?

Given a choice, firms will exhaust the cheapest source of external funding first before moving on to the ________ source.

Below the break-even EBIT, the owners can benefit from financial leverage.

Consider two companies that are alike except in borrowing choices. Company 1 has no debt financing, and Company 2 uses debt financing. The EBIT for both companies is $800. Company 1 has 400 shares outstanding and pays no interest. Company 2 has 300 shares outstanding and pays $250 in interest. What is the EPS for each company?

Alice lends $200,000 for each new idea. Alice's history is that she selects low-risk projects or ideas that hit 50% of the time. What rate of return must each successful project pay Alice for her to break even?

The highest return to the investor is the lowest cost for the seller and vice versa.

Capital structure refers to how the firm finances its operations and growth through a combination of ________.

Longmont Inc. is in the property management business and has a required return on its assets of 10%. It can borrow in the debt market at 5%. If there are no taxes and M&M's proposition II holds, what is the cost of equity if there is 10% equity financing and 90% debt financing?

Pain-Free Inc. is a business dealing in pain reduction medication. It has a required return on its assets of 18%. It can borrow in the debt market at 10%. If there are no taxes and M&M's proposition II holds, what is the cost of equity if there is 50% equity financing and 50% debt financing?

Shareholders can be made better off in terms of EPS with financial leverage when earnings are sufficiently high to offset the interest expense of debt.

Bernadette's Boutique has a project that costs $90,000. It has a 50% chance of paying off $200,000 and a 50% chance of paying off $0. What is the expected payoff and the expected profit or loss from the new project?

Consider the Modigliani and Miller world of corporate taxes. An unleveraged (all-equity) firm value is $100 million. By adding debt, the annual interest expense is $10 million, the corporate tax rate is 40%, and the discount rate on the tax shield is 10%. What is the gain to leverage or the value added from issuing debt?

When bankruptcy is added to the M&M world of capital structure, which of the following statements is true as more debt is added to the financing mix of the company?

The federal government bond market is open only to ________.

Describe in detail the costs of bankruptcy. In your answer discuss both the direct and indirect costs.

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 80% of the time. Bea's history is that she takes on high-risk projects that hit 40% of the time. What rate of return must each successful project pay Al and Bea for them to break even?

In their later proposition II with taxes, Modigliani and Miller concluded that as more debt is added, the WACC of the firm falls, and the firm's overall value increases for the equity holder.

The Pecking Order Hypothesis predicts which of the following?

The process of borrowing money from others to make money on your idea is commonly known in the investment world as ________.

The best combination of debt and equity creates what we call an imperfect capital structure.