Exam 16: Capital Structure

Consider two companies that are alike except in borrowing choices. District Corp. has no debt financing, and Energy Corp. uses debt financing. The EBIT for both companies is $3,500,000. District Corp. has 400,000 shares outstanding and pays no interest. Energy Corp. has 250,000 shares outstanding and pays $500,000 in interest. What is the EPS for each company?

Proposition II from M&M says that the cost of equity is a function of which of the items below?

In the original Modigliani/Miller world, the value of the firm is sensitive to the funding choice between debt and equity.

At the optimal debt-to-equity ratio, the cost of capital (WACC) is ________ for the firm. This point reflects the maximum benefit of leverage.

Transitions Inc. is an import-export company specializing in products from Asia and the West Coast. It can borrow in the debt market at 8%. Its cost of equity with 40% D/V ratio is 12%. Its corporate tax rate is 30%. If the M&M world of taxes holds true, what is the WACC for Transitions Inc. with a 40% D/V financing?

Which of the statements below is FALSE?

In regards to the formula which of the statements below is FALSE?

According to the Pecking Order Hypothesis, selling equity is the first choice for firms that require outside financing.

Garson Corp. is looking at two possible capital structures. Currently, the firm is an all-equity firm with $1.2 million dollars in assets and 200,000 shares outstanding. The market value of each share of stock is $6.00. The CEO of Garson is thinking of leveraging the firm by selling $600,000 of debt financing and retiring 100,000 shares, leaving 100,000 outstanding. The cost of debt is 10% annually, and the current corporate tax rate for Garson is 30%. If the CEO believes that Garson will earn $100,000 per year before interest and taxes, should she leverage the firm? Explain.

To say that the investing decision and financing decision of a firm are separable is to say ________.

Which of the statements below is FALSE?

In their first venture into the optimal capital structure question, Nobel laureates Franco Modigliani and Merton Miller began with a very simple model and a hypothetical world of ________.

Firewall Corp. is a small company looking at two possible capital structures. Currently, the firm is an all-equity firm with $900,000 in assets and 100,000 shares outstanding. The market value of each share is $9.00. The CEO of Firewall is thinking of leveraging the firm by selling $270,000 of debt financing and retiring 30,000 shares, leaving 70,000 shares outstanding. The cost of debt is 6% annually, and the current corporate tax rate for Donat is 30%. The CEO believes that Donat will earn $100,000 per year before interest and taxes. Which of the statements below is TRUE?

A ________ is a separate entity and in that capacity can borrow from banks, bondholders, preferred stockholders, and common shareholders.

If company earnings give a rate of return less than the cost of debt, then it may be advantageous for the firm to be ________.

Which of the formulations below expresses the weighted average cost of capital (WACC) formula?

Corporate financing problems are ________ personal financing ones.

A rising WACC ________ the values of the firm's future cash flows.

Firms in need of financing tend to use external funds first and then revert to internal funds, or retained earnings, as a last resort.

With the background ideas of using the cheapest source first and the impact of asymmetric information, the Pecking Order Hypothesis predicts which of the following?