Exam 11: Understanding Financing and Payout Decisions

________ describes a legal state whereby a firm cannot pay its creditors

Which of the following is NOT one of M&M's perfect capital market assumptions?

Under U.S.Bankruptcy code,claims against the firm are prioritized along the lines of secured creditors followed in order by:

Under conditions of asymmetric information,when a firm issues debt this is more likely to be a negative signal,rather than a positive signal regarding the firm's future prospects.

All else equal,an individual investor would prefer ________ even if rates on both are equal,since ________ can be deferred.

Due primarily to concerns about financial distress,we tend to see very few firms financed with ________ or more of their capital structure as debt.

Under terms of the U.S.federal bankruptcy code,chapter ________ call for a ________ pr.

Dividend payments and share repurchases are conceptually equivalent.

When a firm is young and growing,managers tend to have high dividend payout ratios in an attempt to encourage investors to buy the stock.

Which of the following is NOT one of M&M's perfect capital market assumptions?

Which of the following statements is most accurate in the M&M world including taxes and financial distress?

In a world of both personal and corporate taxes,individual investors may not be able to get the full advantage of debt by borrowing personally.Corporate borrowing rates,personal borrowing rates,and tax rates may differ.

Longneck Brewery Inc.has net income of $3.00 per share and a dividend payout ratio of 35%.How large is the firm's per share dividend payment?

$\begin{array}{c}\begin{array}{|l|}\hline \\\hline \\ \hline \text {Anticipated operating income }\\ \hline \text {Interest}\\ \hline \text {Earnings before tax}\\ \hline \text {Tax at 30 \% }\\ \hline \text {Earnings after tax}\\\hline \\ \hline \text {Combined debt and equity income }\\ \text {(interest plus earnings after tax)}\\ \hline \end{array}\begin{array}{l|} \hline \text {ALL EQUTTY}\\ \hline \\ \hline \$ 1,000,000 \\\hline \underline{\quad\quad}\\ \hline\$1,00,000\\ \hline\underline{\$300,000}\\ \hline \$ 700,000 \\ \hline\\ \hline\\\$700,000\\ \hline\end{array}\begin{array}{l|} \hline \text {EQUITY AND DEBT}\\\hline\\\hline\$ 1,000,000 \\\hline\underline{\$ 200,000} \\\hline\$ 800,000 \\\hline\underline{\$-}\\\hline\$\\\hline\\\hline\\\$\\\hline\end{array}\end{array}$ -The combined debt plus equity income is equal to the equity income + (Interest * the tax rate).

$\begin{array}{c}\begin{array}{|l|}\hline \\\hline \\ \hline \text {Anticipated operating income }\\ \hline \text {Interest}\\ \hline \text {Earnings before tax}\\ \hline \text {Tax at 30 \% }\\ \hline \text {Earnings after tax}\\\hline \\ \hline \text {Combined debt and equity income }\\ \text {(interest plus earnings after tax)}\\ \hline \end{array}\begin{array}{l|} \hline \text {ALL EQUTTY}\\ \hline \\ \hline \$ 1,000,000 \\\hline\underline{\quad\quad}\\ \hline\$1,00,000\\ \hline\underline{\$300,000}\\ \hline \$ 700,000 \\ \hline\\ \hline\\\$700,000\\ \hline\end{array}\begin{array}{l|} \hline \text {EQUITY AND DEBT}\\\hline\\\hline\$ 1,000,000 \\\hline\underline{\$ 200,000} \\\hline\$ 800,000 \\\hline\underline{\$-}\\\hline\$\\\hline\\\hline\\\$\\\hline\end{array}\end{array}$ -What is the combined debt and equity income (interest plus earnings after tax)for the Equity and Debt firm?

The majority of firms view cutting dividends as a way to send a POSITIVE signal to the market as an indication that they have increased opportunities to invest earnings.

$\begin{array}{c}\begin{array}{|l|}\hline \\\hline \\ \hline \text {Anticipated operating income }\\ \hline \text {Interest}\\ \hline \text {Earnings before tax}\\ \hline \text {Tax at 30 \% }\\ \hline \text {Earnings after tax}\\\hline \\ \hline \text {Combined debt and equity income }\\ \text {(interest plus earnings after tax)}\\ \hline \end{array}\begin{array}{l|} \hline \text {ALL EQUTTY}\\ \hline \\ \hline \$ 1,000,000 \\\hline\underline{\quad\quad}\\ \hline\$1,00,000\\ \hline\underline{\$300,000}\\ \hline \$ 700,000 \\ \hline\\ \hline\\\$700,000\\ \hline\end{array}\begin{array}{l|} \hline \text {EQUITY AND DEBT}\\\hline\\\hline\$ 1,000,000 \\\hline\underline{\$ 200,000} \\\hline\$ 800,000 \\\hline\underline{\$-}\\\hline\$\\\hline\\\hline\\\$\\\hline\end{array}\end{array}$ -In an M&M world with taxes,as a firm takes on ________ debt,the cost of equity ________.

Direct forms of bankruptcy costs include legal and administrative costs associated with the actual bankruptcy proceedings,as well as the money paid to lawyers.

$\begin{array}{c}\begin{array}{|l|}\hline \\\hline \\ \hline \text {Anticipated operating income }\\ \hline \text {Interest}\\ \hline \text {Earnings before tax}\\ \hline \text {Tax at 30 \% }\\ \hline \text {Earnings after tax}\\\hline \\ \hline \text {Combined debt and equity income }\\ \text {(interest plus earnings after tax)}\\ \hline \end{array}\begin{array}{l|} \hline \text {ALL EQUTTY}\\ \hline \\ \hline \$ 1,000,000 \\\hline\underline{\quad\quad}\\ \hline\$1,00,000\\ \hline\underline{\$300,000}\\ \hline \$ 700,000 \\ \hline\\ \hline\\\$700,000\\ \hline\end{array}\begin{array}{l|} \hline \text {EQUITY AND DEBT}\\\hline\\\hline\$ 1,000,000 \\\hline\underline{\$ 200,000} \\\hline\$ 800,000 \\\hline\underline{\$-}\\\hline\$\\\hline\\\hline\\\$\\\hline\end{array}\end{array}$ -What are the Earnings after tax for the Equity and Debt firm?

PrintQuik Inc.has a cost of equity of 14% and a cost of debt of 6%.If the firm is financed with 70% equity and 30% debt,and they operate under the conditions of a perfect capital market,what is the firm's average cost of capital?