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

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

Conflicts of interest between stockholders and bondholders are known as:

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: 20% Personal tax rate on income from stocks: 0%

The TrunkLine Company debtholders are promised payments of $35 if the firm does well, but will receive only $20 if the firm does poorly. If the bonds are selling at a price of $25, the promised return to the bondholders is approximately:

The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

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

Indirect costs of bankruptcy are born principally by:

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

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

Is there an easily identifiable debt-equity ratio that will maximize the value of a firm? Why or why not?

The value of the firm is the sum of all claims against it. These marketed and non-marketed claims:

The Zercon Company has EBIT of $50,000 and market value debt of $100,000 outstanding with a 9% coupon rate. The cost of equity for an all equity firm would be 14%. Zercon has a 35% corporate tax rate. Investors face a 20% tax rate on debt receipts and a15% rate on equity. Determine the value of Zercon.

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

Describe some of the sources of business risk and financial risk. Do financial decision makers have the ability to "trade off" one type of risk for the other?

When small companies issue large stock offerings, we can expect owner managers to:

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

When graphing firm value against debt levels, the debt level that maximizes the value of the firm is the level where:

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

The optimal capital structure has been achieved when the:

The All-Mine Corporation is deciding whether to invest in a new project. The project would have to be financed by equity, the cost is $2000 and will return $2500 or 25% in one year. The discount rate for both bonds and stock is 15% and the tax rate is zero. The predicted cashflows are $4500 in a good economy, $3000 in an average, economy and $1000 in a poor economy. Each economic outcome is equally likely and the promised debt repayment is $3000. Should the company take the project? What is the value of firm and its components before and after the project addition?