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

The optimal capital structure of a firm _____ the marketed claims and _____ the nonmarketed claims against the cash flows of the firm.

The legal proceeding for liquidating or reorganizing a firm operating in default is called a:

The value of a firm is maximized when the:

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

The optimal capital structure:

The explicit costs, such as the legal expenses, associated with corporate default are classified as _____ costs.

Given the following information, leverage will add how much value to the unlevered firm per dollar of debt? Corporate tax rate: 40% Personal tax rate on income from bonds: 20% Personal tax rate on income from stocks: 30%

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

Holly Berry Incorporated will earn $40 in one year if it does well.The debtholders are promised payments of $25 in one year if the firm does well.If the firm does poorly, expected earnings in one year will be $20 and the repayment will be $15 because of the dead weight cost of bankruptcy.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 8%.

Which of the following industries would tend to have the highest leverage?

The explicit and implicit costs associated with corporate default are referred to as the _____ costs of a firm.

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?

The Aggie Company has EBIT of $70,000 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%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

Conflicts of interest between stockholders and bondholders are known as:

Wigdor Manufacturing is currently all equity financed, has an EBIT of $2 million, and is in the 34% tax bracket. Louis, the company's founder, is the lone shareholder. -If the firm were to convert $4 million of equity into debt at a cost of 10%, what would be the total cash flow to Louis if he holds all the debt? Compare this to Louis' total cash flow if the firm remains unlevered.

The Do-All-Right Marketing Research firm has promised payments to its bondholders that total $100.The company believes that there is a 85% chance that the cash flow will be sufficient to meet these claims.However, there is a 15% chance that cash flows will fall short, in which case total earnings are expected to be $65.If the bonds sell in the market for $84, what is an estimate of the bankruptcy costs for Do-All-Right? Assume a cost of debt of 10%.

Studies have found that firms with high proportions of intangible assets are likely to use ____________ debt compared with firms with low proportions of intangible assets.

Given realistic estimates of the probability and cost of bankruptcy, the future costs of a possible bankruptcy are borne by:

One of the indirect costs to bankruptcy is the incentive toward underinvestment.Following this strategy may result in: