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

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%.

While difficult to determine exactly,Lawrence A. Weiss estimated the distress costs to be about ____________ of firm value.

Establishing a capital structure for a firm is not simple.Although financial theory guides the process,there is no simple formula.List and explain four main items that one should consider in determining the capital structure.

The MM theory with taxes implies that firms should issue maximum debt.In practice,this is not true because:

Suppose a Miller equilibrium exists with corporate tax rate of 30% and personal tax rate on income from bonds of 35%.What is the personal tax rate on income from stocks?

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

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

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

In Miller's model,when the quantity (1-T_c)(1-T_s)= (1-T_b),then:

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%

Although the use of debt provides tax benefits to the firm,debt also puts pressure on the firms to:

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 basic lesson of MM theory is that the value of a firm is dependent upon the:

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.

Indirect costs of bankruptcy are born principally by:

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 a 15% rate on equity.Determine the value of Zercon.

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

The possibility of bankruptcy has a negative effect on the value of the firm because:

The optimal capital structure:

The Lanoi Company has EBIT of $30,000 and market value debt of $150,000 outstanding with an 8% coupon rate.The cost of equity for an all equity firm would be 12%.Lanoi has a 30% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 12% rate on equity.Determine the value of Lanoi.