Exam 16: Capital Structure

Fuji Inc.is registered as a business in the film-making industry.It can borrow in the debt market at 9%.Its cost of equity with 50% debt is 12%.Its corporate tax rate is 30%.If the M&M world of taxes holds,what is the WACC for Fuji with 50% debt financing?

The Modigliani and Miller original proposition II states that the value of the firm depends on three things: the required rate of return on the firm's assets,the firm's cost of debt,and the firm's debt-to-equity ratio.

You have a project that costs $800,000.It has a 1/3 chance of paying off $3,000,000 and a 2/3 chance of paying off $0.What is the expected profit from the new project?

Simplistic Inc.has a project that costs $600,000.It has a 70% chance of a $1,000,000 payoff and a 30% chance of a $100,000 payoff.What is the expected payoff and the expected profit or loss from the new project?

Shareholders can be made better off in terms of EPS with financial leverage when earnings are sufficiently high to offset the interest expense of debt.

Moving from one source of funding to another in a particular order is called the ________.

Although the work of Modigliani and Miller produced a near-100% debt mix for firms in a world of taxes,the actual debt-to-equity ratio for most firms falls far short of 100% debt financing.

One way of measuring the advantage of financial leverage to the owners of the company is ________.

Refer to the scenario above.What would the unleveraged and leveraged EPSs look like if EBIT were $2,400?

In a perfect financial world,a company's value is dependent on its capital structure.

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

Refer to the scenario above.What would the unleveraged and leveraged EPSs look like if EBIT were only $1,200?

The Modigliani-Miller model of capital structure begins with the simple assumption that the investing decision and financing decision of a firm are inseparable.

Two different individuals or companies can go to the same bank and request exactly the same amount of funding for their projects and yet can be required to pay different costs for their funds.Why? Can we find a parallel situation in the bond and equity markets? Explain.

Given a choice,firms will exhaust the cheapest source of external funding first before moving on to the ________ source.

The process of borrowing money from others to make money on your idea is commonly known in the investment world as ________.

Refer to the scenario above.What level of EBIT would make this an attractive strategy?

Bankruptcy is the point at which the equity value of the firm is zero.That is,the value of the assets is equal to or less than the value of the liabilities of the firm.

Consider two companies in a world with no taxes that are alike except in borrowing choices.Company 1 has no debt financing,and Company 2 uses debt financing.The EBIT for both companies is $800.Company 1 has 400 shares outstanding and pays no interest.Company 2 has 300 shares outstanding and pays $250 in interest.What is the EPS for each company?

In general,the cost of funds for an individual or company will be directly related to the lender's view of the risk of repayment of the funds.