Deck 17: Capital Structure and Corporate Strategy

Question 1

The "predation" explains that:

A)if a preferred financing source is not available,the firm will try to raise funding through the next preferred choice.
B)there is a natural hierarchy of preferred financing routes for managers wishing to raise funds.
C)firms weigh the costs of having too much debt when they are doing poorly against the tax benefits of debt when they are doing well to arrive at their optimal capital structures.
D)a competitor might purposely lower its prices in an attempt to drive the highly levered competitor out of business.

Answer 1

D

Question 2

Explain the stakeholder theory.

Answer 2

Financial distress can be costly for a firm,because it affects how the firm is viewed by its customers,employees,suppliers and any other firms or individuals that in some way have stakes in its success.The stakeholders' views are especially important for firms whose products need future servicing,such as automobiles and computers,or whose product quality is important but difficult to observe,such as prescription drugs.Financial distress will also be costly for firms that require their employees and suppliers to invest in product-specific training and physical capital.On the other hand,firms that produce non-durable goods,such as agricultural products,or provide services that are not particularly specialized,such as hotel rooms,probably have low financial distress costs.The stakeholder theory explains why some firms choose not to borrow when lenders are willing to provide debt financing at attractive terms.The presence of debt reduces the firm's profits even if bankruptcy never occurs.Indeed,some firms cannot be viable if their probability of bankruptcy becomes too high.In such cases,the stakeholders' fear that the firm may ultimately fail can actually cause the firm to fail.

Question 3

Which of the following is a reason for a government to subsidize a failing firm?

A)The government's concern for organized union employees
B)The government's concern for the impact on tax revenue
C)The government's concern for the firm's equity holders
D)The government's concern for the firm's debt holders

Answer 3

A

Question 4

Which of the following is a reason why high debt ratios might cause firms to lose market share?

A)Firms with high debt to equity ratio have lower costs of financial distress and hence cannot take advantage of forcing employees to make wage concessions.
B)Firms with high debt to equity ratio have to pay a major part of their revenue as interest expense reducing the dividend payout ratios.
C)Because of concerns about its long-term viability and the quality of its products,a highly levered firm may find it difficult to retain and attract customers.
D)Rivals may view a highly levered firm as a major formidable competitor,and try to improve their product's quality to steal customers.

Question 5

Which of the following is true of the competitive dynamics of an industry?

A)An increase high leverage ratio could be indicative of a firm's intention to increase production.
B)Leverage has no impact on the competitive dynamics of an industry.
C)An increase in leverage is usually indicative of defensive behaviour.
D)The greater a firm's leverage,the less its incentive to produce a high level of output.

Question 6

Explain how financial distress of a firm affects its reputation.

Question 7

Financial distress is especially costly for firms:

A)with products for whom quality that is not important.
B)with products that require future servicing.
C)that sell non-durable goods and services.
D)that sell basic necessities.

Question 8

According to the static capital structure theory:

A)because of their preference to finance investment from retained earnings,firms avoid debt and adapt their dividend policies to reflect their anticipated investment needs.
B)if the firm has excess cash,it will tend to pay off its debt prior to repurchasing shares.
C)firms weigh the costs of having too much debt when they are doing poorly against the tax benefits of debt when they are doing well to arrive at their optimal capital structures.
D)if external financing is required; firms tend to issue the safest security first.

Question 9

Which of the following is true of the stakeholder theory?

A)It assumes that non-financial stakeholders do not have a stake in the financial health of the firm.
B)It states that some firms will not choose to borrow when lenders are willing to provide debt financing at attractive terms.
C)It states that the presence of debt increases a firm's profits even if there is no probability of new investment opportunities.
D)It states that financial distress should be more costly for firms that sell non-durable goods.

Question 10

Which of the following could be a benefit to the firms in financial distress?

A)Firms can use the financial distress to negotiate a lower cost of borrowing with banks.
B)The costs of financial distress will reduce the prices and will result in increased sales.
C)Higher costs of financial distress can reduce the tax burden.
D)Firms can force employees to make wage concessions during financial distress.

Question 11

Which of the following is true of the market-timing theory of capital structure?

A)Each firm will have an optimal capital structure,and firms will aim over the long term to converge to that capital structure.
B)Managers take advantage of exiting conditions to derive the maximum value from financing.
C)The dynamic capital structure of firms is determined by a pecking order of financing choices.
D)Firms will tend to have more equity after good performance,and more debt after bad performance.

Question 12

In bilateral monopolies:

A)the terms of trade between the parties are not open to negotiation.
B)the financial distress of a firm may provide it with a negotiating advantage.
C)the market concentration is quite high.
D)there will be no relationship between the capital structure and financial distress.

Question 13

Explain the pecking order theory.

Question 14

Which of the following is a non-financial stakeholder of a firm?

A)Employees
B)Equity holders
C)Preferred stockholders
D)Debt holders

Question 15

Which of the following is the least attractive employer for potential job-seekers?

A)A firm with a high current ratio
B)A highly levered firm
C)An unlevered firm
D)A firm with low cost of goods sold

Question 16

Explain the concept of predation.

Question 17

Which of the following is true of non-financial stakeholders?

A)They do not have a stake in the financial health of the firm.
B)They do not have debt or equity stakes in the firm.
C)They include preferred stockholders of the firm.
D)They include suppliers of the firm.

Question 18

Which of the following is true of employment and financial distress?

A)The cyclical nature of the size of a firm's labour force is inversely related to its financial leverage.
B)Firms with lower debt are more likely to maintain a smaller workforce through a recession than are firms with higher debt ratios.
C)Highly levered firms have a greater tendency to lay off workers.
D)A firm with lower debt obligations may prefer to maintain less employment when the financial conditions are bad.

Question 19

As per the pecking order of financing choices:

A)firms prefer to finance investments with retained earnings rather than external sources of funds.
B)firms weigh the costs of having too much debt when they are doing poorly against the tax benefits of debt when they are doing well to arrive at their optimal capital structures.
C)the capital structures of firms are optimized period by period.
D)if a firm has excess cash,it will tend to repurchase shares prior to paying off its debt.