Assessment 11

What are the important disadvantages of debt, in practice?

A,B The greater the leverage of the firm, the greater the likelihood of bankruptcy and incu AND Debt generates agency costs, such as the tendency of firms to take on excessive risk

If corporate and personal taxes exist, and interest payments are tax deductible for corporations, would firms take on as much debt as possible?

A,C No. The effective personal tax rate on equity is usually lower than the effective personal tax rate.... AND No. Even though interest payments are tax-deductible to the corporation.....

Bankruptcy is bad for the following reasons

A,C,D In bankruptcy, claims are often restructured and the new claims have to be valued, which involves negotiating costs. This reduce firm value AND Illiquid assets often have to be sold off in a rush at lower than intrinsic value. This reduces firm value AND In bankruptcy, asset either have to be sold off, generating transaction costs. Those that are not sold and this generates negotiating costs. this reduces firm value

If bankruptcy was costless and there was no information asymmetry, but interest payments are tax-deductible, what is the average cost of capital

The WACC is the weighted average of the cost of equity and the after-tax cost of debt

If transaction costs are zero, there is no information asymmetry or personal taxes and bankruptcy is costless and interest payments are tax-deductible, what is the optimal amount of debt to have

as much debt as possible

Bondholders do not have to worry about opportunistic managerial actions because they can always use bond covenants to specify what a manager can or cannot do

false

Leverage should have no impact on human resource management

false

Managers acting on excessive dividends when a firm is in trouble because the firm needs to keep all the financial resources it has

false

There is a lot of cross-sectional variation in debt-equity ratios but they do not vary systematically across....

false

Firms selling durable goods are more affected by financial distress than firms selling nondurable goods

true