Ch 13

Omega Corp has $20 million in perpetual debt outstanding with a coupon rate of 8 percent. the tax rate is 40%, what is the PV of the tax shield?

0.40*$20 million = $8 million

according to MM Proposition 1 with corporate taxes, the optimal capital structure is (blank)

100% debt

Alpha Co. has a debt equity ratio of .6, a pretax cost of debt of 7.5% and an unlevered cost of equity of 12%. what is their cost of equity if you ignore taxes

12%+.6(12%-7.5)=14.7%

an investor who invests in the stock of a levered firms rather than in an all equity firm will require (blank)

a higher expected return

examples of direct costs of financial distress

admin expenses legal fees

During bankruptcy, the ownership of the firm's assets is transferred from stockholders to (blank)

bondholders

according to mm proposition 1, the value of a firm is the same for debt financing as it is for equity financing because

debt financing is neither better nor worse than equity financing and the asset to be financed is the same

M&M proposition I states if the assets and operations (left hand side of the balance sheet) for two firms are the same then (blank)

how the firms are financed is irrelevant and the value of the two firms is equal

Capital structure decisions are made (blank) investment decisions

independent of

MM Proposition 1 does not work with corporate taxes because

levered firms pay lower taxes than unlevered firms

examples of indirect financial distress costs

lost sales lost reputation

an optimal capital structure will

maximize the value of the firm and maximize the cost of capital

Volatility or (blank) increases for equity holders when leverage increases

risk

how does the level of debt affect the weighted average cost of capital (WACC)

the WACC initially falls and then rises as debt increases

what will apply when a firms debt levels are extremely high

the benefits of debt financing may be more than offset by the costs of financial distress and the possibility of financial distress will become a chronic problem

a corporation gains no value from an interest tax shield if which of the following are true

the corporation has no debt corporate tax rates are zero and the corporation is an all-equity firm

which of the following are generally true about the cost of equity and the cost of debt?

the cost of debt is generally lower than the cost of equity, and the cost of equity may increase with leverage and the cost of debt increases with leverage

a firms capital structure refers to

the firms mix of debt and equity

under MM Proposition 2 with no taxes, the weighted average cost of capital is invariant to the debt level because

the return on assets is unchanged