Fin ch 16

What are some ways in which a bankruptcy filing might hinder a firm's normal business operations?

- Banks may place restrictions on the firm's financial activities - Suppliers may not supply inventory, fearing nonpayment - Customers may not buy, fearing future service problems

Which two of the following are broad types of costs of financial distress?

- Indirect costs - Direct costs

Which of the following are nonmarketed claims to the firms cash flows?

- Taxes - Legal fees

Which of the following will apply when a firm's debt levels are extremely high?

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

In the absence of taxes, the value of a firm is the same with debt financing as it is with equity financing because

- the asset to be financed is the same - MM demonstrated that debt financing is neither better nor worse than equity financing in the absence of taxes

What is the preferred source of financing for firms according to the pecking-order theory?

1. Retained earnings 2. Debt 3. Common stock

Place the steps needed to calculate the value of a levered firm with perpetual cash flows in order starting with the first step

1. calculate EBIT 2. Multiply EBIT by 1 minus the corporate tax rate 3. divide by the cost of equity for an all-equity firm 4. Add the present value of the debt tax shield

If the current share price of an all-equity firm is $25, going to a capital structure with 50% debt and 50% equity will result in a new share price of ______ when ignoring the impact of taxes

25

According to M&M Proposition I, a firm's capital structure choices:

Do not affect the value of the firm

An investor who invests in the stock of a levered firm rather than in an all-equity firm will require _____________

a higher expected return

Stockholders & Bondholders:

are not the only claimants to the cash flows of the firm

The WACC is the cost of __________ times its weight in the capital structure plus the cost of ____________ times its weight in the capital structure

debt; equity

The manager of a firm should change the capital structure if and only if

it increases the value of the firm

The value of the firm is maximized when the weighted average cost of capital (WACC) is:

minimized

MM Proposition II shows that

the cost of equity rises with leverage