Finance 4300 Chapter 6 Concept Questions

Capital structures used by non financial U.S Firms in general

Vary significantly across industries

Financial Distress costs include:

-Direct Bankruptcy costs -Indirect Bankruptcy costs -Direct costs related to being financially but NOT bankrupt -Indirect costs related to being financially distressed but NOT bankrupt

The following factors favor the issuance of debt in the financing decision

-Market signaling -Distress costs -Tax benefits

The interest tax shield has no value when a firm has

-No taxable income -Zero debt -No leverage

The following are helpful for evaluating the effect of leverage on companies risk and potential returns

1) Estimated pro forma coverage ratios 2) A range of earnings chart and proximity of expected EBIT to the breakeven value

The pecking order theory proposed by Stewart Myers of MIT

1) For financing needs, firms prefer to first tap internal sources such as retained profits or excess cash 2)There is an inverse relationship between a firms profit and debt level 3)A firms capital structure is dictated by its need for external financing

What is financial leverage?

1) Increases breakeven, like operating leverage, but increases the rate of earnings per share growth once breakeven is achieved 2) Is a fundamental financial variable affecting sustainable growth 3) Increases expected return and risk to owners

The following factors favor the issuance of equity in the financing decision

1)Market signaling 2)Management incentives

The borrowing or lending of money by individual shareholders as a means of adjusting their level of financial leverage is called:

Homemade leverage

The best financing choice is the one that

Maximizes expected cash flows

The lesson of the M&M theory is that the value of a firm is dependent upon

The total cash flows of the firm