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
