Exam 2 corporate finaNCE
Financial distress can arise in the form of possible
-Legal bankruptcy -Business failure
According to MM Proposition I, the value of a firm is the same for debt financing as it is for equity financing because of which of the following?
-MM demonstrated that debt financing is neither better nor worse than equity financing. -The asset to be financed is the same.
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.
Which of the following are generally true about the cost of equity and the cost of debt?
-The cost of equity may increase with leverage. -The cost of debt is generally lower than the cost of equity. -`The cost of debt increases with leverage.
M&M Proposition I states if the assets and operations (left-hand side of the balance sheet) for two firms are the same, then ___________________ .
-how the firms are financed is irrelevant -the value of the two firms is equal
A capital restructuring may include
-issuing more equity -issuing debt and repurchasing equity -issuing more debt
Which answer is correct in order of priority of payment: 1) Payment to common shareholders. 2) Bankruptcy administrative expenses. 3)Consumer claims. 4)Wages, salaries, and commissions
2,4,,3,1
The legal process of bankruptcy is typically quick and inexpensive.
F
Which of the following assumptions is necessary for MM Proposition I to hold?
Individuals can borrow on their own at an interest rate equal to that of the firm.
The tax savings attained by a firm from the tax deductibility of interest expense is called
Legal bankruptcy Business failure
How does the level of debt affect the weighted average cost of capital (WACC)?
The WACC initially falls and then rises as debt increases.
Which of the following statements are true regarding the effect of financial leverage and the firm's operating earnings (EBIT)?
The rate of return on assets is unaffected by leverage.
What is the expression for the value of a levered firm in the presence of corporate taxes?
What is the expression for the value of a levered firm in the presence of corporate taxes?
The fact that failure to meet debt obligations can result in bankruptcy is ______.
bad for the firm
Bankruptcy costs may exceed the tax shield benefits of ________.
debt
The value of a levered firm is higher than the value of an unlevered firm in the presence of corporate taxes owing to the tax shield benefit of:
debt
Which costs of financial distress are easier to measure?
direct costs
According to M&M Proposition I, a firm's capital structure choices:
do not affect the value of tech firm
Which of the following industries tend to have a low leverage?
drugs, computers
Direct costs are very difficult to measure and, thus, are often estimated.`
false
Holding equity in an unlevered firm has no risk.
false
There is a precise mathematical equation for determining the optimal level of debt for any firm.
false
______ is the term that describes the capital structure when debt is used to finance assets.
financial leverage
An investor who buys the common stock of a levered firm is subject to more risk due to the addition of
financial risk
The equity risk that comes from the financial policy or capital structure decisions of the firm is known as:
financial risk
Stockholders care most about the dividend maximization of the firm
flase
The tax deductibility of interest payments is?
good for the firm
The value of a levered firm will be_______, Incorrect Unavailable than the value of an identical unlevered firm because the levered firm's taxes will be_______.
greater, lower
An individual can duplicate a levered firm through a strategy called ______ leverage where the investor uses his own funds plus borrowed funds to buy stocks.
homeade
With ______ ______, an investor is able to replicate a corporation's capital structure by borrowing funds and using those funds along with their own money to buy the company's stock.
homemade leverage
The costs of financial distress depend mostly on how easily the ownership of the firm's ________ can be transferred.
how the firms are financed is irrelevant the value of the two firms is equal
How is the optimal debt level is determined?
in a subjective manner
If the degree of leverage increases, the cost of debt will ______.
increase
Capital structure decisions are made ______ investment decisions.
independent of
Customers refusing to buy GM cars when the company filed for Chapter 11 for fear of not being able to get service for the cars in the future is an example of ______ costs of financial distress.
indirect
Which of the two types of costs of bankruptcy are more difficult to quantify?
indirect costs`
What is generally the most important component of direct bankruptcy costs?
legal costs
MM Proposition I does not work with corporate taxes because
levered firms pay lower taxes than unlevered firms
The tax shield afforded by debt will be of the least use to firms with ______ .
losses carried forward -negavtive EBT
What are some examples of indirect financial distress costs?
lost reputation lost sales
The value of a levered firm will be greater than the value of an identical unlevered firm because the levered firm's taxes will be ______.
lower
The value of a levered firm in MM Proposition I with corporate taxes equals the value of an all equity firm:
plus the tax rate times the value of debt
The expected return on equity is _____ to leverage.
positively related
Volatility or ______ increases for equity holders when leverage increases.
risk
It is often in everyone's best interest to devise a "workout" strategy that avoids bankruptcy because:
the bankruptcy process can be long and expensive
A firm's capital structure refers to ___.
the firm's mix of debt and equity
The Static Theory of Capital Structure suggests employing debt to the point that its cost equals the cost of ____________________.
the increased probability of bankruptcy
It is possible for the present value of distress costs to exceed the present value of tax savings.
true
Which of the following is true of the impact of financial leverage
true
A firm is considered bankrupt when the value of its equity is ____
zero