FIN 362-SMT BK 7
According to the Tax Cuts and Jobs Act of 2017, after 2021, the net interest deduction drops to what percent of EBIT?
30
______ is the term that describes the capital structure when debt is used to finance assets.
Financial leverage
Who is likely to have the most information about a firm's future prospects?
The firm's manager
Modigliani and Miller suggest that there is a(n) ______ relationship between leverage and firm value in the presence of corporate taxes.
positive
In 2019, the net interest deduction is limited to what percent of EBITDA?
50
Which of the following is not a possible cause of financial distress?
Accounting regression
Which of the following industries tend to have a high leverage?
Airlines Cable television
The theory is the dominant theory of capital structure.
Blank 1: static
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.
Which of the following is not a reason that bankruptcy may be valuable to a company?
It generally instills greater confidence among a firm's main customers.
What is financial slack?
It is excess cash accumulated by the firm.
What are the advantages of using internal financing?
It prevents the adverse market reaction that tends to accompany a stock issue. It may be cheaper than debt or equity issues.
What is the most important benefit of debt?
It provides a tax benefit.
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. The corporation is an all-equity firm.
Which capital structure theory suggests that profitable firms will use less debt?
The pecking order theory
An investor who invests in the stock of a levered firm rather than in an all-equity firm will require:
a higher expected return.
Under the MM propositions with no taxes, managers cannot change the value of the firm by repackaging its securities because __.
as debt is added, the equity becomes more risky the overall cost of capital cannot be reduced
An unlevered firm ____.
has an all-equity capital structure
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
Rank each of the following in order of priority of payment starting with the highest priority item to lowest priority item.
1. Bankruptcy administrative expenses 2. Wages, salaries, and commissions 3. Consumer claims 4. Payment to common shareholders
The value of the firm is maximized when the weighted average cost of capital (WACC) is (minimized/maximized).
Blank 1: minimized
Financial is the term used to describe when a firm stockpiles internally generated cash in order to avoid selling new equity.
Blank 1: slack
Financial distress can arise in the form of possible:
Business failure Legal bankruptcy
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 of the following industries tend to have low leverage?
Drugs
Bankruptcy is very valuable due to which of the following?
Payments to creditors cease pending the outcome of the bankruptcy process. It can be used strategically to improve a firm's competitive position.
Which theory of capital structure leads to a target debt ratio?
The static trade-off theory of capital structure
What do Modigliani and Miller assert about the relationship between leverage and firm value in the presence of corporate taxes?
The value of the firm increases with leverage.
The equity risk that comes from the nature of a firm's operating activities is known as _____ risk.
business
When calculating the cash flow for a levered firm, you must consider _____.
cash flows to both bondholders and stockholders
The value of a firm is equal to the value of its _____.
debt plus equity
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
According to M&M Proposition I, a firm's capital structure choices _____.
do not affect the value of the firm
Financial leverage affects the performance of a firm because the range of possible values for ___.
earnings per share is wider
Voluntary arrangements to restructure a company's debt to avoid bankruptcy may be beneficial to all involved parties. This may involve _____.
extension or composition
Which of the following industries tend to have a high leverage?
having to rely on external financing
The cost of equity is generally ______ ______ the cost of debt.
higher than
An individual can duplicate a levered firm through a strategy called ____ where the investor uses his own funds plus borrowed funds to buy stocks.
homemade leverage
With ____, an investor is able to replicate a corporation's capital structure by borrowing funds and using those funds along with her own money to buy the company's stock.
homemade leverage
In the presence of corporate taxes, the tax shield effect of debt will ____ the value of the firm.
increase
The manager of a firm should change the capital structure if and only if ___.
it increases the value of the firm
Under the pecking order theory, profitable firms will tend to have ______ levels of debt.
lower
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.
Volatility or ______ increases for equity holders when leverage increases.
risk
An increase in the value of a previously all-equity firm occurs when debt is borrowed to repurchase stock because _____.
shareholders capture the interest tax shield
A beneficial rule to follow is to set the firm's capital structure so that
the firm's value is maximized
The value of a levered firm in MM Proposition I with corporate taxes equals the value of an all-equity firm Blank______.
plus the tax rate times the value of debt
Under pecking order theory firms can choose between debt or equity for external financing, which will they prefer?
Debt
Which of the following statements are true regarding the effect of financial leverage and the firm's operating earnings?
Financial leverage increases the slope of the EPS line. Below the indifference or break-even point in EBIT, an unlevered capital structure is best. The rate of return on assets is unaffected by leverage.
Why do firms prefer not to issue equity?
Share prices tend to drop when equity is issued.
The equity risk that comes from the financial policy or capital structure decisions of the firm is known as _____ risk.
financial
A company should select the capital structure that _____.
maximizes the company's value
The value of the firm is maximized when the weighted average cost of capital (WACC) is _____.
minimized
The absolute priority rule establishes priority _____.
of claims in liquidation
If a firm issues new equity, investors will infer that the firm's outstanding stock must be ___.
overvalued
Under MM Proposition II, a firm's cost of equity capital is ______ related to the firm's debt-equity ratio provided the cost of capital for an all-equity firm exceeds the cost of debt.
positively
The expected return on equity is _____ to leverage.
positively related
The ______ theory has dominated thinking about capital structure for a long time.
static
One of the important reasons why firms choose to raise capital by issuing debt is because of the ______ benefits of debt.
tax
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
A firm's capital structure refers to ___.
the firm's mix of debt and equity
How do predictions for leverage by profitable firms differ under the pecking order theory and the static theory?
Pecking order theory predicts that profitable firms will use less leverage.
True or false: Holding equity in an unlevered firm has no risk.
False
Under M&M Proposition II with no taxes, the weighted average cost of capital is invariant to the debt level because ___.
the return on assets (RA) is unchanged
