Chp 13 BA323
Based on M&M Proposition I with corporate taxes, the optimal capital structure is Blank______.
100% debt
True or false: Based on M&M Proposition I, even including taxes, capital structure does not matter to the firm
False
True or false: The legal process of bankruptcy is typically quick and inexpensive.
False
True or false: When total book liabilities exceed the book value of the total assets, a firm is said to have reached fallen angel insolvency.
False
______ is the term that describes the capital structure when debt is used to finance assets
Financial leverage
Which of the two types of costs of bankruptcy are more difficult to quantify?
Indirect costs are difficult to quantify.
Which of the following is true of the impact of financial leverage?
It magnifies gains and losses.
Which of the following are examples of firms which filed for bankruptcy for strategic reasons?
Johns Manville Texaco Dow Corning Continental Airlines
According to M&M 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?
M&M demonstrated that debt financing is neither better nor worse than equity financing. The asset to be financed is the same.
The present value of the interest tax shield equals what?
TC × D
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 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.
A corporation gains no value from an interest tax shield if which of the following are true?
The corporation is an all-equity firm. The corporation has no debt. Corporate tax rates are zero.
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.
Which of the following describe a firm that takes advantage of a reorganization?
The firm continues to operate. The business must have its reorganization approved by its creditors. It is allowed to issue new securities.
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.
True or false: It is possible for the present value of distress costs to exceed the present value of tax savings.
True
True or false: M&M demonstrated that debt financing is neither better nor worse than equity financing.
True
What are some examples of indirect financial distress costs?
What are some examples of indirect financial distress costs?
An investor who invests in the stock of a levered firm rather than in an all-equity firm will require Blank______.
a higher expected return
The costs of financial distress depend mostly on how easily the ownership of the firm's Blank______ can be transferred.
assets
The fact that failure to meet debt obligations can result in bankruptcy is Blank______.
bad for the firm
The equity risk that comes from the nature of a firm's operating activities is known as Blank______.
business risk
Bankruptcy costs may exceed the tax shield benefits of
debt
The cost of debt will begin to increase as the Blank______.
degree of leverage increases
According to M&M Proposition I, a firm's capital structure choices Blank______.
do not affect the value of the firm
Which of the following industries tend to have a low leverage?
drugs computers
The optimal level of debt in the presence of corporate taxes and bankruptcy costs occurs at the point at which the present value of distress costs Blank______ the present value of the tax shield benefits.
equals
True or false: Stockholders care most about the dividend maximization of the firm.
false
The weighted average cost of capital rises at higher levels of debt owing to Blank______.
financial distress costs
The equity risk that comes from the financial policy or capital structure decisions of the firm is known as Blank______.
financial risk
The tax deductibility of interest payments is Blank_____
good for the firm
If the degree of leverage increases, the cost of debt will Blank______.
increase
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 Blank______ costs of financial distress.
indirect
Which two of the following are broad types of costs of financial distress?
indirect costs direct costs
Bankruptcy is very valuable because Blank______.
it can be used strategically to improve a firm's competitive position payments to creditors cease pending the outcome of the bankruptcy process
Financial distress can arise in the form of possible Blank______.
legal bankruptcy business failure
What is generally the most important component of direct bankruptcy costs?
legal costs
Which of the following are direct costs of financial distress?
legal fees administrative expenses
Liquidation differs from reorganization in that Blank______.
liquidation terminates business activity, while reorganization allows the firm to continue operating
The cost of debt is generally _____ than the cost of equity. (Enter only one word per blank.)
lower
The tax shield afforded by debt will be of the least use to firms with Blank______.
negative EBT losses carried forward
The value of a levered firm in M&M Proposition I with corporate taxes equals the value of an all equity firm Blank______.
plus the tax rate times the value of debt
The expected return on equity is Blank______ to leverage
positively related
Which of the following industries tend to have a high leverage?
restaurants airlines
Volatility or ______ increases for equity holders when leverage increases.
risk
The idea that a firm borrows to the point that the tax benefit of debt is exactly equal to the increased probability of financial distress is called the Blank______ theory of capital structure.
static
It is often in everyone's best interest to devise a "workout" strategy that avoids bankruptcy because Blank______.
the bankruptcy process can be long and expensive
M&M Proposition II shows that Blank______.
the cost of equity rises with leverage
A firm's capital structure refers to ______.
the firm's mix of debt and equity
A beneficial rule to follow is to set the firm's capital structure so that Blank______.
the firm's value is maximized
Under M&M Proposition II, a firm's WACC remains unchanged regardless of changes in its capital structure because as the % of debt increases Blank______.
the increase in the cost of both debt and equity is exactly offset by the increase in the % of lower cost debt
The static theory of capital structure suggests employing debt to the point that its cost equals the cost of Blank______.
the increased probability of bankruptcy
The tax savings attained by a firm from the tax deductibility of interest expense is called Blank______.
the interest tax shield
Under M&M Proposition II with no taxes, the weighted average cost of capital is invariant to the debt level because Blank______.
the return on assets (RA) is unchanged
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______.
the value of the two firms is equal how the firms are financed is irrelevant
