Exam 18: How Much Should a Corporation Borrow

According to Rajan and Zingales, debt ratios of individual companies depend on: I.size: large firms have higher debt ratios; II.tangible assets: firms with high ratios of fixed assets to total assets have higher debt ratios; III.profitability: more profitable firms have lower debt ratios; IV.market to book: firms with higher ratios of market-to-book value have lower debt ratios; V.market structure: firms with monopoly power have higher debt ratios

The right to default is valuable to shareholders.

In order to calculate the tax shields provided by debt, the tax rate used is the

The existence of personal taxes on interest income and equity income will always increase the advantage of debt to a firm.

Explain the impact of government loan guarantees on corporate financing.

How is Modigliani-Miller's Proposition I modified when taxes and financial distress costs are considered?

Although the use of debt provides tax benefits to the firm, debt also puts pressure on the firm to: I.meet interest and principal payments, which if not met can put the company into financial distress; II.make dividend payments, which if not met can put the company into financial distress; III.meet both interest and dividend payments, which when met increase the firm cash flow; IV.meet increased tax payments, thereby increasing firm value

In order to find the present value of the tax shields provided by debt, the discount rate used is the

If a firm borrows $50 million for one year at an interest rate of 10 percent, what is the present value of the interest tax shield? Assume a 21 percent marginal corporate tax rate.

MM's Proposition I corrected for the inclusion of corporate income taxes is expressed as

The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because: I.debt is more risky than equity; II.bankruptcy and its attendant costs are a disadvantage to debt; III.the payment of personal taxes may offset the tax benefit of debt

The pecking order theory implies that firms prefer internal to external financing.

Given corporate taxes, why does adding debt to the capital structure increase firm value? I.Extra cash flow goes to the firm's investors rather than the tax authorities. II.Earnings before interest and taxes are fully taxed at the corporate rate. III.Personal tax rates are the same as marginal corporate tax rates.

What signal is sent to the market when a firm decides to issue new stock to raise capital?

Financial slack includes: I.cash; II.marketable securities; III.readily salable real assets; IV.ready access to debt markets or bank loans

In order to calculate the tax shield of interest payments for a corporation, always use the: I.average corporate tax rate; II.marginal corporate tax rate; III.marginal rate on personal income tax

Financial distress always results in bankruptcy.

Suppose that a company can direct $1 to either debt interest or to capital gains for equity investors. The capital gains tax rate is 15 percent. Which investor would not care how the money is channeled? (The marginal corporate tax rate is 21 percent.)

Financial distress occurs when promises to creditors are not honored or honored with great difficulty.

Briefly explain the trade-off theory of capital structure.