Exam 15: Capital Structure Policy

Other things the same,the use of debt financing reduces the firm's total tax bill,resulting in a higher total market value.

Which of the following factors favors the use of more debt in a company's financial structure?

Sunshine Candy Company's capital structure for the past year of operation is shown below. First mortgage bonds at 12% $2,000,000 Debentures at 15% 1,500,000 Common stock (1 million shares)5,000,000 Retained earnings 500,000 Total $9,000,000 The federal tax rate is 50%.Sunshine Candy Company,home-based in Orlando,wants to raise an additional $1 million to open new facilities in Tampa and Miami.The firm can accomplish this via two alternatives: (1)it can sell a new issue of 20-year debentures with 16% interest;or (2)20,000 new shares of common stock can be sold to the public to net the candy company $50 per share.A recent study,performed by an outside consulting organization,projected Sunshine Candy Company's long-term EBIT level at approximately $6.8 million.Find the indifference level of EBIT (with regard to EPS)between the suggested financing plans.

The MAX Corporation is planning a $4 million expansion this year.The expansion can be financed by issuing either common stock or bonds.The new common stock can be sold for $60 per share.The bonds can be issued with a 12% coupon rate.The firm's existing shares of preferred stock pay dividends of $2.00 per share.The company's combined state and federal corporate income tax rate is 46%.The company's balance sheet prior to expansion is as follows: MAX Corporation Current assets $ 2,000,000 Fixed assets 8,000,000 Total assets $10,000,000 Current liabilities $ 1,500,000 Bonds: (8%,$1,000 par value)1,000,000 (10%,$1,000 par value)4,000,000 Preferred stock: ($100 par value)500,000 Common stock: ($2 par value)700,000 Retained earnings 2,300,000 Total liabilities and equity $10,000,000 a.Calculate the indifference level of EBIT between the two plans. b.If EBIT is expected to be $3 million,which plan will result in higher EPS?

Use the following information to answer the following question(s). Your firm is trying to determine whether it should finance a project requiring $800,000 with new common stock or with debt.The firm is faced with the following financing alternatives: I: Issue new common stock.Sale price of the common stock is expected to be $40 per share. II: Issue new bonds with a coupon rate of 12%. The firm has a marginal tax rate of 34%,the company currently has 40,000 shares of common stock outstanding,and $90,000 face value of 10% debt outstanding. -Total shares outstanding will be

The Times Interest Earned Ratio measures a firm's ability to meet both interest payments and scheduled principal repayments.

In the original version of the Modigliani and Miller capital structure theorem,as a firm increases the amount of debt in its capital structure,the cost of equity will rise but the cost of capital will remain the same.

How does the text distinguish between firm's financial structure and its capital structure?

Debt ratios and debt to enterprise value ratios differ widely from one industry to another.

The EBIT-EPS indifference point

Which industry would you expect to have the highest Debt to Asset ratios?

Companies faced with higher tax burdens are likely to use more debt.

Fibonacci Property Management's balance sheet shows total liabilities of $5 million and total assets of $13 million.Interest bearing liabilities total $3 million (book value).The market value of Fibonnacci's equity is $21 million.What is Fibonacci's debt ratio?

Farar,Inc.projects operating income of $4 million next year.The firm's income tax rate is 40%.Farar presently has 750,000 shares of common stock,no preferred stock,and no debt.The firm is considering the issuance of $6 million of 10% bonds to finance a new product that is not expected to generate an increase in income for two years.If Farar issues the bonds this year,what will projected EPS be next year?

A company whose rate of return on investments is higher than the interest rate on its debt is said to have

An optimal capital structure is achieved

The EBIT-EPS indifference point,sometimes called the break-even point,identifies the optimal range of financial leverage regardless of the financing plan chosen by the financial manager.

Which of the following is part of a firm's financial structure but NOT a component of its capital structure?

Which two ratios would be most helpful in managing a firm's capital structure?

Which of the following factors was most often cited by CFOs as an important influence on debt use?