Exam 15: Capital Structure Policy

A firm is analyzing two different capital structures for financing a new asset that will cost $100,000.The effects of the two structures on the firm's balance sheet are described below. Plan A: finance with 50% debt New asset $100,000 Debt $50,000 Common equity $50,000 Total $100,000 Plan B: finance with 70% debt New asset $100,000 Debt $70,000 Common equity $30,000 Total $100,000 Based on the information provided,we can conclude that

Which of the following is NOT a component of a firm's capital structure?

A company that earns a rate of return on its investments lower than the interest rate on its debt is said to have

Investors require a higher return on common stock investments if a firm uses less leverage.

Abbot Corp has a debt ratio (debt to assets)of 20%.Management is wondering if its current capital structure is too conservative.Abbot Corp's present EBIT is $4.5 million,and profits available to common shareholders are $2,910,600,with 600,000 shares of common stock outstanding.If the firm were to instead have a debt ratio of 40%,additional interest expense would cause profits available to stockholders to decline to $2,851,200,but only 480,000 common shares would be outstanding.What is the difference in EPS at a debt ratio of 40% versus 20%?

The Modigliani and Miller Capital Structure Theorem suggests that the cost of equity decreases as financial leverage increases.

Using the original Modigliani and Miller assumptions if a firm's cost of capital is 12% when it is all equity financed and it's cost of debt is 8%,the cost of equity will be ________% when the firm is financed with equal amount of debt and equity.

At the beginning of the financial crisis of 2008,excessive debt caused serious problems in the ________ industry.

Chelsea Corporation's cost of equity is 16% and it is 100% equity financed.If it can borrow enough money at 10% to buy back half of its stock,what would would happen to the cost of equity be under the original assumptions of the Modigliani and Miller Capital Structure Theorem.

If a firm chose to increase its debt ratio from 20% to 40%,what is the potential risk?

Adams Inc.expects EBIT of $50 million if there is a recession,$100 million if the economy is normal,and $150 million if the economy expands.Bellingham Inc.also expects EBIT of $50 million if there is a recession,$100 million if the economy is normal,and $150 million if the economy expands.Adams is financed entirely with equity while Bellingham is financed 50% with debt at 10%.Adams has $200 million in equity;Bellingham is financed with $100 million of debt and $100 million of equity.The tax rate is 30%.Both firms pay out all available earnings as dividends.If there is a recession,compare dividends and total distributions to investors for each company.

Which of the following will happen if the original Modigliani and Miller Theorem is relaxed to include taxes,but not bankruptcy costs?

An optimal capital structure is achieved

Merrimac Brewing company's total assets equal $18 million.The book value of Merrimac's equity is $6 million.Excess cash is $200,000.The market value of Merrimac's equity is $10 million.Its Debt to Enterprise Value ratio is .5.What is the book value of Merrimac's interest- bearing debt?

The Tradeoff theory of capital structure suggests that if a firm moves from zero debt in its capital structure to moderate usage of debt,the result is an increase in a firm's

The level of EBIT that will equate EPS between two different financing plans is called the

Why is the Debt to Assets Ratio always higher than the Debt to Value ratio?

Top management's desire to avoid the scrutiny that comes with higher levels of debt may influence the capital structures of some firms.

Merrimac Brewing company's total assets equal $18 million.The book value of Merrimac's equity is $6 million.Excess cash is $200,000.The market value of Merrimac's equity is $10 million.Its Debt to Enterprise Value ratio is .5.What is Merrimac's Debt Ratio?

Comparative leverage ratio analysis does not involve the use of industry norms.