Exam 15: Capital Structure Policy

Cabot Corp has a debt ratio (debt to assets)of 60%.Management is wondering if its current capital structure is too conservative.Cabot Corp's present EBIT is $4.5 million,and profits available to common shareholders are $2,791,800,with 384,000 shares of common stock outstanding.If the firm were to instead have a debt ratio of 80%,additional interest expense would cause profits available to stockholders to decline to $2,732,400,but only 307,200 common shares would be outstanding.What is the difference in EPS at a debt ratio of 80% versus 60%?

The original form of the Modigliani and Miller Capital Structure Theorem

Tremont Inc.'s Total Assets =$25 million.The balance sheet shows Accounts payable and accruals totaling $7 million,common stock and retained earnings total $10 million.There is no preferred stock.What is the book value of interest bearing debt?

Briefly explain what the empirical evidence suggests about financial managers' actions as they relate to the capital structure theory.

The debt ratio is usually computed using book values for both debt and equity.

Bipolar Beverages total assets equal $360 million.The book value of Bipolar's equity is $180 million.The market value of Bipolar's equity is $ 250 million.The book value of the company's interest bearing debt is $120 million.Compute Bipolar's Debt Ratio and Debt to Value Ratio.

Young Enterprises is financed entirely with 3 million shares of common stock selling for $20 a share.Capital of $4 million is needed for this year's capital budget.Additional funds can be raised with new stock (ignore dilution)or with 13% 10-year bonds.Young's tax rate is 40%. a.Calculate the financing plan's EBIT indifference point. b.Does the "indifference point" calculated in question (a)above truly represent a point where stockholders are indifferent between stock and debt financing? Explain your answer.

Financial structure includes long-term and short-term sources of funds.

Under what conditions are shareholders likely to incur agency costs when managers make capital budgeting decisions?

U.S.companies differ very little in their capital structures.

In its original form,the Modigliani and Miller Capital Structure Theorem

Babbit Corp has a debt ratio (debt to assets)of 40%.Management is wondering if its current capital structure is too conservative.Babbit Corp's present EBIT is $4.5 million,and profits available to common shareholders are $2,851,200,with 480,000 shares of common stock outstanding.If the firm were to instead have a debt ratio of 60%,additional interest expense would cause profits available to stockholders to decline to $2,791,800,but only 384,000 common shares would be outstanding.What is the difference in EPS at a debt ratio of 60% versus 40%?

The inclusion of bankruptcy risk in firm valuation

What is meant by the terms "favorable" and "unfavorable" leverage?

The Tradeoff Theory of capital structure theory indicates that

If interest expense lowers taxes,why does the WACC not decrease indefinitely with the addition of more debt?

Which of the following is a reasonable conclusion from the Tradeoff theory of capital structure?

The Tradeoff Theory view of capital structure management says that the cost of capital curve is

The enterprise value of the firm is defined as

A firm's financial structure is defined by the Debt Ratio,while its capital structure is defined by the Debt to Value ratio.