Exam 15: Capital Structure Policy

What is being traded off in tradeoff theory?

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

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 Fibonacci's equity is $21 million. Fibonacci's debt ratio is

The Tradeoff Theory of capital structure theory indicates that

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

Roberts, Inc. is trying to decide how best to finance a proposed $10 million capital investment. Under Plan I, the project will be financed entirely with long-term 9% bonds. The firm currently has no debt or preferred stock. Under Plan II, common stock will be sold to net the firm $20 a share; presently, 1 million shares are outstanding. The corporate tax rate for Roberts is 40%. a. Calculate the indifference level of EBIT associated with the two financing plans. b. Which financing plan would you expect to cause the greatest change in EPS relative to a change in EBIT? Why? c. If EBIT is expected to be $3.1 million, which plan will result in a higher EPS?

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

The pecking order theory of capital structure indicates that firms prefer to finance investment opportunities with least expensive forms of financing first and the most expensive last.

Which of the following is consistent with the original formulation of the Modigliani and Miller Capital Structure Theorem?

Given the existence of taxes and bankruptcy costs, the optimal capital structure is 100% debt.

From the information below, select the optimal capital structure for Mountain High Corp.

Which of the following should be excluded from a firm's capital structure?

Which of the following is a conclusion of agency theory?

The trade-off theory of capital structure recognizes the tax-shield benefit of debt financing, but also recognizes that the benefit may at some point be offset by costs associated with financial distress.

Obligations under capital leases do not appear as liabilities on the balance sheet.

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.

An optimal capital structure is achieved

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

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 most acceptable view of capital structure, according to the text, is that the weighted average cost of capital