Exam 15: Capital Structure Policy

Allston-Brighton Corp. has total assets of $10 million, total liabilities of $4 million, of which $1 million are non-interest bearing. Interest expense was $180,000. Earnings before interest and taxes were $2.5 million. Depreciation was $1.5 million. Compute the following ratios: Debt ratio, Interest-bearing debt ratio, Times interest earned ratio, and EBITDA coverage ratio.

The capital structure that minimizes the weighted average cost of capital will also

Optimal capital structure is

On balance sheets, long-term capital leases are treated as

The pecking order theory of capital structure is derived from

With taxes, but in the absence of financial distress costs, the optimal capital structure would be

Basic tools of capital structure management include

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

The tradeoff theory of capital structure management assumes

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

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

Newbury Inc. has retained $2 million in earnings this year. It can borrow up to $1.5 million at a rate of 8% and sell the same amount of new stock at a cost of 17%. Newbury's cost of common equity without selling any new stock is 16%. If Newbury's capital budget is $2.5 million, pecking order theory says management will use

From the table above we can conclude

Lowell Corporation and Lawrence Corporation each have EBIT of $4 million. Lowell has no debt and no interest expense; Lawrence has $2 million in debt at a before-tax rate of 8%. The tax rate is 40%. How much cash does each firm return to its investors.

List and briefly explain at least two important reasons why capital structures tend to differ between industries and even companies within the same industry.

The indifference level of EBIT is

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

Boylston Inc.'s total interest bearing debt is $10,000,000 on which it pays interest at the rate of 5%. Boylston's rate of return on assets is 10%. How much cash flow does leverage add to shareholders equity?

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

The theory that managers may prefer internal sources of funds to the lowest cost source of funds is known as