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精品文檔精品文檔Chapter17CapitalStructure:LimitstotheUseofDebtMultipleChoiceQuestionsTheexplicitcosts,suchasthelegalexpenses,associatedwithcorporatedefaultareclassifiedascosts.flotationbetaconversiondirectbankruptcyindirectbankruptcyunleveredThecostsofavoidingabankruptcyfilingbyafinanciallydistressedfirmareclassifiedascosts.flotationdirectbankruptcyindirectbankruptcyfinancialsolvencycapitalstructureTheexplicitandimplicitcostsassociatedwithcorporatedefaultarereferredtoasthecostsofafirm.flotationdefaultbetadirectbankruptcyindirectbankruptcyfinancialdistressIndirectcostsoffinancialdistress:effectivelylimittheamountofequityafirmissues.serveasanincentivetoincreasethefinancialleverageofafirm.includedirectcostssuchaslegalandaccountingfees.tendtoincreaseasthedebt-equityratiodecreases.includethecostsincurredbyafirmasittriestoavoidseekingbankruptcyprotection.精品文檔5.精品文檔5.Thelegalproceedingforliquidatingorreorganizingafirmoperatingindefaultiscalleda:A.tenderoffer.B.bankruptcy.C.merger.D.takeover.精品文檔5.精品文檔5.Thelegalproceedingforliquidatingorreorganizingafirmoperatingindefaultiscalleda:A.tenderoffer.B.bankruptcy.C.merger.D.takeover.E.proxyfight.Thevalueofafirmismaximizedwhenthe:costofequityismaximized.taxrateiszero.leveredcostofcapitalismaximized.weightedaveragecostofcapitalisminimized.debt-equityratioisminimized.Theoptimalcapitalstructurehasbeenachievedwhenthe:debt-equityratioisequalto1.weightofequityisequaltotheweightofdebt.costofequityismaximizedgivenapre-taxcostofdebt.debt-equityratioissuchthatthecostofdebtexceedsthecostofequity.debt-equityratioselectedresultsinthelowestpossibleweighedaveragecostofcapital.Inaworldwithtaxesandfinancialdistress,whenafirmisoperatingwiththeoptimalcapitalstructure:I.thedebt-equityratiowillalsobeoptimal.theweightedaveragecostofcapitalwillbeatitsminimalpoint.therequiredreturnonassetswillbeatitsmaximumpoint.theincreasedbenefitfromadditionaldebtisequaltotheincreasedbankruptcycostsofthatdebt.IandIVonlyIIandIIIonlyIandIIonlyII,III,andIVonlyI,II,andIVonly精品文檔精品文檔精品文檔精品文檔Theoptimalcapitalstructurewilltendtoincludemoredebtforfirmswith:thehighestdepreciationdeductions.thelowestmarginaltaxrate.substantialtaxshieldsfromothersources.lowerprobabilityoffinancialdistress.lesstaxableincome.Theoptimalcapitalstructureofafirmthemarketedclaimsandthenonmarketedclaimsagainstthecashflowsofthefirm.minimizes;minimizesminimizes;maximizesmaximizes;minimizesmaximizes;maximizesequates;(leaveblank)Theoptimalcapitalstructure:willbethesameforallfirmsinthesameindustry.willremainconstantovertimeunlessthefirmmakesanacquisition.ofafirmwillvaryovertimeastaxesandmarketconditionschange.placesmoreemphasisontheoperationsofafirmratherthanthefinancingofafirm.isunaffectedbychangesinthefinancialmarkets.ThebasiclessonofMMtheoryisthatthevalueofafirmisdependentuponthe:capitalstructureofthefirm.totalcashflowsofthefirm.percentageofafirmtowhichthebondholdershaveaclaim.taxclaimplacedonthefirmbythegovernment.sizeofthestockholdersclaimsonthefirm.CorporationsintheU.S.tendto:minimizetaxes.underutilizedebt.relylessonequityfinancingthantheyshould.haveextremelyhighdebt-equityratios.relymoreheavilyonbondsthanstocksasthemajorsourceoffinancing.Ingeneral,thecapitalstructuresusedbyU.S.firms:tendtooverweighdebtinrelationtoequity.areeasilyexplainedintermsofearningsvolatility.areeasilyexplainedbyanalyzingthetypesofassetsownedbythevariousfirms.tendtobethosewhichmaximizetheuseofthefirm'savailabletaxshelters.varysignificantlyacrossindustries.TheMMtheorywithtaxesimpliesthatfirmsshouldissuemaximumdebt.Inpractice,thisisnottruebecause:debtismoreriskythanequity.bankruptcyisadisadvantagetodebt.firmswillincurlargeagencycostsofshorttermdebtbyissuinglongtermdebt.BothAandB.BothBandC.Althoughtheuseofdebtprovidestaxbenefitstothefirm,debtalsoputspressureonthefirmto:meetinterestandprincipalpaymentswhich,ifnotmet,canputthecompanyintofinancialdistress.makedividendpaymentswhichifnotmetcanputthecompanyintofinancialdistress.meetbothinterestanddividendpaymentswhichwhenmetincreasethefirmcashflow.meetincreasedtaxpaymentstherebyincreasingfirmvalue.Noneoftheabove.精品文檔17.精品文檔17.Givenrealisticestimatesoftheprobabilityandcostofbankruptcy,thefuturecostsofapossiblebankruptcyareborneby:A.allinvestorsinthefirm.B.debtholdersonlybecauseifdefaultoccursinterestandprincipalpaymentsarenotmade.精品文檔17.精品文檔17.Givenrealisticestimatesoftheprobabilityandcostofbankruptcy,thefuturecostsofapossiblebankruptcyareborneby:A.allinvestorsinthefirm.B.debtholdersonlybecauseifdefaultoccursinterestandprincipalpaymentsarenotmade.shareholdersbecausedebtholderswillpaylessforthedebtprovidinglesscashfortheshareholders.managementbecauseifthefirmdefaultstheywilllosetheirjobs.Noneoftheabove.Conflictsofinterestbetweenstockholdersandbondholdersareknownas:trusteecosts.financialdistresscosts.dealercosts.agencycosts.underwritingcosts.Oneoftheindirectcostsofbankruptcyistheincentiveformanagerstotakelargerisks.Whenfollowingthisstrategy:thefirmwillrankallprojectsandtaketheprojectwhichresultsinthehighestexpectedvalueofthefirm.bondholdersexpropriatevaluefromstockholdersbyselectinghighriskprojects.stockholdersexpropriatevaluefrombondholdersbyselectinghighriskprojects.thefirmwillalwaystakethelowriskproject.BothAandB.Oneoftheindirectcoststobankruptcyistheincentivetowardunderinvestment.Followingthisstrategymayresultin:thefirmalwayschoosingprojectswiththepositiveNPVs.thefirmturningdownpositiveNPVprojectsthatitwouldclearlyacceptinanallequityfirm.stockholderscontributingthefullamountoftheinvestment,butbothstockholdersandbondholderssharinginthebenefitsoftheproject.BothAandC.BothBandC.精品文檔精品文檔精品文檔精品文檔Whichofthefollowingistrue?Afirmwithlowanticipatedprofitwilllikelytakeonahighlevelofdebt.Asuccessfulfirmwillprobablytakeonzerodebt.Rationalfirmsraisedebtlevelswhenprofitsareexpectedtodecline.Rationalinvestorsarelikelytoinferahigherfirmvaluefromazerodebtlevel.Investorswillgenerallyviewanincreaseindebtasapositivesignforthefirm'svalue.Studieshavefoundthatfirmswithhighproportionsofintangibleassetsarelikelytousedebtcomparedwithfirmswithlowproportionsofintangibleassets.morethesameamountoflesseithermoreorthesameamountofanyamountofdebtWhatthreefactorsareimportanttoconsiderindeterminingatargetdebttoequityratio?Taxes,assettypes,andpeckingorderandfinancialslackAssettypes,uncertaintyofoperatingincome,andpeckingorderandfinancialslackTaxes,financialslackandpeckingorder,anduncertaintyofoperatingincomeTaxes,assettypes,anduncertaintyofoperatingincomeNoneoftheabove.Anexchangemayoffer:allowcustomersa30daymoney-backguaranteeonthefirm'sproduct.allowcustomersa90daywarrantyonthefirm'sproductfromdefects.allowbondholderstoexchangesomedebtforstock.allowstockholderstoexchangesomeoftheirstockfordebt.BothCandD.Whichofthefollowingisnotempiricallytruewhenformulatingcapitalstructurepolicy?Somefirmsusenodebt.Mostcorporationshavelowdebt-assetratios.Therearenodifferencesinthecapital-structureofdifferentindustries.Debtlevelsacrossindustriesvarywidely.Debtratiosinmostcountriesareconsiderablylessthan100%.Whenshareholderspursueselfishstrategiessuchastakinglargerisksorpayingexcessivedividends,thesewillresultin:noactionbydebtholderssincetheseareequityholderconcerns.positiveagencycosts,asbondholdersimposevariousrestrictionsandcovenantswhichwilldiminishfirmvalue.investmentsofthesameriskclassthatthefirmisin.undertakingscaleenhancingprojects.loweragencycosts,asshareholdershavemorecontroloverthefirm'sassets.Indirectcostsofbankruptcyarebornprincipallyby:bondholders.stockholders.managers.thefederalgovernment.thefirm'ssuppliers.Thevalueofafirminfinancialdistressisdiminishedifthefirm:isdeclaredbankruptandproceedstobeliquidated.isdeclaredinsolventandundergoesfinancialreorganization.isapartnership.BothAandC.BothAandB.Covenantsrestrictingtheuseofleasingandadditionalborrowingsprimarilyprotect:theequityholdersfromaddedriskofdefault.thedebtholdersfromtheaddedriskofdilutionoftheirclaims.thedebtholdersfromthetransferofassets.themanagementfromhavingtopayagencycosts.Noneoftheabove.Ifafirmissuesdebtbutwritesprotectiveandrestrictivecovenantsintotheloancontract,thenthefirm'sdebtmaybeissuedatainterestratecomparedwithotherwisesimilardebt.significantlyhigherslightlyhigherequallowerEitherAorBWhengraphingfirmvalueagainstdebtlevels,thedebtlevelthatmaximizesthevalueofthefirmisthelevelwhere:theincreaseinthepresentvalueofdistresscostsfromanadditionaldollarofdebtisgreaterthantheincreaseinthepresentvalueofthedebttaxshield.theincreaseinthepresentvalueofdistresscostsfromanadditionaldollarofdebtisequaltotheincreaseinthepresentvalueofthedebttaxshield.theincreaseinthepresentvalueofdistresscostsfromanadditionaldollarofdebtislessthantheincreaseofthepresentvalueofthedebttaxshield.distresscostsaswellasdebttaxshieldsarezero.distresscostsaswellasdebttaxshieldsaremaximized.Whenfirmsissuemoredebt,thetaxshieldondebt,theagencycostsondebt(i.e.,costsoffinancialdistress),andtheagencycostsonequity.increases;increase;increasedecreases;decrease;decreaseincreases;increase;decreasedecreases;decrease;increaseincreases;decrease;decrease精品文檔33.精品文檔33.Thefreecashflowhypothesisstates:A.thatfirmswithgreaterfreecashflowwillpaymoreindividendsreducingtheriskoffinancialdistress.B.thatfirmswithgreaterfreecashflowshouldissuenewequitytoforcemanagerstominimizewastingresourcesandtoworkharder.精品文檔33.精品文檔33.Thefreecashflowhypothesisstates:A.thatfirmswithgreaterfreecashflowwillpaymoreindividendsreducingtheriskoffinancialdistress.B.thatfirmswithgreaterfreecashflowshouldissuenewequitytoforcemanagerstominimizewastingresourcesandtoworkharder.thatissuingdebtrequiresinterestandprincipalpaymentsreducingthepotentialofmanagementtowasteresources.BothAandC.BothBandC.Issuingdebtinsteadofnewequityinacloselyheldfirmmorelikely:causestheowner-managertoworklesshardandshirktheirdutiesastheyhavelesscapitalatrisk.causestheowner-managertoconsumemoreperquisitesbecausethecostispassedtothedebtholders.causesbothmoreshirkingandperquisiteconsumptionsincethegovernmentprovidesataxshieldondebt.causesagencycoststofallasowner-managersdonotneedtoworryaboutothershareholders.causestheowner-managertoreduceshirkingandperquisiteconsumptionastheexcesscashflowmustbeusedtomeetdebtpayments.Thepeckingorderstateshowfinancingshouldberaised.Inordertoavoidasymmetricinformationproblemsandmisinterpretationofwhethermanagementissendingasignalonsecurityovervaluation,thefirm'sfirstruleisto:financewithinternallygeneratedfunds.alwaysissuedebtthenthemarketwon'tknowwhenmanagementthinksthesecurityisovervalued.issuenewequityfirst.issuedebtfirst.Noneoftheabove.精品文檔精品文檔精品文檔精品文檔Growthopportunitiestheofdebtfinancing.increase;advantagedecrease;advantagedecrease;disadvantageBothAandCNoneoftheaboveWhichofthefollowingindustrieswouldtendtohavethehighestleverage?DrugsComputerPaperElectronicsBiologicalproductsTheintroductionofpersonaltaxesmayrevealadisadvantagetotheuseofdebtifthe:personaltaxrateonthedistributionofincometostockholdersislessthanthepersonaltaxrateoninterestincome.personaltaxrateonthedistributionofincometostockholdersisgreaterthanthepersonaltaxrateoninterestincome.personaltaxrateonthedistributionofincometostockholdersisequaltothepersonaltaxrateoninterestincome.personaltaxrateoninterestincomeiszero.Noneoftheabove.InMiller'smodel,whenthequantity[(1-Tc)(1-Ts)=(1-Tb)],then:thefirmshouldholdnodebt.thevalueoftheleveredfirmisgreaterthanthevalueoftheunleveredfirm.thetaxshieldondebtisexactlyoffsetbyhigherpersonaltaxespaidoninterestincome.thetaxshieldondebtisexactlyoffsetbyhigherlevelsofdividends.thetaxshieldondebtisexactlyoffsetbyhighercapitalgains.InaMillerequilibrium,whattypeofinvestmentsdohightaxbracketinvestorstendtohold?BondsStocksDebenturesBothstocksandbonds.Neitherstocksnorbonds.TheTrunkLineCompanywillearn$60inoneyearifitdoeswell.Thedebtholdersarepromisedpaymentsof$35inoneyearifthefirmdoeswell.Ifthefirmdoespoorly,expectedearningsinoneyearwillbe$30andtherepaymentwillbe$20becauseofthedeadweightcostofbankruptcy.Theprobabilityofthefirmperformingpoorlyorwellis50%.Ifbondholdersarefullyawareofthesecostswhatwilltheypayforthedebt?Theinterestrateonthebondsis10%.$25.00$27.50$29.55$32.50$35.00TheTrunkLineCompanydebtholdersarepromisedpaymentsof$35ifthefirmdoeswell,butwillreceiveonly$20ifthefirmdoespoorly.Bondholdersarewillingtopay$25.Thepromisedreturntothebondholdersisapproximately:2.9%16.9%27.3%40.0%100%Aninvestmentisavailablethatpaysatax-free6%.Thecorporatetaxrateis30%.Ignoringrisk,whatisthepre-taxreturnontaxablebonds?4.20%6.00%7.67%8.57%Noneoftheabove.精品文檔44.精品文檔44.Yourfirmhasadebt-equityratioof.60.Yourcostofequityis11%andyourafter-taxcostofdebtis7%.Whatwillyourcostofequitybeifthetargetcapitalstructurebecomesa50/50mixofdebtandequity?A.9.50%B.10.50%精品文檔44.精品文檔44.Yourfirmhasadebt-equityratioof.60.Yourcostofequityis11%andyourafter-taxcostofdebtis7%.Whatwillyourcostofequitybeifthetargetcapitalstructurebecomesa50/50mixofdebtandequity?A.9.50%B.10.50%11.00%11.25%12.00%45.TheAggieCompanyhasEBITof$50,000andmarketvaluedebtof$100,000outstandingwitha9%couponrate.Thecostofequityforanallequityfirmwouldbe14%.Aggiehasa35%corporatetaxrate.Investorsfacea20%taxrateondebtreceiptsanda15%rateonequity.DeterminethevalueofAggie.$120,000$162,948$258,537$263,080$332,14346.Giventhefollowinginformation,leveragewilladdhowmuchvaluetotheunleveredfirmperdollarofdebt?Corporatetaxrate:34%Personaltaxrateonincomefrombonds:30%Personaltaxrateonincomefromstocks:30%$-0.050$0.006$0.246$0.340$0.660精品文檔.Giventhefollowinginformation,leveragewilladdhowmuchvaluetotheunieveredfirmperdollarofdebt?Corporatetaxrate:30%Personaltaxrateonincomefrombonds:20%Personaltaxrateonincomefromstocks:0%A$0.125$0.472$0.528$0.825Noneoftheabove[1-((1-Tc)(1-Ts)/(1-Tb))]B=[1-((.70)(1)/(1-.2)]B=.125B;$0.125Difficultylevel:ChallengeTopic:ADDEDVALUEOFLEVERAGEWITHTAXESType:PROBLEMSHollyBerryIncorporatedwillearn$40inoneyearifitdoeswell.Thedebtholdersarepromisedpaymentsof$25inoneyearifthefirmdoeswell.Ifthefirmdoespoorly,expectedearningsinoneyearwillbe$20andtherepaymentwillbe$15becauseofthedeadweightcostofbankruptcy.Theprobabilityofthefirmperformingpoorlyorwellis50%.Ifbondholdersarefullyawareofthesecostswhatwilltheypayforthedebt?Theinterestrateonthebondsis8%.A$18.52$30.00$32.55$35.75$37.04[0.5($25)+0.5($15)]/1.08=$18.52Difficultylevel:MediumTopic:VALUEOFDEBTType:PROBLEMS精品文檔精品文檔精品文檔精品文檔HollyBerryIncorporateddebtholdersarepromisedpaymentsof$25ifthefirmdoeswell,butwillreceiveonly$20ifthefirmdoespoorly.Bondholdersarewillingtopay$15.Thepromisedreturntothebondholdersisapproximately:5.65%45.65%50.00%66.67%100.00%($25/$15)-1=.6667=66.67%Difficultylevel:MediumTopic:RETURNTOBONDHOLDERSType:PROBLEMSAninvestmentisavailablethatpaysatax-free7%.Thecorporatetaxrateis40%.Ignoringrisk,whatisthepre-taxreturnontaxablebonds?4.20%7.00%7.47%11.67%NoneoftheaboveRb=.07/(1-.4)=.07/.6=.1167=11.67%Difficultylevel:MediumTopic:PRE-TAXRETURNONBONDSType:PROBLEMSEssayQuestions精品文檔精品文檔精品文檔62.精品文檔62.TheDo-All-RightMarketingResearchfirmhaspromisedpaymentstoitsbondholdersthattotal$100.Thecompanybelievesthatthereisa85%chancethatthecashflowwillbesufficienttomeettheseclaims.However,thereisa15%chancethatcashflowswillfallshort,inwhichcasetotalearningsareexpectedtobe$65.Ifthebondssellinthemarketfor$84,whatisanestimateofthebankruptcycostsforDo-All-Right?Assumeacostofdebtof10%.Whataretheadvantagesofaprepackagedbankruptcyforafirm?Whatarethedisadvantages?Aprepackallowsafirmtominimizeitsstayinbankruptcycourtandshouldallowthefirmtominimizeitsbankruptcycostsaswell.Ineithercase,managementisfreeduptospendtimeonmoreproductivetaskssuchasoperatingthefirm.Thenegativesideofaprepackisalittlemoredifficulttodiscern.Astutestudentswillrecognizethatprepackstaketimetonegotiate,thatis,theymaysavetimeduringbankruptcy,buttheyarelikelytotakemoretimeupfrontthanastraightbankruptcyfiling.Furthermore,itisalsolikelythatthefirmmustgivecreditorsabetterdealinordertogetthemtosignontothebankruptcyagreement.Shouldthisbethecase,thefirmmayactuallygetbettertermsfromitscreditorsbygoingthroughwithafullbankruptcyprocess.Topic:PREPACKAGEDBANKRUPTCYType:ESSAYSIsthereaneasilyidentifiabledebt-equityratiothatwillmaximizethevalueofafirm?Whyorwhynot?Studentsshouldexplainthatinaworldwithtaxes,transactioncosts,andfinancialdistresscosts,therearebothbenefitsandcoststohigherdebtloads,andthereisnowaytotargetexactlywhattheidealcapitalstructureshouldbe.Topic:CAPITALSTRUCTURETHEORYType:ESSAYSDescribesomeofthesourcesofbusinessriskandfinancialrisk.Dofinancialdecisionmakershavetheabilityto"tradeoff"onetypeofriskfortheother?Studentsshouldintuitivelyrecognizethatsomeoftheobservedvariationsincapitalstructuresacrossindustriesreflectthedifferencesinthenatureoftheindustriesthemselvesi.e.,businessrisk.Similarly,intuitionwouldsuggestthatfirmswithlargecapitalrequirementsandstablecashflows(e.g.,electricutilities)aremorelikelytobewillingtoraisefundsvialargeamountsofborrowing.Alternatively,firmswithlowertangibleassetneedsandhighlyuncertaincashflows(e.g.,smallsoftwarecompanies)aremorelikelytoemployequity.Topic:BUSINESSANDFINANCIALRISKType:ESSAYSTheexpectedamountbondholdersreceiveifcashflowsfallshortunderbankruptcyis:$84=[($100*.85)+(X*.15)]/1.1;X=$49.34Withoutbankruptcycosts,thebondswouldsellfor:[(100*.85)+($65*.15)]/1.1=$86.14Therefore,estimatedbankruptcycostsmustbe$65.00-$49.34=$15.66.Impactonpriceis(.15(15.66))/1.1=$2.14Topic:BANKRUPTCYCOSTSType:ESSAYSEstablishingacapitalstructureforafirmisnotsimple.Althoughfinancialtheoryguidestheprocess,thereisnosimpleformula.Listandexplainfourmainitemsthatoneshouldconsiderindeterminingthecapitalstructure.Somepointstoconsiderare:oTaxes--taxshieldtodebtifTC>TBoTypeofAssets--tangibleassetsbasedfirmshavelowercostsoffinancialdistressoUncertaintyofoperatingincome--firmsinhigherriskclasseshavegreaterprobabilityofexperiencingfinancialdistressPeckingorderandFinancialslack--Externalfinancingismoreexpensive.FinancialslackallowsforshortfallcoverageTopic:CAPITALSTRUCTURECONSIDERATIONSType:ESSAYSWigdorManufacturingiscurrentlyallequityfinanced,hasanEBITof$2million,andisinthe34%taxbracket.Louis,thecompany'sfounder,istheloneshareholder.

Ifthefirmweretoconvert$4millionofequityintodebtatacostof10%,whatwouldbethetotalcashflowtoLouisifheholdsallthedebt?ComparethistoLouis'totalcashflowifthefirmremainsunievered.InlevetedLeveredEBITInterestS2J)OOtOOO*0*S2M0.00040(1000EBTTaxesS2^00t000￡680,00051,60(^000S544,000EATAddbackinterestS1J20M00-0-31,056,000400,000TotalcashflowS1320M0SI,456,000Topic:TOTALCASHFLOWFORTHEUNLEVEREDFIRMType:ESSAYS精品文檔精品文檔精品文檔精品文檔Assumethatallearningsarepaidoutasdividends.NowconsiderthefactthatLouismustpaypersonaltaxonthefirm'scashflow.Louispaystaxesoninterestatarateof33%,butpaystaxesondividendsatarateof28%.CalculatethetotalcashflowtoLouisafterhepayspersonaltaxes.UnleveredLeveredDividendsSl,056M00TuxonDividendsS369,60029x680CashFlawFromDmtdends$950,40(/760320Interest-0-S400,000Taxoninterest-0-CashFlowfromInterest4268.000TotalCaahFlowS950A00SL028J20Debtstillispreferitble.Topic:TOTALCASHFLOWAFTERPERSONALTAXESType:ESSAYSConsideraneconomyinwhichtherearethreegroupsofinvestorsandnoothers.GroupPlumbersDorlorvonbonds60%GroupPlumbersDorlorvonbonds60%50%Llayers40%($millions)2tSOO10(1Therearenopersonaltaxesonincomefromstocks.Aninvestmentisavailablethatpaysatax-free4%.Thecorporatetaxrateis50%.Totalcorporateincomebeforeearningsandtaxes(EBIT)is$224millionforever.Whatisthemaximumdebt-to-equityratiofortheeconomy