03 Lecture

Question 1

What are the Mezzanine financing instruments

Answer 1

Between Equity and Debt

• Convertible Bonds
• Preferred Stocks
• Subordinated debt

Question 2

What is the most important mechanism between equity and debt

Answer 2

risk and return

others are (Control rights, Priority of being served)

Question 3

How are equity holders are called

Answer 3

Residual Claimholders

Question 4

What explains the 27% variation in leverage

Answer 4

• Industry median leverage
• Tangibility
• Profitability
• Firm Size
• Market-to.book assets ratio
• Expected inflation

Question 5

What are the assumptions of the Modigliani-Miller Theory and what does it state?

Answer 5

1. No Taxes
2. No cost of bankruptcy
3. Perfect information
4. No transaction costs for issuing debt and equity
5. Investment decisions not affected by capital structure

=> Firm value is independent of its capital structure

Question 6

What does the trade-off theory state?

Answer 6

Optimal capital structure balances tax-shield against cost of financial distress

Question 7

What effects does the announcement of an equity increase have?

Answer 7

• Reduces the share price

- Increases the cost of equity

Question 8

What does the pecking order theory state?

Answer 8

Pecking order theory suggests preference in financing sources

1. Retained earnings
2. Debt financing
3. External equity financing

Question 9

What are the main assumptions of the free cash flow theory

Answer 9

• Separation of ownership and control

- Asymmetry information between management and investors?

Question 10

What is the main result of the free cash flow theory?

Answer 10

Managers can maximize their wealth at expense of shareholders

Question 11

What are problems of too much debt according to the free cash flow theory?

Answer 11

• Assets Substitution:
  Incentive to increase the riskiness of your company
• Debt Overhang
  Equityholders will not give money for projects