31: Capital Structures

Question 1

Stock dividends, like stock splits, have what impact on a company’s equity?

Answer 1

no impact on the value of a company’s equity

Question 2

Share appreciation/depreciation has what impact on a company’s equity?

Answer 2

increase the market value of equity, thus increasing equity relative to debt

Question 3

Cash flow typically turns positive during the _____ stage, but it may be negative, particularly at the beginning of this stage

Answer 3

growth stage

Question 4

Modigliani-Miller Proposition I, with _____ states that in perfect markets the level of debt versus equity in the capital structure has what effect?

Answer 4

no taxes;
capital structure has no effect on company value
aka “the capital structure irrelevance theorem”

Question 5

Modigliani-Miller Proposition, with taxes states that a company’s WACC is ______ and its value maximized, with _____

Answer 5

WACC minimized
value maximized with 100% debt financing

the value of the levered company is greater than that of the all-equity company by an amount equal to the tax rate multiplied by the value of the debt, also termed the debt tax shield.”

Question 6

The optimal capital structure:

Answer 6

maximizes firm value and minimizes its WACC

Question 7

The cost of equity _____ with the _____ debt in the capital structure

Answer 7

equity increases with the use of debt
Modigliani- Miller proposition II, no taxes

Question 8

If the company’s WACC increases as a result of taking on additional debt, the company has moved beyond _____

Answer 8

the optimal capital range

Question 9

The static trade-off theory indicates that there is a trade-off between the ______ and the ______, leading to _______ in a company’s tcapital structure

Answer 9

tax shield from interest on debt
costs of financial distress
an optimal amount of debt

Question 10

Debt can be a significant portion of the optimal capital structure because of the ______

Answer 10

tax-deductibility of interest

Question 11

Because of information asymmetry, Issuing debt may signal to investors:

Answer 11

that management is confident in company’s ability to make these payments

Question 12

Because of information asymmetry, Issuing equity may signal to investors:

Answer 12

that management believes the stock is overvalued

Question 13

The pecking order state:
1. ____________ are preferable to both:
2. ______
3. _____

Answer 13

internally generated funds
new debt
new equity

Question 14

arise because management and shareholders may have conflicting interests

Answer 14

agency costs

Question 15

Agency costs can be reduced by:

Answer 15

increased debt issuance

Question 16

A company will typically use debt for the largest percentage of its financing during which stage?

Answer 16

Mature companies are able to support more debt than start-up companies or growth stage companies because they typically have predictable positive cash flows, lower business risk, and significant liquid assets.

Question 17

Companies have an optimal level of debt, according to which theory?

Answer 17

Static trade off

Question 18

____-term debt is more exposed to the risk of a management decision that is not debt-holder friendly, likely resulting in debt-equity conflicts

Answer 18

long term debt

Question 19

Sales risk and operating risk compromise:

Answer 19

business risk

Question 20

Risk associated with the refinancing of debt:

Answer 20

Rollover risk:

a company financing long-term assets with short-term obligations faces rollover risk, which may threaten profitability if short-term financing costs go up over the financing period

Question 21

A company financing short-term assets by issuing long-term debt most likely increases:

Answer 21

Default risk