cap str Flashcards
MM assumptions (3). modigliani-miler theory in a world without taxes. reasonable in real world?>EX
no taxes
no transaction costs
individual and corporation borrow at the same rate
no. because they are unrealistic
no tax world, no trans cost and no cost of fin distress. T,F,Uncertain:
If a firm issues equity to repurchase some of its debt, the price per share of the firm’s stock will rise because the shares are less risky. Explain
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In a world with no taxes, no transaction costs, and no costs
of financial distress, T, F, Uncertain:
Moderate borrowing will not increase the required return on a firm’s equity. Explain
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What is the quirk in the tax code that makes a levered firm more
valuable than an otherwise identical unlevered firm?
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Explain what is meant by business and
financial risk. Suppose Firm A has greater business risk than Firm B. Is it true that
Firm A also has a higher cost of equity capital? Explain.
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How would you answer in the following debate?
Q : Isn’t it true that the riskiness of a firm’s equity will rise if the firm increases its
use of debt financing?
A : Yes, that’s the essence of MM Proposition II.
Q : And isn’t it true that, as a firm increases its use of borrowing, the likelihood of
default increases, thereby increasing the risk of the firm’s debt?
A : Yes.
Q : In other words, increased borrowing increases the risk of the equity and the debt?
A : That’s right.
Q : Well, given that the firm uses only debt and equity financing, and given that
the risks of both are increased by increased borrowing, does it not follow that
increasing debt increases the overall risk of the firm and therefore decreases the
value of the firm?
A : ?
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Is there an easily identifiable debt–equity ratio that will
maximize the value of a firm? Why or why not?
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Why is the use of debt financing referred to as financial
“leverage”?
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What is homemade leverage?
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What is the basic goal of financial management with regard
to capital structure?
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