Chapter 16 - Capital Structure

Question 1

Financial leverage

Answer 1

extent to which firm relies on debt

more beneficial with more EBIT

Question 2

Debt magnification

Answer 2

debt magnifies gains AND losses

Question 3

Factors influencing k-e

Answer 3

1. ROA
2. cost of debt
3. debt to equity ration

Question 4

financial risk

Answer 4

additional risk stockholders bear because equity

Question 5

business risk

Answer 5

unsystematic risk

Question 6

total systematic risk

Answer 6

business risk + financial risk

Question 7

Taxing saving

Answer 7

Cash outflow for taxes is lower with debt

Question 8

PV tax saving

Answer 8

tax-saving / k-i

Question 9

bankruptcy cost concept

Answer 9

as debt rises so does the probably firm cannot pay it

Question 10

bankruptcy

Answer 10

legally turn assets over to bondholders

A=L or E=0

Question 11

Direct vs indirect bankruptcy

Answer 11

indirect - cost of avoiding

direct - legal / administrative costs associated with turning over assets

Question 12

Financial distress

Answer 12

firm has problems meeting debt obligations

Question 13

Stockholder vs bondholder conflicts

Answer 13

bondholders will get all firms assets in bankruptcy and stockholders get nothing

Question 14

static theory of capital structure

Answer 14

borrow until tax benefit = increased probability of financial distress

Question 15

Influences of total CF

Answer 15

1. bankruptcy costs
2. bondholder / stockholder claims
3. taxes

Question 16

marketed claims

Answer 16

claim of government that can be bought or sold in the market

Question 17

Stock undervalue

Answer 17

issue debt to avoid selling too cheap

Question 18

Stock overvalued

Answer 18

issue equity to take advantage of high stock price

Question 19

Pecking order theory

Answer 19

use internal financing whenever possible