Chapter 16: Capital Structure Basic Concepts

Question 1

value of a firm

Answer 1

V = B + S
b - debt
s - equity

Question 2

Changes in capital structure

Answer 2

benefit shareholders if and only if firm value increases

Question 3

can someone reproduce the EPS of the levered firm through borrowing and lending?

Answer 3

Yes, if my personal debt-equity ratio is the same as that of the levered firm

eps - earnings per share

this is the fundamental insight of MM

Question 4

MM Proposition 1 (no taxes)

Answer 4

firm value is not affected by leverage

Vl = Vu

Question 5

MM Proposition 2 (no taxes)

Answer 5

relates the cost of equity to the underlying risk of the firm

Question 6

MM Proposition 1 (with corporate taxes)

Answer 6

Vl=Vu+TcB

some of the increase in equity risk and return is offset by interest tax shield

Question 7

levered firm pays more or less in taxes than an all-equity firm

Answer 7

levered firm pays less in taxes than does the all-equity firm

government ‘takes a smaller slice of pie’ in the form of taxes