Debt Policies

Question 1

what is a leveraged recapitalization

Answer 1

the firm will borrow money in order to reduce the equity via share repurchase of via large special dividend

Question 2

MM proposition 1?

Answer 2

the value of a firm is not affected by its financing but by the amount of total cash flows

equity + debt = value if unlevered = value of assets

Question 3

MM proposition 2?

Answer 3

–> the cost of capital of levered equity equals the cost of capital of unlevered equity plus a premium that is proportional to the market value debt to equity ratio

Question 4

what is equity dilution

Answer 4

phenomenon where when the company issues new equity, the earnings will be divided amongst more shares so everyone gets less
–> according to MM this can not happen

Question 5

what is net debt

Answer 5

debt minus cash and risk free securities

Question 6

MM 1 with taxes

Answer 6

VL = VU + PV (interest tax shield)

Question 7

what is the purpose of the notional interest deduction

Answer 7

to reduce the tax benefit of debt vs equity

Question 8

what are the determinants of financial distress costs

Answer 8

the probability of financial distress

the magnitude of the costs after the firm is in distress

Question 9

what are the three strategies associated with agency cost of debt

Answer 9

over invest
under invest
cashing out

Question 10

how can debtholders limit the behaviour of shareholders where they try to withdraw money

Answer 10

debt maturity: shorter term debt has smaller agency costs

debt covenants

Question 11

what are the agency benefits of debt

Answer 11

preserving the control of ownership

reducing the wasteful investments: empire building, overconfidence, FCF-hyp

Question 12

what is adverse selection

Answer 12

is the idea that when buyers and sellers have different information, the average quality of assets in the market differs from the average quality overall.

Question 13

what is lemons principle

Answer 13

when a seller has private information about the value of a good, buyers will discount the price they are willing to pay due to adverse selection

Question 14

what is the pecking order theory and what does it imply?

Answer 14

retained earnigns, debt, equity

equity is last because it has the highest asymmetrical information problem

Question 15

which themes are discussed in debt policy (ook de theorien geven)

Answer 15

MM
MM with taxes
MM with financial distress costs (trade-off theory)
MM with agency costs of debt
MM with agency benefits of debt
assymmetric information and capital structure (pecking order theory)