Topic 11- Financing Analysis: Capital Structure

Question 1

Is debt or equity paid first?

Answer 1

debt

Question 2

Debt is the promise of

Answer 2

fixed payments in the future

Question 3

What happens if debt payments aren’t made?

Answer 3

shareholders can lose control of the firm

Question 4

for debt interest is

Answer 4

tax deductible

Question 5

low or high priority for debt in financial trouble?

Answer 5

high

Question 6

low or high priority for equity in financial trouble?

Answer 6

low

Question 7

debt does or doesn’t have management control

Answer 7

doesn’t

Question 8

2 examples of debt

Answer 8

bank debt, bonds

Question 9

equity is when equity holders

Answer 9

get (or reinvest) the leftover CFs after debt payments are made

Question 10

equity is what type of claim?

Answer 10

residual

Question 11

dividends are or aren’t tax deductible

Answer 11

aren’t

Question 12

life of equity vs debt

Answer 12

equity inf, debt fixed

Question 13

equity does or doesn’t have management control

Answer 13

does

Question 14

2 examples of equity

Answer 14

owner’s equity (in a limited partnership) or common shares (corporate)

Question 15

3 advantages of debt

Answer 15

• tax benefit
• disciple
• incentives to managers to increase CFs of the firm

Question 16

Tax benefit is when

Answer 16

int expenses on debt are tax deductible

Question 17

CFs for equity aren’t

Answer 17

tax deductible

Question 18

increase in tax rate decreases or increases tax benefit

Answer 18

increase

Question 19

for disciple borrowing forces

Answer 19

managers to be careful and not invest stupidly

Question 20

an increase in separation between managers and stockholders creates an increase in

Answer 20

tax benefit

Question 21

3 disadvantages of debt

Answer 21

• insolvency costs
• agency costs
• loss of flexibility

Question 22

insolvency costs are due to

Answer 22

an increase in debt meaning an increase in the likelihood of NOT being able to make debt payments

Question 23

bankruptcy costs formula

Answer 23

E(b)= prob(going bankrupt) x cost (going bankrupt)

Question 24

with more volatile earnings comes an increase in

Answer 24

the porb of going bankrupt

Question 25

firms with high/low bankruptcy costs should borrow more/less for any given level of earnings

Answer 25

low, more

Question 26

agency costs arise from

Answer 26

actions by managers and shareholders that benefit themselves not the firm

Question 27

a greater potential for conflict comes from an

Answer 27

increase cost borne by borrowers (increased IR)

Question 28

what types of firms should borrow more?

Answer 28

firms with lenders monitoring how the $$ is used

Question 29

Why is loss of flexibility a disadvantage for debt?

Answer 29

borrowing capacity of debt means less flexibility to finance other projects with debt

Question 30

increase in debt intake==== (4 pts)

Answer 30

increase int payments,increase tax shield, increase tax benefit, increase bankruptcy costs

Question 31

value of a levered firm=

Answer 31

value of un levered firm + PV (tax shield)

Question 32

does industry depend on debt?

Answer 32

yes

Question 33

industry dependant on debt pharmaceuticals examples

Answer 33

• a riskier firm such as pharmaceuticals as they are constantly developing new tech to sell should have less debt

Question 34

industry dependant on debt utilities examples

Answer 34

• a low-risk firm such as utilities with strong assets (dam, power plant…) should take on more debt

Question 35

debt amplifies/ ….

Answer 35

leverages risk

Question 36

debt creates fixed

Answer 36

commitments

Question 37

there is more ??? for levered firms CFs

Answer 37

volatility

Question 38

with debt in a recession net income

Answer 38

increases more

Question 39

if you have mortgage you are decreasing/leveraging risk

Answer 39

leveraging

Question 40

when buying a house you have 3 components

Answer 40

• house worth
  -deposit/eq
• bank principal

Question 41

the relationship between NPV and debt

Answer 41

increase in debt, decreases NPV

Question 42

enterprise value is the p…

Answer 42

present value of all FCFs

Question 43

if FCFs are held constant and _____ the value of firm ____

Answer 43

cost of capital minimized, maximized

Question 44

__ debt,__ wacc/coc, __ firm value,

Answer 44

increase, decrease, increase

Question 45

do you want a high or low wacc?

Answer 45

low

Question 46

capital restructuring is all about

Answer 46

changing proportions on the RHS of BS without changing firm assets

Question 47

increase leverage by issuing

Answer 47

bonds and repurchasing shares

Question 48

decrease leverage by issuing

Answer 48

issuing new shares and retiring outstanding debt (get shares to pay off the debt)

Question 49

the goal of capital restructuring is to

Answer 49

determine the leverage that maximizes firm value (or decrease wacc)

Question 50

int payments are/aren’t tax deductible

Answer 50

are

Question 51

dividend payments are/aren’t tax deductible

Answer 51

aren’t

Question 52

distributing cash to security holders through interest payments does what to the firm value?

Answer 52

increases