Assuming the presence of corporate taxes, Modigliani and Miller Case 2 argues that firms should take out only _________________. In reality, firms face increasing costs of distress from taking on additional debt like bankruptcy costs that reduce the optimal debt a firm should carry due to the large _____________ interest payments from debt. The _______________ theory argues that firms should balance the marginal benefits from the tax-deductibility of interest payments with the marginal costs of additional bankruptcy or financial distress risk.
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Question 2 According to the static theory of capital structure, a firm borrows up to which one of the following points? point where the firm is financed totally with debt point where an additional dollar of debt would have a benefit exactly equal to its cost point where WACC equals the debt-equity ratio point where the debt-equity ratio equals 1.0 Question 3 According to M&M Proposition I with taxes, the value of a levered firm is equal to the value of the unlevered firm plus which one of the following? current market value of the debt par value of the debt present value of the depreciation tax shield present value of the interest tax shield Question 4 Which one of the following is the equity risk arising from the daily operations of a firm? Business risk Financial risk Operating risk Strategic risk
Adi S.
ACCM Inc. is considering adding leverage to its capital structure. The firm’s managers believe they can issue more debt to exploit the tax benefit of leverage. However, they also recognize that higher debt increases the risk of financial distress. Based on simulation of the firm’s future cash flows, the managers have made the following estimates (in millions of dollars) for different levels of debt (%) in the firm capital structure. Debt level 10% 20% 30% 40% 50% PV(Interest tax shield) 1 2.5 3.75 4.5 5.25 PV(Financial distress cost) 0.5 0.75 2.25 3.1 6.25 The optimal capital structure (debt level) of the firm is closest to: A. 20% B. 30% C. 50% D. 40%
Lottie A.
Which of the following statements is false? Real estate firms are likely to have low costs of financial distress, as much of their value derives from assets that can be sold relatively easily. For low levels of debt, the risk of default remains low and the main effect of an increase in leverage is an increase in the interest tax shield. There is little incentive to increase debt levels so most firms should pay down debt to avoid potential bankruptcy. The probability of financial distress depends on the likelihood that a firm will be unable to meet its debt commitments and therefore default.
Jennifer S.
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