( Capital structure theory ) Which of the following statements most appropriately describes how agency costs affect a firm’s choice of capital structure? Explain. a. When firm owners borrow money, they have an incentive to engage in excessive risk taking (that is, investing in very risky projects) since they are managing someone else’s money. b. When firms have very limited investment opportunities and little debt financing combined with healthy profits that provide them with free cash flow , their management team might squander the firm’s earnings on questionable investments.

Foundations of Finance (9th Edition) (Pearson Series in Finance)

9th Edition

ISBN: 9780134083285

Author: Arthur J. Keown, John D. Martin, J. William Petty

Publisher: PEARSON

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Textbook Question

Chapter 12, Problem 7SP

(Capital structure theory) Which of the following statements most appropriately describes how agency costs affect a firm’s choice of capital structure? Explain.

a. When firm owners borrow money, they have an incentive to engage in excessive risk taking (that is, investing in very risky projects) since they are managing someone else’s money.
b. When firms have very limited investment opportunities and little debt financing combined with healthy profits that provide them with free cash flow, their management team might squander the firm’s earnings on questionable investments.

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1. Which of the following statements most appropriately describe how agency cost affect the firms choice structure? Explain. a. When firm owners borrow money they have an incentive to engage in excessive risk taking (that is investing in very risky projects). Since they are managing someone else money.b. When firm have very limited investment opportunities and little debt financing combine with wealth profit that provide them with free cash flow, their management team might squander the firms' earnings on questionable investments. 2. What is the primary weakness of using EBIT-EPS analysis as a financing tool. 3. Why might firms who's sale level change drastically overtime, choose to use debt only sparingly in their capital structure 4. What does the term independence hypothesis means as it applies to capital structure theory 5. Explain how industry norms might be used by the finance manager in the design of the company's financing mix note: if you can provide the source of the info,…

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Solution Summary: The author analyzes how agency costs affect a firm's choice of capital structure. Supervisors can form choices that aren't perfectly observed by the company’s stockholders.

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