Concept explainers
a.
To identify: The situation which would encourage a firm to increase the debt in its capital structure.
Introduction:
Capital Structure:
Capital structure refers to the securities or debt included in the total capital of the firm. Adequate capital structure is required for the optimum utilization of funds.
b.
To identify: The situation which would encourage a firm to increase the debt in its capital structure.
c.
To identify: The situation which would encourage a firm to increase the debt in its capital structure.
d.
To identify: The situation which would encourage a firm to increase the debt in its capital structure.
e.
To identify: The situation which would encourage a firm to increase the debt in its capital structure.
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Fundamentals of Financial Management (MindTap Course List)
- Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant? a. An increase in the corporate tax rate. b. An increase in the personal tax rate. c. The Federal Reserve tightens interest rates in an effort to fight inflation. d. The company's stock price hits a new low. e. An increase in costs incurred when filing for bankruptcy. Explain your answerarrow_forwardIdentify and explain each of the if it encourage a firm to increase or decrease debt in its capital structure? a. The corporate tax rate increases b. The personal tax rate increases c. Due to market changes, the firm's assets become less liquid d. The firm's sales and earnings become more volatile.arrow_forward5. The relationship between a firm's capital structure and other company attributes As a firm takes on more debt, its probability of bankruptcy increases Other factors held constant, a firm whose earnings are relatively volatile faces a lower chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use debt than a more stable firm. When bankruptcy costs become more important, they increase the tax benefits of debt. General Forge and Foundry Corporation currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm's unlevered beta is 1.2, and its cost of equity is 12.40%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.40%. The risk-free rate of interest (TRF) is 4%, and the market risk premium (RPM) is 7%. General Forge's marginal tax rate is 25%. General Forge is examining how…arrow_forward
- Which of the following statements is FALSE? As debt increases, the risk associated with bankruptcy and agency costs is reduced. Debt is often the least costly form of financing for a firm. Firms should probably use some debt in their capital structure. Different firms are subject to different levels of risk.arrow_forwardWhich of the following is NOT an effect of the possibility of bankruptcy? O reduce the possible payoff to stockholders. increase financial distress costs. reduce the interest rate on debt. reduce the current market value of the firm.arrow_forwardWhich of the following statements is CORRECT? O The debt ratio that maximizes expected EPS generally exceeds the debt ratio that maximizes share price. O Increasing its use of financial leverage is one way to increase a firm's return on investors' capital (ROIC). O If a company were to issue debt and use the money to repurchase common stock, this would reduce its return on investors' capital (ROIC). O If a change in the bankruptcy code made bankruptcy less costly to corporations, this would tend to reduce corporations' debt ratios.arrow_forward
- 5. The relationship between a firm's capital structure and othercompany attributes As a firm takes on more debt, its probability of bankruptcy . Other factors held constant, a firm whose earnings are relatively volatile faces a chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use debt than a more stable firm. When bankruptcy costs become more important, they the tax benefits of debt. General Forge and Foundry Corporation currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm’s unlevered beta is 1.25, and its cost of equity is 13.00%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 13.00%. The risk-free rate of interest (rRFrRF) is 3%, and the market risk premium (RPMRPM) is 8%. General Forge’s marginal tax rate is 25%. General Forge is examining how…arrow_forwardPlease help solve and show work. As a firm takes on more debt, its probability of bankruptcy ___ . Other factors held constant, a firm whose earnings are relatively volatile faces a ____ chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use ____ debt than a more stable firm. When bankruptcy costs become more important, they ____ the tax benefits of debt. Blue Ram Brewing Company currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm’s unlevered beta is 1.05, and its cost of equity is 12.40%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.40%. The risk-free rate of interest (rRFrRF) is 4%, and the market risk premium (RPMRPM) is 8%. Blue Ram’s marginal tax rate is 25%. Blue Ram is examining how different levels of debt will affect its costs of debt and…arrow_forwardHolding everything else constant, which of the following statements is TRUE? * If amendments to the bankruptcy code make bankruptcy less difficult for companies, the average corporation's debt ratio will likely decrease. An rise in the personal tax rate is likely to increase the average corporation's debt ratio. A rise in a company's operating leverage is likely to allow it to use more debt in its capital structure. An rise in the corporate tax rate is likely to allow a company's capital structure to incorporate more debt. Firms with relatively stable assets have relatively low bankruptcy costs, so they use relatively little debt.arrow_forward
- Which of the following statements is true? a. High liquidity means a company is short on cash and may be unable to pay its debts.b. When a company decides to go public through an IPO, it is typically targeting to sell its shares to only a handful of shareholders. c. If the company has a higher than expected extremely high profit this year, equity holders will benefit more than debt holders as debtholders are the residual claimers for the cash flows of the company.d. In the extreme case, the debt holders take legal ownership of the firm's assets through a process called bankruptcy.e. Equity holders expect to receive dividends and the firm is always legally obligated to pay them.arrow_forwardWhich of the following statement is correct? O A. Firms that do not take on debt as part of their capital structure are known as leveraged firms. O B. Pecking order theory implies that profitable company will have more debt capacity. OC. According to pecking order theory, firms prefer external financing first. O D. The greater amount of debt carried by a firm, the lesser chance of bankruptcy.arrow_forwardSuppose managers of a firm know that the company is approaching financial distress. Should the managers borrow from creditors and issue a large one-time dividend to shareholders? How might creditors control this potential transfer of wealth?arrow_forward
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