Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
4th Edition
ISBN: 9780134083278
Author: Jonathan Berk, Peter DeMarzo
Publisher: PEARSON
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Textbook Question
Chapter 16, Problem 15P
Real estate purchases are often financed with at least 80% debt. Most corporations, however, have less than 50% debt financing. Provide an explanation for this difference using the trade-off theory.
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Students have asked these similar questions
When a corporation invests borrowed money in assets that generate profits greater than the after-tax cost of the debt, it
increases the return on equity for common shareholders.
creates financial leverage.
has a mix of debt and equity in its capital structure.
does all of these options.
If the effective rate of interest is greater than the contract rate, the bonds will sell at
par.
a premium.
a discount.
any of these choices, depending on other circumstances.
There are advantages and disadvantages of debt financing in contrast to equity financing. Which of the following is less likely to represent an advantage of debt financing?
a.
The cost of debt should be lower than the cost of equity for most companies due to the lower risk to the lender and the tax deductibility of interest
b.
The repayment of debt capital may affect the liquidity of the company
c.
If the return on assets exceeds the cost of debt, then this will result in a higher return on shareholders’ funds as compared to the return on assets
d.
The increase in borrowings will not normally affect the voting control of the current shareholders as compared to the issue of shares
e.
Fixed interest rate loans will result in the variability in the market value of such loans over time which will normally be less than the variability in the value of the equity of the company
Which of the following is a disadvantage of long-term debt as a means of company financing?
Group of answer choices
Debtholders have preferential status in the event of a company being wound up.
Tax relief is available on interest payments.
Debt is often quicker to arrange compared to equity.
The amount and timing of interest payments is predictable, making budgeting easier.
Chapter 16 Solutions
Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
Ch. 16.1 - Prob. 1CCCh. 16.1 - Does the risk of default reduce the value of the...Ch. 16.2 - If a firm files for bankruptcy under Chapter 11 of...Ch. 16.2 - Why are the losses of debt holders whose claims...Ch. 16.3 - Prob. 1CCCh. 16.3 - True or False: If bankruptcy costs are only...Ch. 16.4 - Prob. 1CCCh. 16.4 - According to the trade-off theory, all else being...Ch. 16.5 - Prob. 1CCCh. 16.5 - Why would debt holders desire covenants that...
Ch. 16.6 - Prob. 1CCCh. 16.6 - Prob. 2CCCh. 16.7 - Coca-Cola Enterprises is almost 50% debt financed...Ch. 16.7 - Why would a firm with excessive leverage not...Ch. 16.7 - Describe how management entrenchment can affect...Ch. 16.8 - How does asymmetric information explain the...Ch. 16.8 - Prob. 2CCCh. 16.9 - Prob. 1CCCh. 16.9 - Prob. 2CCCh. 16 - Gladstone Corporation is about to launch a new...Ch. 16 - Baruk Industries has no cash and a debt obligation...Ch. 16 - When a firm defaults on its debt, debt holders...Ch. 16 - Prob. 4PCh. 16 - Prob. 5PCh. 16 - Suppose Tefco Corp. has a value of 100 million if...Ch. 16 - You have received two job offers. Firm A offers to...Ch. 16 - As in Problem 1, Gladstone Corporation is about to...Ch. 16 - Kohwe Corporation plans to issue equity to raise...Ch. 16 - Prob. 10PCh. 16 - Prob. 11PCh. 16 - Hawar International is a shipping firm with a...Ch. 16 - Your firm is considering issuing one-year debt,...Ch. 16 - Marpor Industries has no debt and expects to...Ch. 16 - Real estate purchases are often financed with at...Ch. 16 - On May 14, 2008, General Motors paid a dividend of...Ch. 16 - Prob. 17PCh. 16 - Consider a firm whose only asset is a plot of...Ch. 16 - Prob. 19PCh. 16 - Prob. 20PCh. 16 - Prob. 21PCh. 16 - Consider the setting of Problem 21 , and suppose...Ch. 16 - Consider the setting of Problems 21 and 22, and...Ch. 16 - You own your own firm, and you want to raise 30...Ch. 16 - Empire Industries forecasts net income this coming...Ch. 16 - Ralston Enterprises has assets that will have a...Ch. 16 - Prob. 27PCh. 16 - If it is managed efficiently, Remel Inc. will have...Ch. 16 - Which of the following industries have low optimal...Ch. 16 - According to the managerial entrenchment theory,...Ch. 16 - Info Systems Technology (IST) manufactures...Ch. 16 - Prob. 32PCh. 16 - Prob. 33P
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- Is this statement true or false? Please explain in detail As debt-financing is usually cheaper than equity financing, debt-financing will lower risk for transnational company.arrow_forwardIdentify the following as elther an advantage or a disadvantage of bond financing for a company. a. Bonds increase return on equity if the company earns a higher return with borrowed funds than it pays in interest. b. Interest on bonds is tax deductible. c. Bonds require payment of par value at maturity. d. Bonds do not affect owner control. e. A company earns a lower return with borrowed funds than it pays in interest. f. Unlike equity ownership, a par value payment is required at a specified date. Advantagearrow_forwardABC Corp. and LMN Corp. have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. However, ABC uses more debt than LMN. Which of the following statements is CORRECT? Group of answer choices ABC would have the higher net income as shown on the income statement. ABC would have the lower net income as shown on the income statement. ABC would have to pay more in income taxes. ABC would have the lower equity multiplier for use in the DuPont equation.arrow_forward
- You have the following information about two firms, Debt Free, Incorporated and Debt Spree, Incorporated. Both firms have the same prospects for sales and EBIT, and both have the same level of assets, tax rate and borrowing rate. They differ in their use of debt financing. Scenario Sales Bad year $ 200 EBIT $ 28 Normal year $ 275 $ 36 Good year $ 380 $ 52 Total assets Tax rate Debt Equity Borrowing rate Debt Free $ 250 Debt Spree 21% $ 250 21% $ 0 $ 250 $ 150 $ 100 16% 16% Required: a. Calculate the interest expense for each firm: Interest expense for Debt Free Interest expense for Debt Spree b. Calculate the following items for each firm for each scenario (bad year, normal year, good year): return on assets (ROA), net profit, and return on equity (ROE). (Use a minus sign to indicate negative answers. Round your answers to 2 decimal places.) Scenario Bad year Normal year Good year ROA Debt Free Net Profit Debt Spree ROE ROA Net Profit ROE % % % % % % % % % % %arrow_forwardIndustries vary with regard to their capital structure. In the observed capital structure, which of the following tends to have the LEAST debt leverage? All industries have about 50% debt and 50% equity. Electrical utilities O Airline operators O Drug manufacturersarrow_forwardWhy do companies often prefer debt financing to other forms of financing for capitalinvestments?a. Actually, they don't prefer debt financing. They usually try to use retainedearnings for capital investments.b. Because bond holders are happy to just break even on their bonds.c. Because the MARR all but guarantees the projects will return yields greater thanthe interest on the loans.d. Because debt interest is tax deductible, reducing significantly the actual cost ofborrowing money for projects.arrow_forward
- Identify the following as either an advantage or a disadvantage of bond financing for a company. a. Bonds do not affect owner control. b. A company earns a lower return with borrowed funds than it pays in interest. c. A company earns a higher return with borrowed funds than it pays in interest. d. Bonds require payment of periodic interest. e. Interest on bonds is tax deductible. f. Bonds require payment of par value at maturity.arrow_forwardPlease answer multi-choice question in photo.arrow_forwardWhich of the following is most correct about the cost of capital? The cost of debt reflects the interest rates on debt capital before taking into account the tax effects. Cost of capital is affected by the required rates of return of each of the source of capital, regardless of the capital structure. The capital asset pricing model is the most widely used model to estimate the cost of common equity. To minimize the cost of capital, firms should borrow more than their capacity because increasing the lower cost of debt yields the lowest cost of capital, thus, enhances shareholder value.arrow_forward
- (39). Subject :- Finance Companies Heidee and Leaudy have the same sales, tax rate, interest rate on their debt, total assets, and basic earningpower. Both companies have positive net incomes. Company Heidee has a higher debt ratio and, therefore, a higher interestexpense. Which of the following statements is CORRECT?O a. Company Heidee has a lower equity multiplier.O b. Company Heidee has a higher ROA.O c. Company Heidee pays less in taxes.d. Company Heidee has a higher times interest earned (TIE) ratio.O e. Company Heidee has more net income.arrow_forwardYou are working for a mid-sized company that is looking to estimate its cost of debt. The company has never had an issuance in the bond market. What would be the best proxy to estimate its cost of debt? A. Cost of its bank debt B. Cost of its equity C. Cost of debt from companies of a similar market capitalization D. Cost of debt in the corporate bond marketarrow_forwardWhy would a company typically choose to source external financing by issuing bonds rather than stock? A. Bonds are simpler to issue. O B. Bonds have longer maturity dates than stock. O C. Companies pay taxes on the proceeds from stock issues. D. Bonds are a cheaper funding source.arrow_forward
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