Corporate Finance
3rd Edition
ISBN: 9780132992473
Author: Jonathan Berk, Peter DeMarzo
Publisher: Prentice Hall
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Textbook Question
Chapter 2, Problem 36P
You are analyzing the leverage of two firms and you note the following (all values in millions of dollars):
- a. What is the market debt-to-equity ratio of each firm?
- b. What is the book debt-to-equity ratio of each firm?
- c. What is the EBIT/interest coverage ratio of each firm?
- d. Which firm may have more difficulty meeting its debt obligations? Explain.
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Please answer multi-choice question in photo.
Which of the following statements is most correct? (Hint: Work Problem 4-16 before answering 4-17, and consider the solution setup for 4-16, as you think about 4-17.)
a. If a firm's expected basic earning power (BEP) is constant for all of its assets and exceeds the interest rate on its debt, then adding assets and financing them with debt will raise the firm'
expected return on common equity (ROE).
b. The higher its tax rate, the lower a firm's BEP ratio will be, other things held constant.
c. The higher the interest rate on its debt, the lower a firm's BEP ratio will be, other things held constant.
d. The higher its debt ratio, the lower a firm's BEP ratio will be, other things held constant.
e. If a firm's expected basic earning power (BEP) is constant for all of its assets and exceeds the interest rate on its debt, then adding assets and financing them with debt will decrease the
firm's expected return on common equity (ROE).
Which of the following businesses are most exposed to interest rate risk? *
A. A company with a high equity to debt ratio
B. A company with a large amount of floating rate debt
C. An al-equity company
D. An investment company with an investment portfolio that matches its investment horizon.
Chapter 2 Solutions
Corporate Finance
Ch. 2.1 - Prob. 1CCCh. 2.1 - Prob. 2CCCh. 2.2 - Prob. 1CCCh. 2.2 - Prob. 2CCCh. 2.2 - Prob. 3CCCh. 2.3 - What it is the difference between a firms gross...Ch. 2.3 - What is the diluted earnings per share?Ch. 2.4 - Prob. 1CCCh. 2.4 - Prob. 2CCCh. 2.5 - Prob. 1CC
Ch. 2.5 - Prob. 2CCCh. 2.6 - Why is EBITDA used to assess a firms ability to...Ch. 2.6 - Prob. 2CCCh. 2.6 - Prob. 3CCCh. 2.6 - Prob. 4CCCh. 2.7 - Describe the transactions Enron used to increase...Ch. 2.7 - Prob. 2CCCh. 2 - Prob. 1PCh. 2 - Prob. 2PCh. 2 - Prob. 4PCh. 2 - Prob. 5PCh. 2 - Prob. 7PCh. 2 - Prob. 8PCh. 2 - Prob. 9PCh. 2 - Prob. 10PCh. 2 - Prob. 11PCh. 2 - Prob. 12PCh. 2 - Prob. 13PCh. 2 - Prob. 14PCh. 2 - Prob. 15PCh. 2 - Prob. 16PCh. 2 - Suppose a firms tax rate is 35%. a. What effect...Ch. 2 - Prob. 18PCh. 2 - Prob. 19PCh. 2 - Prob. 20PCh. 2 - Prob. 21PCh. 2 - Prob. 22PCh. 2 - Can a firm with positive net income run out of...Ch. 2 - Suppose your firm receives a 5 million order on...Ch. 2 - Nokela Industries purchases a 40 million...Ch. 2 - Prob. 26PCh. 2 - Prob. 27PCh. 2 - Prob. 28PCh. 2 - Prob. 29PCh. 2 - Prob. 30PCh. 2 - Prob. 31PCh. 2 - Prob. 32PCh. 2 - Prob. 33PCh. 2 - Prob. 34PCh. 2 - Prob. 35PCh. 2 - You are analyzing the leverage of two firms and...Ch. 2 - Prob. 37PCh. 2 - Prob. 38PCh. 2 - Prob. 39PCh. 2 - Prob. 40PCh. 2 - Prob. 41PCh. 2 - Prob. 42PCh. 2 - Consider a retailing firm with a net profit margin...Ch. 2 - Prob. 44PCh. 2 - Prob. 45P
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Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Which one of the following factors would likely cause a firm to increase its use of debt financing as measured by the debt to total capital ratio? A.Increased economic uncertainty. B.An increase in the degree of operating leverage. C.An increase in the corporate income tax rate. D.An increase in the price-earnings ratio.arrow_forwardSelect all that are true with respect to the cost of debt. Group of answer choices it is the return the firm needs to earn overall to satisfy all investors It is the rate the debt holders demand given the risk they face as debt holders Can be estimated using CAPM Cannot be estimated using CAPM because CAPM is used for estimating the cost of equity Is always equal to the YTM on a company's existing bonds Is lower than the YTM on a company's existing debt if there is default risk Can be proxied by the YTM on a company's existing debt if the debt is risk free Flag question: Question 7arrow_forwardLeverage and the Capital Structure. Why is the use of debt financing referred to as financial “leverage?” What is the basic goal of financial management with regard to the capital structure? Is there an easily identifiable debt-equity ratio that will maximize the value of a firm? Why or why not?arrow_forward
- What is WACC? Why do firms compute it? What happens to WACC when the debt level of a firm changes?arrow_forwardWhich is easier to calculate directly, the expected rate of return on the assets of a firm or the expected rate of return on the firm’s debt and equity?arrow_forwardPlease solvearrow_forward
- WHICH OF THE FOLLOWING STATEMENTS IS MOST CORRECT? A. IF A FIRM'S EXPECTED BASIC EARNING POWER (BEP) IS CONSTANT FOR ALL ITS ASSETS AND EXCEES INTEREST RATE ON ITS DEBT, THEN ADDING ASSETS FINANCING THEM WITH DEBT WILL RAISE THE FIRM'S EXPECTED RATE OF RETURN ON COMMON EQUITY (ROE)? B. THE HIGHER ITS TAX RATE, THE LOWER A FIRM'S BEP RATIO WILL BE, OTHER THINGS HELD CONSTANT. C. THE HIGHER THE INTEREST RATE ON ITS DEBT, THE LOWER THE FIRM'S BEP RATIO WILL BE, OTHER THINGS HELD CONSTANT. D. THE HIGHER ITS DEBT RATIO, THE LOWER THE FIRM'S BEP RATIO WILL BE, OTHER THINGS HELD CONSTANT. E. STATEMENT A IS FALSE, BUT B, C AND D ARE ALL TRUE.arrow_forward1. Which of the following pairs of financial statement analysis tool will be given more emphasis by a firm that is considering whether to grant trade credit or sell on account to a new client? Choices: Current and cash ratio Return on sales and return on asset Debt and debt-to-equity ratio Book value and price-to-earnings ratio 2. It is assumed that the Cost of equity and rate of return are both constant under Walter's Model of Dividend Relevance, if the cost of equity is higher than the rate of return, it is optimal that Choices: No dividend to be given to shareholders None of the choices is correct. The firm is indifferent as to distribute dividends or to reinvest the income All the earnings for the period shall be distributed to shareholders 3. Which of the following is correct with regards to cash discounts offering? Choices: These are granted because customer acquires high quantity of products and goods It is used lengthen the cash conversion cycle without putting pressure…arrow_forwardIn the Merton model of corporate equity which is based on the Black Scholes formula, what is the quantity (S0/KT)? Assume that interest rates are zero (r=0) so the time value of money can be ignored, therefore S0 = ST. (a) Debt-to-equity ratio. (b) Debt-to-assets ratio. (c) Assets-to-debt ratio. (d) Assets-to-equity ratio. (e) Equity-to-assets ratiarrow_forward
- Leverage. Suppose that a firm has both floating-rate and fixed-rate debt outstanding. What effect will a decline in market interest rates have on the firm's times interest earned ratio? On the market-value debt-to-equity ratio? On the basis of these answers, would you say that leverage has increased or decreased?arrow_forwardA profitability measure of ROE is affected by the level of a firm’s debt. Thus,an investor must consider the debt-equity ratio to evaluate the firm’sprofitability. The debt-equity ratio determines a firm’s financial leverage whichindicates how much of assets the firm is able to deploy for each monetary unitof stockholders’ equity.1) Explain how the financial leverage effect can be defined as the differencebetween ROE and ROA. 2) Explain how the financial leverage effect is affected by the debt ratio and theinterest rate.arrow_forwardWhen using the capital asset pricing model to estimate the cost of equity for a firm being valued, beta is often adjusted to account for: Debt ratios of comparable firms that are leveraged differently from that of the firm being valued. The level of cash held at comparable firms. The number of common stock shares outstanding at comparable firms. The default rate of corporate bonds over the last year. All of the above.arrow_forward
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