FIN 357 FINAL EXAM: Concepts from textbook with correct answers 100%

FIN 357 FINAL EXAM: Concepts from textbook with correct answers 100% Changes in capital structure benefit the stockholders IF and ONLY IF the value of the firm increases - Correct Answer These changes hurt stockholders IF AND ONLY IF the value of the firm decreases No debt All-equity Unlevered - Correct Answer Has debt Debt and equity Levered MM Prop 1(no taxes) - Correct Answer The TOTAL value of a firm is always the same under different capital structures Homemade leverage - Correct Answer individuals borrow on their personal accounts to buy shares from unlevered firms and duplicate the effects of corporate leverage on their own ? Do changes in capital structure affect stockholders' welfare? - Correct Answer No (?) because their welfare is related directly to the firm's value Leverage increases risk - Correct Answer Levered investors have better returns in good times than unlevered, but also have worse returns in bad times than unlevered investors MM Prop 2 - Correct Answer the expected return on equity is (+) related to leverage, because the risk to equity holders increases with leverage R(wacc) is a constant for a firm regardless of their capital structure - Correct Answer MM Prop 1 (no taxes) As a firm adds debt, the remaining equity becomes more risky. As the risk rises, the cost of equity capital rises as a result - Correct Answer The increase in cost of remaining equity capital offsets higher proportion of the firm financed by low-cost debt Summary of MM Prop 1&2 (no taxes) - Correct Answer Assumptions: no taxes no transaction costs individuals and corporations borrow at same rate Results: Prop 1: VL=VU Prop 2: Re= Re + D/E(Re - Rd) In a world with taxes, - Correct Answer managers should select high leverage due to a quirk in the US tax law Summary of MM Prop 1&2 (with taxes) - Correct Answer Assumptions: corporations are taxed at the rate t(c) on earnings after interest no transaction costs individuals and corporations borrow at the same rate Results: Prop 1: VL= VU + [t(c) X debt] Prop 2: Re= Re + D/E(1-t(c))(Re-Rd) Intuition: Prop 1: Corporations can deduct interest payments but not dividend payments, so corporate leverage lowers tax payments Prop 2: The cost of equity rises with leverage, because the risk to equity rises with leverage As the debt-to-equity ratio rises, so does the probability that the firm will be unable to pay its debts. - Correct Answer Ownership of the firm's assets is transferred from stockholders to the bondholders A firm becomes bankrupt when the value of the assets = value of its debt - Correct Answer when this happens, value of equity is zero Direct bankruptcy costs - Correct Answer legal and administrative expenses associated with the bankruptcy proceeding (disincentive to debt financing) ex: lawyers and accountant fees during bankruptcy process Indirect bankruptcy costs - Correct Answer costs of avoiding a bankruptcy filing incurred by a financially distressed firm ex: impaired ability to conduct business incentive to take on risky projects incentive toward underinvestment distribution of funds to stockholders prior to bankruptcy Financial distress costs refer to - Correct Answer direct + indirect bank