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Exam 18: How Much Should a Corporation Borrow

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Question 41

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What is the relative tax advantage of debt? (T_C = corporate tax rate; Tp_E = personal tax rate on equity income; and Tp = personal tax rate on interest income.)

A) $\frac { 1 - \mathrm { T } _ { \mathrm { C } } } { \left( 1 - \mathrm { T } _ { \mathrm { pE } _ { \mathrm { E } } } \right) \left( 1 - \mathrm { T } _ { \mathrm { p } } \right) }$
B) $\frac { 1 - \mathrm { T } _ { \mathrm { p } } } { \left( 1 - \mathrm { T } _ { \mathrm { p } _ { \mathrm { E } } } \right) \left( 1 - \mathrm { T } _ { \mathrm { C } } \right) }$
C)

D) C:\

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Question 42

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Discuss some examples of conflicts of interest that may arise between bondholders and stockholders when a firm is in financial distress.

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When a firm is in distress,the sharehold...

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Question 43

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The indirect costs of bankruptcy are borne principally by:

The pecking order theory of capital structure predicts that:

Inclusion of restrictions in a bond contract leads to:

Briefly explain the trade-off theory of capital structure.

The costs of financial distress depend on the: I.probability of financial distress; II.corporate and personal tax rates; III.magnitude of costs encountered if financial distress occurs

Financial slack includes: I.cash; II.marketable securities; III.readily salable real assets; IV.ready access to debt markets or bank loans

Suppose that a company can direct $1 to either debt interest or capital gains for equity investors.If there were no personal taxes on capital gains,which of the following investors would not care how the money was channeled? (The marginal corporate tax rate is 35%.)

The existing tax code encourages a preference for equity over debt in corporate financing.

Which of the following statements regarding financial distress is (are) true? I.Firms in financial distress always end up in bankruptcy. II.Firms can postpone bankruptcy for many years. III.Ultimately,the firm may recover from financial distress and avoid bankruptcy altogether.

What are some of the possible consequences of financial distress? I.Bondholders,who face the prospect of getting only part of their money back,will likely want the company to take additional risks. II.Equity investors would like the company to cut its dividend payments to conserve cash. III.Equity investors would like the firm to shift toward riskier lines of business.

The value of a levered firm,given permanent debt level D,is: Value of levered firm = value of unlevered firm + (T_C)× (D).This assumes zero costs of financial distress.

What does "risk shifting" imply?

In order to calculate the tax shields provided by debt,the tax rate used is the: