Capital Structure Decisions (FIN)

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1.What are some ways in which the capital structure decisions can affect the value of operations?

2.Explain the difference between a firm’s optimal capital structure and target capital structure.

3.What is business risk, and how can it be measured?

4.What are some determinants of business risk?

5.Why do public utility companies usually have capital structures that are different from those of retail firms?

6.What is operating leverage and how does it affect business risk?

7.Define the degree of operating leverage (DOL) and write out it’s equation.

8.What is financial risk, and how does it arise?

9.Explain this statement: Using financial leverage has both good and bad effects.

10.Why is EBIT generally considered to be independent of financial leverage? Why might EBIT be influenced by financial leverage at high debt levels?

11.Would the market-value debt ratio tend to be higher than the book-value debt ratio during a stock market boom or a recession? Explain.

12.Why would the WACC based on market values tend to be higher than the one based on book values if the stock price exceeded its book value?

13.Which would you expect to be more stable over time, a firm’s book-value or market-value capital structure? Explain.

14.What does the MM theory with no taxes state about the value of a levered firm versus the value of an otherwise identical but unlevered firm? What does this imply about the optimal capital structure?

15.Why does the MM theory with corporate taxes lead to 100% debt?

16.What does the Miller model with personal and corporate taxes imply about value relative to the MM model with just corporate taxes?

17.What is the trade-off theory?

18.Explain how asymmetric information and signals affect capital structure decisions.

19.What is meant by reserve borrowing capacity, and why is it important to firms?

20.What is the pecking order hypothesis, and how does it influence firms’ capital structures?

21.How can the use of debt serve to discipline managers?

22.Which capital structure theories does the empirical evidence seem to support? Explain.

23.What issues should managers consider when making capital structure decisions?

24.What happens to the component costs of debt and equity when the debt ratio is increased?

25.Write out the Hamada equation.

26.What is the equation for calculating a firm’s unlevered beta?

27.What are some factors that financial managers consider when choosing the maturity structure of their debt?

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