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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Chapter 16.7, Problem 1CC
Coca-Cola Enterprises is almost 50% debt financed , while Intel, a technology firm, has no net debt. Why might these firms choose such different capital structures?
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Which of the following statements is CORRECT?
Group of answer choices
Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity.
The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes.
If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.
Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt.
Higher flotation costs tend to reduce the cost of equity capital.
If the financial market is frictionless, the cost of equity is higher than the cost of debt in all firms. Therefore, in this circumstance, firms must finance their projects by issuing debt rather than equity.
Is it right?
It has been suggested that the WACC of a company is not affected by changes in capital structure, but depends only on business activities. Consider two companies in the same line of business, Loss plc and Shade plc. If Loss plc is financed only by equity and if its cost of equity is 12%, what will be the cost of equity of Shade plc if it is financed 40% by a 7 % bank loan and 60% by equity? (Work to the nearest 1%
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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- 6. Backroads Sporting Goods is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. To estimate how much its debt would cost at different debt levels, the company's treasury staff has consulted with investment bankers and, on the basis of those cussions, has created the following table: 4 Debt-to-Capital Ratio 0.0 0.2 0.4 0.6 a 9.56% h 10.48% Equity-to- Capital Ratio 11.13% d. 11.45% e. 12.25 % (w.) 1.0 0.8 0.6 0.4 0.2 Debt-to-Equity Ratio (D/E) 0.00 0.25 0.67 1.50 4.00 Bond Rating A BBB BB Before-Tax Cost of Debt 65% 7.5 9.5 D Backroads uses the CAPM to estimate its cost of common equity. r.. The company estimates that the risk-free rate is 6%, the market risk premium is 5%, and its tax rate is 40%. Backroads estimates that if it had no debt, its "unlevered" beta, bu, would be 1.25. On the basis of this information,…arrow_forwarda) In each of the theories of capital structure the cost of equity rises as the amount of debt increases. So why don’t financial managers use as little debt as possible to keep the cost of equity down? After all, isn’t the goal of the firm to maximize share value and minimize shareholder costs?b) Country Markets has an unlevered cost of capital of 12 percent, a tax rate of 38 percent, and expected earnings before interest and taxes of $15,700. The company has $12,000 in bonds outstanding that have a 6 percent coupon and pay interest annually. The bonds are selling at par value. What is the cost of equity?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
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