Chapter 13 Finance Quiz

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capital structure
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this is defined as the relative amount of permanent short-term debt, long-term debt, preferred stock, and common equity used to finance a firm
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optimal capital structure
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this occurs at the point at which the cost of capital is minimized and firm value is maximized
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leverage
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this involves the use of fixed operating costs or fixed capital costs by a firm
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business risk
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this is the inherent variability or uncertainty of a firm’s operating income
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business risk
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this is caused by many factors, including sales variability and the use of operating leverage
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financial risk
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this is the additional variability of earnings per share and the increased probability of insolvency resulting from the use of fixed-cost sources of capital, such as debt and preferred stock
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independent
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the value of the firm is what of capital structure given perfect capital markets and no corporate income taxes
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optimal capital structure
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this consists entirely of debt if a corporate income tax exists and there are no financial distress costs or agency costs
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both debt and equity
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given a corporate income tax, financial distress costs, and agency costs, an optimal capital structure consists of some combination of what?
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changes in the capital structure
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these often serve as a signal to outside investors about management’s expectations concerning future earnings prospects for the company
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pecking order theory
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according to this, companies perfer internal financing to external financing and, given that external financing is necessary, they prefer to issue debt securities first and then issue equity securities as a last resort
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capital structure
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this is defined as the relative amount of permanent short-term debt, long-term debt, preferred stock, and common stock used to finance a firm.
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capital structure decision
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this is important to the firm because there exists in practice a capital structure at which the cost of capital is minimized
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optimal capital structure
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the minimum-cost capital structure is this because the value of the firm is maximized at this point
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business risk
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this of a firm refers to the variability of a firm’s operating income
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business risk
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this is influenced by the variability of sales volumes, prices, and costs over the business cycle
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business risk
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this is also influenced by a firm’s market power and its use of operating leverage
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financial risk
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this of a firm is the additional variability of earnings per share and the increased probability of insolvency that arises when a firm uses fixed-cost sources of funds, such as debt and preferred stock, in its capital structure
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financial leverage
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the use of this results in an increase in perceived risk to the suppliers of a firm’s capital; to offset this increased risk, higher returns are required
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independent of capital structure
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Modigliani and Miller (MM) show that the value of the firm is what given perfect capital markets and no corporate income taxes.
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corporate income tax
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MM also show that the optimal capital structure consists entirely of debt if what exists
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both debt and equity
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given a corporate income tax, financial distress costs, and agency costs, an optimal capital structure consisting of what is shown to exist
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tax shield; expected financial distress costs and the agency costs
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determination of the optimal capital structure involves balancing the present value of what (accruing from debt financing) against the present value of what associated with debt financing.
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asymmetric information
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managers have access to better information about a firm’s future prospects than do outside investors
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signal
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capital structure changes often ______ important information to investors about a firm’s future prospects
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pecking order theory
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according to this, there is no particular optimal capital structure for a firm
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internal financing
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companies prefer this to external financing and, given that external financing is necessary, they prefer to issue debt securities first and then equity securities only as a last resort
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market value of firm
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= market value of equity + market value of debt
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market value of firm
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= (D/ke) + (I/kd)
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Tax shield amount
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= i x B x T
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present value of tax shield
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= B x T
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market value of levered firm
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= market value of unlevered firm + present value of tax shield
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market value of levered firm
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= (market value of unlevered firm) + (present value of tax shield) – (present value of financial distress costs) – (present value of agency costs)

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