FIN 300 Lecture Notes - Lecture 1: Capital Structure, Cash Flow, Dividend

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ceruleanserval340

15 Nov 2017

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When a firm went from zero debt to higher debt, stock price will increase initially, then hit a peak and then begin to decline because, at first, creditor will be paid followed by shareholder of company. This made shareholder to become riskier since they only can claim company cash flow and this arise the cost of stock. When inflation rate increase, interest rate will increase and the bond price will drop. Besides, the shareholder could also sell some of the new shares to create his or her own cash dividend.

Related Questions

a. Discuss the following statemet: All else equal, firms with relatively stable sales are able to carry relatively high debt ratios. Is this statement true or false? Why?

b. WHy is EBIT generally considered independent of financial leverage? Why might EBIT actually be affected by financial leverage at high debt levels?

c. If a firm goes from zero debt to successively higher levels of debt, why would you expect its stock price to rise first, then hit a peak, and then begin to decline?

As a firm increases its debt/asset ratio, the value of the firm initially increases, reaches a maximum point, and then decreases. Why does the value of a firm decrease beyond the maximum point?

A. If the firm whishes to raise more new capital beyond the optimal target, it must offer stock and bond investors lower rates of return.

B. The decision by the firm to use more debt beyond the optimal target causes an upward shift in the market line.

C.As the firm increases its debt ratio beyond the optimal target, it is required to pay higher taxes.

D. As the firm increases its debt ratio beyond the optimal target, marginal bankruptcy costs begin to exceed the marginal tax advantage of debt.

carminespider600

1.Fixed cost sources of financing include both debt and common stock.

True

False

2.The desire to maintain high bond ratings will tend to increase the use of debt financing in a firmâs capital structure.

True

False

3. Financial risk is the basic risk inherent in the operations of a firm. It can be viewed as the volatility of a firmâs EBIT.

True

False

4. As a firm increases its use of debt financing, what is the impact upon the cost of equity?

The cost of equity decreases.

The cost of equity remains the same.

The cost of equity increases.

None of the above.

5.An investment banking firm has estimated the following after-tax cost of debt and cost of equity for Marquez Luxury Travel Tours.

Proportion of Debt After-tax Cost of Debt Cost of Equity

30% 3.5% 10.5%

40% 3.8% 11.3%

50% 5.0% 12.9%

60% 7.2% 14.5%

What is the cost of capital at Marquezâ optimal capital structure given the above information?

8.95%

8.40%

8.30%

8.15%

6. How does high business risk affect firm risk?

Higher business risk increases the volatility of capital structure.

Higher business risk increases the volatility of EBIT.

Higher business risk increases the volatility of financial costs.

Higher business risk increases the volatility of the firmâs asset structure.

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FIN 300 Lecture Notes - Lecture 1: Capital Structure, Cash Flow, Dividend

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