Q12-1. Why is use of long-term debt financing referred to as using financial leverage?

Q12-2. What is the fundamental principle of financial leverage?

Q12-3. What is the basic conclusion of the original Modigliani and Miller Proposition I?

Q12-4. Following from the conclusion of Proposition I, what is the crux of M&M Proposition II? What is the natural relationship between the required returns on debt and equity that results from Proposition II?

Q12-5. In what way did M&M change their conclusion regarding capital structure choice with the additional assumption of corporate taxes? In this context, what composes the difference in value between levered and unlevered firms?

Q12-6. By introducing personal taxes into the model for capital structure choice, how did Miller alter the previous M&M conclusion that 100 percent debt is optimal? What happens to the gains from leverage if personal tax rates on interest income are significantly higher than those on stock-related income?

Q12-7. Why do a firm’s stockholders hold a valuable “default option”? How could this option induce stockholders to employ high levels of financial leverage?

Q12-8. All else equal, which firm would face a greater level of financial distress, a software-development firm or a hotel chain? Why would financial distress costs affect the firms so differently?

Q12-9. Describe how managers whose firms have debt outstanding and face financial distress could jeopardize the investments of creditors with the “games” of asset substitution and under-investment.

Q12-10. Differentiate between direct and indirect costs of bankruptcy. Which of the two is generally more significant?

Q12-11. How can restrictive covenants in bonds be both an agency cost of debt and a way to prevent agency costs of debt?

Q12-12. What are the trade-offs in the agency cost/tax shield trade-off model? How is the firm’s optimal capital structure determined under the assumptions of this model? Does empirical evidence support this model?

Q12-13. What industrial and national capital structure patterns are exhibited globally? What factors seem to be driving these patterns?

12-14. What is the observed relationship between debt ratios and profitability and the perceived costs of financial distress? Why does the relationship between leverage and profitability imply that capital structure choice is residual in nature?

Q12-15. How influential are corporate and personal taxes on capital structure? Historically, have changes in American tax rates greatly affected debt ratios?

Q12-16. How do stock prices generally react to announcements of firms’ changes in leverage? Why is this result perplexing and seemingly contradictory given your answer to Question 12-2?

steffb713 posted a question Apr 24, 2011 at 8:55pm