5283answers12.apr053 - 1 End of Chapter 12 Questions,...

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End of Chapter 12 Questions, Problems and Solutions CORPORATE FINANCE Professor Megginson April 5, 2003 Questions [See problems in book] *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** Answers to End of Chapter 12 Questions 12.1. Certain industries appear to have high debt levels. These for the most part are mature, low growth industries with stable cash flows and tangible assets. High tech, high growth industries, which are highly cyclical with uncertain cash flows tend to have lower levels of debt in their capital structures. Firms that are riskier, with intangible assets will have less debt in their capital structures. There are patterns across countries as well. Firms in developing countries borrow less than those in developed countries. This is consistent with the concept that higher risk ventures take on less long term debt. Differences in leverage may reflect differences in the industrial composition of national economies, as well as historical, institutional and cultural factors. 12.2. In general, more profitable firms will have less debt in their capital structures. This is because they are relying more on internally generated funds, and have less need for external financing. This does imply that capital structure is residual. Firms use internal financing first, and then move on to external sources if they do not have sufficient internal funds. The greater the perceived costs of financial distress, the less debt financing the company will have as well. The higher the costs, the less likely bondholders will receive full payment in the event of financial distress. Lenders will either be reluctant to lend to such a company or will charge higher rates when they do lend. 12.3. Corporate and personal taxes do influence capital structures, but are not the only factor that explain differences in capital structures. For example, U.S. corporations used no less debt before income taxes were introduced in 1913 than after 1913. Taxes peaked in the World War II period, yet book values of debt were at their lowest. Market values of debt rose from 1951 to 1973 and then declined. In other words there have been gradual changes in leverage, even though the tax law changes tend to be sudden. Research has shown that increases in corporate taxes are associated with increased debt usage and decreases in the personal tax rates on equity income relative to personal taxes on interest income are associated with less debt in capital structures. 12.4. Shareholders find leverage increasing events to be good news and leverage decreasing events to be bad news. Stock prices rise when a company announces debt for equity exchanges, debt-financed share repurchases and debt-financed cash tender offers. Stock prices decline with announcements of equity for debt exchanges, new stock offerings and acquisitions involving payment with a firm’s own shares. This result seems perplexing in light of question 12-2 because in that question we saw
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5283answers12.apr053 - 1 End of Chapter 12 Questions,...

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