CFM4 Solns Chap 16


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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition Solutions Manual , Chapter 16 Chapter 16 Questions 1. The corporate tax view of capital structure is the view that since interest payments on debt are tax deductible and dividend payments are not, the after-tax cost of capital is cheaper for debt than for equity. Optimally, a firm should be 100% debt financed. 2. An example of a tax-timing option is the ability to delay the sale of an asset with an unrealized capital gain. By delaying the sale, taxes are delayed. This is valuable because the present value of paying the taxes later is lower than the present value of paying the taxes today. 3. A firm’s ability to use tax credits can affect capital structure because the tax credits are one of the benefits of using debt. A firm that does not have any income incurs the expected costs of bankruptcy but does not benefit from tax savings. This type of firm should not take on risky debt. 4. Higher transaction costs associated with small issues of securities may affect a firm’s financing decision. For example, a firm may need $1 million in financing and may wish to issue $1million of bonds. However, the large percentage of transactions costs for small issues could cause the firm to seek a bank loan instead. 5. A leverage clientele is a group of investors in similar tax brackets that prefer firms to have a certain level of leverage that minimizes total taxes and transaction costs. 6. If Equation (15.7) holds, taxes are not asymmetric because the personal taxes on debt equal the combined corporate and personal taxes on equity and the total tax is the same for both debt and equity. 7. According to the perfect market view, the WACC curve is a horizontal line. The WACC does not change with the mix of debt and equity financing because there is no asymmetric tax or transaction cost causing one type of financing to be advantageous to the other. 8. According to the capital market imperfections view, the WACC curve is U-shaped. For low levels of leverage, the benefit of the tax advantage of debt is higher than the corresponding bankruptcy costs. For high levels of leverage, the bankruptcy costs outweigh any tax savings. WACC can be minimized by selecting the leverage that balances the tradeoffs between tax savings and bankruptcy costs. 9. Investors care about after-tax rates of return. If taxes are higher on income derived from debt than they are on income derived from equity, investors will adjust their required rates of return to take into account the difference in taxes. The conclusion of the personal tax view of capital structure is that asymmetric personal taxes mitigate the corporate tax view. In fact, it is possible for the personal tax rates to eliminate completely the corporate tax bias in favor of debt. 10. The statement is false.
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This note was uploaded on 09/18/2011 for the course FIN 303 taught by Professor Bernile during the Spring '11 term at University of Miami.

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