CFM4 Solns Chap 17

CFM4 Solns Chap 17 - CORPORATE FINANCIAL MANAGEMENT, Fourth...

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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition Solutions Manual , Chapter 17 Chapter 17 Questions 1. Subordinated debt ranks below senior debt because it has a lower claim on assets in bankruptcy proceedings and is therefore riskier. 2. Selecting a target senior debt rating is a reasonable approach to choosing a capital structure because it ensures that the firm has access to the debt markets. A single-A rating is prudent because it is more likely that the firm will have access to the debt markets at all stages in the economy. Below a single-A rating, the company may not be able to raise capital during economic downturns, a time when the firm may need capital the most. 3. a. If the firm believes it is overleveraged it should exchange a portion of its outstanding debt for equity. b.If the firm believes it is underleveraged, it should exchange some of its equity for new debt. 4. Pro forma analysis is important when choosing a capital structure to make sure that the firm will be able to service the debt and use its tax credits. 5. Leverage carries a tradeoff between tax savings and higher expected bankruptcy costs. If a firm can not use its tax credits, it receives no benefit from leverage but still incurs the costs of leverage. Therefore, a firm’s ability to use its tax credits will affect the capital structure decision. 6. A large firm is likely to have more diversification than a small firm, and is therefore less risky. The bond ratings for larger firms reflect this. It allows a larger firm to have slightly more debt in its capital structure and still receive a high bond rating. In the comparable firms approach, size matters. Firms should identify comparable firms of similar size when applying comparative credit analysis. 7. Firms cannot offer new securities for each project to determine the required return because of transaction costs and costs associated with asymmetric information. Transaction costs as a percentage of the issue are lower for larger issues. Firms must issue securities in bulk to take advantage of economies of scale in financing. Also, firms face an asymmetric information problem in that outside investors, especially equity, may need to be enticed to invest with a discount for the new shares. Issuing securities for each project would be too expensive. 8. Lenders are more willing to lend a larger proportion of the market value of tangible assets than intangible assets. The reason is that the market for tangible assets is more liquid than the market for intangible and in the case of bankruptcy the lender would like to get the best price for the assets as fast as possible. The lender is therefore more willing to lend a higher percentage of the value of tangible than intangible assets. 9.
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CFM4 Solns Chap 17 - CORPORATE FINANCIAL MANAGEMENT, Fourth...

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