Tut8 ans - FINS5514 Capital Budgeting Tut 8 Capital...

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FINS5514 Capital Budgeting Tut 8 Capital Structure II 1. The static theory advocates borrowing to the point where: a. the pre-tax cost of debt is equal to the cost of equity. b. the cost of equity is equal to the interest tax shield. c. the tax benefit from debt is equal to the cost of the increased probability of financial distress. d. the interest tax shield is maximized. 2. The empirical observation that there is a negative relationship between profitability and leverage is embarrassing for the trade-off theory of capital stricture. Explain why. The trade-off theory of capital structure relies on the idea that a company's capital structure is determined by a trade-off between the net tax benefits of debt and various leverage-related costs, including bankruptcy and agency costs of debt. This theory predicts a positive relationship between profitability and leverage. This is because highly profitable companies have more incentive than others to reduce company income tax by introducing more debt into their capital structures, and
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This note was uploaded on 10/25/2011 for the course FINS 5514 taught by Professor No during the Three '11 term at University of New South Wales.

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Tut8 ans - FINS5514 Capital Budgeting Tut 8 Capital...

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