Countries with a greater presence of information intermediaries (auditors and analysts) have lower D/E ratios and longer debt maturities. Thus A, based on its D/E ratio, has a greater presence of information intermediaries than B. Countries with a greater presence of institutional investors generally have companies with lower D/E ratios and debt with longer maturities. Based on the respective D/E ratios, country A has a greater presence of institutions relative to B. 7. Question ID: 17646 Correct Answer : B Loss of customers due to deterioration of company reputation is an example of indirect cost of financial distress. 8. Question ID: 17647 Correct Answer : A The specialized nature of the research assets suggests that an active market does not exist for such products. Therefore, these assets might have to be sold at a substantial discount to their value in use in order to attract a customer. This specialization of assets would therefore lead to an increase in costs of financial distress. 9. Question ID: 17648 Correct Answer : A An increase in equity would decrease the financial leverage of the firm. This decrease in leverage will subsequently lead to a decrease in the cost of financial distress. 10. Question ID: 17649 Correct Answer : A The tax paid on $10 of dividends and $10 of interest income is as follows: Dividend: Tax Rate=25% Tax Amount= $10*50%*12.5%= $0.625 Interest Income Tax Rate= 20%
Reading 22 Capital Structure FinQuiz.com FinQuiz.com © 2017 - All rights reserved. Tax Amount= $10*20%= $2 Since half of the dividends received are nontaxable, and the effective tax amount paid is lower for dividends as compared to the same amount of inflow through interest, dividend income would be more preferable. 11. Question ID: 17650 Correct Answer : C WACC= [KD*(1-T)*D/V] + [Ke*E/V] WACC= [6 %( 0.72)3/4] + [10%*1/4] WACC= 3.2%+ 2.5% WACC= 5.7% V u = EBIT (1-T)/WACC V u = $15million*(1-0.28)/0.057 V u = $10.8 million/0.057=$189 million V L = V U + tD= $189 million + (28% x $45 million)= $202 million 12. Question ID: 17651 Correct Answer : B Ke= r 0 + (r 0 -r d ) (1-T) D/E Ke= 0.08+ (0.08-0.06) (1-0.28)60/40 Ke= 0.08+ 0.0216 Ke= 10.16% 13. Question ID: 17653 Correct Answer: A Information asymmetry suggests that in the event of a mismatch of information between stakeholders and the management, the costs of capital to the company increase due to a higher uncertainty of management reliability. 14. Question ID: 17654 Correct Answer: B Static trade off theory dictates that the optimal capital structure lies at the point where the costs of financial distress are exactly offset by the incremental tax benefit. 15. Question ID: 17655 Correct Answer: B 0% Debt 50% Debt 75% Debt Assets $45 million $45 million $45 million Debt $0 million $22.5 million $33.75 million Equity $45 million $22.5 million $11.25 million Before Tax Cost of Debt - 8% 11% After Tax Cost of Debt - 5.76% 7.92% Cost of Equity 12% 15% 18% WACC 12% 10.38% 10.44%
Reading 22 Capital Structure FinQuiz.com FinQuiz.com © 2017 - All rights reserved. 16. Question ID: 17656 Correct Answer: B When the company’s WACC increases upon raising additional debt, it indicates that the capitalization ratios have exceeded their optimal range. As a result, the costs of financial distress exceed the additional tax benefit incurred.
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- Finance, Basic financial concepts