Debt financing: capital structure decision and the cost of capital Part I - 1. Please explain the advantages
and disadvantages of debt financing. 2. How does the use of debt financing affect the rate of return that shareholders require on their investment in the firm's shares. How does the cost of equity (i.e., the rate of return investors require on their investment in the firm's shares) change when the firm increases its use of debt. (This is 'Proposition II" of Modigliani and Miller for the Tax Case that I was working. 3. What is meant by an optimal capital structure of the firm? Part II - Consider three companies: Adobe, T-Mobile, and FedEx. Reflect on the nature of the business of these three companies. You are recommended to check what the beta of each of these companies is. Based upon reviewing the nature of the operations of the companies including the nature of their customers and products, what would you recommend should the capital structure (total liabilities or debt and equity proportions) be for each of the three companies? You should relate your answers to what you wrote in your response to question (3) above. Note that I am not asking you to provide specific numbers, just 'low debt ratio', 'medium debt ratio' or 'high debt ratio'. (Do not quote the actual company's capital structure or their debt-to-equity ratios as per their balance sheet.) Be sure to include a reference list.
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