Capital Structure In Finance Discussion1. The combination of ______________ and equity used to
______________ a firm’s projects is referred to as its
______________ structure. The ______________ structure
of a firm is some mix of debt, internally generated
______________, and new ______________.
2. Failure to pay ______________ or principal as promised may
result in ______________ distress. ______________ distress is
the condition where a firm makes ______________ under
pressure to satisfy its legal obligations to its ______________.
These decisions may ______________ be in the best interest
of the owners of the firm.
3. When ______________ financing is used instead of
______________, the owners don’t share the earnings, all
they must do is pay their ______________ the interest on
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174 QUESTIONS AND PROBLEMS
debt. But when ______________ financing is used instead
of ______________, the owners must ______________ the
increased earnings with the additional owners, diluting
their ______________ on equity and ______________ per
4. We can measure the ______________ associated with
alternative forms of financing by calculating the
______________ deviation and the ______________ of
variation of the possible earnings per share. The
______________ the ______________ deviation and
______________ of variation the ______________ the risk.
5. The discount ______________ is referred to as the
______________ rate, which is the ______________ rate
that translates ______________ earnings into a current
______________. The ______________ rate reflects the
uncertainty associated with the expected earnings in the
______________. The more ______________ the future
earnings, the ______________ a dollar of future income is
worth today and the ______________ the capitalization rate.
6. The risk ______________ is the difference between the
______________ rate for the net ______________ to owners and the ______________ rate on ______________ to
creditors (the ______________), which is assumed to be
risk ______________. The ______________ the use of
______________, the ______________ the ______________
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Capital Structure 175
7. The benefit from interest deductibility is referred to as the
interest ______________. It is equal to the ______________
tax rate times the interest ______________. An alternative
calculation is the ______________ tax rate times the
______________ rate on debt times the face ______________
8. If a firm has deductions that ______________ income, the
result is a net ______________ loss. The firm does not have
to pay ______________ in the year of the ______________
and may carry this ______________ to another tax year.
This ______________ may be applied against
______________ years’ taxable ______________, with some
9. For firms whose owners have ______________ liability,
the more the ______________ are financed with
______________, the greater the incentive to take on
______________ projects, leaving ______________ “holding the bag” if the projects turn out to be ______________.
There is a(n) ______________ of interest between
______________ interests and ______________ interests.
10.We can classify ______________ costs into ______________
and ______________ costs. ______________ costs include
the legal, administrative, and ______________ costs associated with the filing for bankruptcy and the administration of bankruptcy. The ______________ costs of
bankruptcy are more ______________ to evaluate.
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176 QUESTIONS AND PROBLEMS
SHORT ANSWER QUESTIONS
Refer to Chapter 18, pages 583–621 in Financial Management and Analysis.
1. Why can debt financing be more attractive than equity
2. Why do debt ratios differ across industries? Within industries?
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Capital Structure 177
3. What is the leverage effect? What happens if earnings are
insufficient to cover interest payments?
4. How does the tax shield affect the value of the firm?
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178 QUESTIONS AND PROBLEMS
5. What is the relationship between financial distress and
capital structure? What are the factors to be considered?
6. What factors should be taken into consideration in capital
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