The traditional theory of optimal capital structure states that firms trade off corporate interest tax shields...
The traditional theory of optimal capital structure states that firms trade off corporate interest tax shields against the possible costs of financial distress due to borrowing. What does this theory predict about the relationship between book profitability and target book debt ratios? Is the theory’s prediction consistent with the facts?
Homework Answers
- The traditional theory of optimal capital structure states that firms trade off corporate interest tax shields against the possible costs of financial distress due to borrowing and this is a trade off theory.
- Trade - off theory states that capital structure is based on trade off between saving in tax & distress of cost of debt.
- This theory explain why capital structure is differ between industries.
- This theory predict that company with steady income & high book profitability have high debt ratio. Company with high profitability can trade off corporate interest tax shields if there is no profit it does not work.
- No, theory's prediction not consistent with the fact. We see in the market that profitable company in the market have lower debt ratio.
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The traditional theory of optimal capital structure states that firms trade off corporate interest tax shields...
correct answer ( trade off theory - market leverage) (a decision to reduce the likelihood of...
correct answer
( trade off theory - market leverage) (a decision to reduce the
likelihood of financial distress by retirement of debt means that
existing debt is acquired at market value, and that the resulting
decrease in interest tax shields is based on the market value of
the retired debt. Similarly, a decision to increase interest tax
shields by increasing debt requires that new debt be issued at
current market prices.)
I don't understand what that means
thanks a lot...
Which of the following best defines the Pecking Order Theory. Select one: a. The theory states...
Which of the following best defines the Pecking Order Theory. Select one: a. The theory states that capital structure is based on a trade-off between tax savings and distress costs of debt. b. The theory states that firms prefer to use equity rather than debt and reduce the risk of financial distress. c. The theory states that an optimal capital structure cannot be determined because firms make use of funds which are easily accessible. d. The theory stating that firms...
According to the trade-off theory, a firm's optimal capital structure: Question 8 options: is the debt-equity...
According to the trade-off theory, a firm's optimal capital structure: Question 8 options: is the debt-equity ratio that results in the lowest possible weighted average cost of capital. exists when the debt-equity ratio is 0.50. is the debt-equity ratio that exists at the point where the firm's weighted after-tax cost of debt is minimized. is found by locating the mix of debt and equity which causes the earnings per share to equal exactly $1.
According to the trade-off theory, a firm's optimal capital structure: Question 11 options: exists when the...
According to the trade-off theory, a firm's optimal capital structure: Question 11 options: exists when the debt-equity ratio is 0.50. is the debt-equity ratio that results in the lowest possible weighted average cost of capital. is found by locating the mix of debt and equity which causes the earnings per share to equal exactly $1. is the debt-equity ratio that exists at the point where the firm's weighted after-tax cost of debt is minimized.
The trade-off theory relies on the threat of financial distress. But why should a public corporation...
The trade-off theory relies on the threat of financial distress.
But why should a public corporation ever have to land in financial
distress? According to the theory, the firm should operate at the
top of the curve in Figure 1. Of course, market movements or
business setbacks could bump it up to a higher debt ratio and put
it on the declining, right-hand side of the curve. But in that
case, why doesn't the firm just issue equity, retire debt,...
8. More on capital structure theory The Modigliani and Miller theories are based on several unrealistic...
8. More on capital structure theory The Modigliani and Miller theories are based on several unrealistic assumptions about debt financing. In reality, there are costs, taxes, and other factors associated with debt financing. These costs or effects have led to several theories that explain the impact of these factors on the capital structure of a firm. Based on your understanding of the trade-off theory, what kind of firms are likely to use more leverage? Firms with a higher proportion of...
According to the trade-off theory, under which of the following conditions will a firm's capital structure...
According to the trade-off theory, under which of the following conditions will a firm's capital structure be optimal? Select one: a. Marginal bankruptcy-related costs = 0 b. Marginal tax shelter benefits - Marginal bankruptcy-related costs = Interest charges c. Debt/assets ratio = Marginal tax shelter benefits d. Marginal tax shelter benefits = Marginal bankruptcy-related costs e. Marginal tax shelter benefits = Interest charges
Capital Structure Theory Modern capital structure theory began in 1958 when Professors Modigliani and Miller (MM)...
Capital Structure Theory Modern capital structure theory began in 1958 when Professors Modigliani and Miller (MM) published a paper that proved under a restrictive set of assumptions that a firm's value is unaffected by its capital structure. By indicating the conditions under which capital structure is irrelevant, they provided dues about what is required to make capital structure relevant and impact a firm's value. In 1963 they wrote a paper that included the impact of corporate taxes on capital structure....
Capital Structure Theory Modern capital structure theory began in 1958 when Professors Modigliani and Miller (MM)...
Capital Structure Theory Modern capital structure theory began in 1958 when Professors Modigliani and Miller (MM) published a paper that proved under a restrictive set of assumptions that a firm's value is unaffected by its capital structure. By indicating the conditions under which capital structure is irrelevant, they provided dues about what is required to make capital structure relevant and impact a firm's value. In 1963 they wrote a paper that included the impact of corporate taxes on capital structure....
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correct answer
( trade off theory - market leverage) (a decision to reduce the
likelihood of financial distress by retirement of debt means that
existing debt is acquired at market value, and that the resulting
decrease in interest tax shields is based on the market value of
the retired debt. Similarly, a decision to increase interest tax
shields by increasing debt requires that new debt be issued at
current market prices.)
I don't understand what that means
thanks a lot...
The trade-off theory relies on the threat of financial distress.
But why should a public corporation ever have to land in financial
distress? According to the theory, the firm should operate at the
top of the curve in Figure 1. Of course, market movements or
business setbacks could bump it up to a higher debt ratio and put
it on the declining, right-hand side of the curve. But in that
case, why doesn't the firm just issue equity, retire debt,...
8. More on capital structure theory The Modigliani and Miller theories are based on several unrealistic assumptions about debt financing. In reality, there are costs, taxes, and other factors associated with debt financing. These costs or effects have led to several theories that explain the impact of these factors on the capital structure of a firm. Based on your understanding of the trade-off theory, what kind of firms are likely to use more leverage? Firms with a higher proportion of...
Capital Structure Theory Modern capital structure theory began in 1958 when Professors Modigliani and Miller (MM) published a paper that proved under a restrictive set of assumptions that a firm's value is unaffected by its capital structure. By indicating the conditions under which capital structure is irrelevant, they provided dues about what is required to make capital structure relevant and impact a firm's value. In 1963 they wrote a paper that included the impact of corporate taxes on capital structure....
Capital Structure Theory Modern capital structure theory began in 1958 when Professors Modigliani and Miller (MM) published a paper that proved under a restrictive set of assumptions that a firm's value is unaffected by its capital structure. By indicating the conditions under which capital structure is irrelevant, they provided dues about what is required to make capital structure relevant and impact a firm's value. In 1963 they wrote a paper that included the impact of corporate taxes on capital structure....
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