Chapter 16 Capital Structure Policy
ADVANCED (Question 27 to 31)
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Operating a firm without debt is generally considered to be a conservative measure.
Discuss how such a conservative approach to a firm’s capital structure is good or bad for
the value of the firm in the absence of information or transaction costs and any effect of debt on the real investment policy of the firm.
Finite Corp. has $250 million of debt outstanding at an interest rate of 11 percent. What is the present value of the debt tax shield if the debt will mature in five years (and no new debt will replace the old debt), assuming that Finite is subject to a 40 percent marginal tax rate?
The Boring Corporation is currently valued at $900 million, but management wants to completely pay off its perpetual debt of $300 million. Boring is subject to a 30 percent marginal tax rate. If Boring pays off its debt, what will be the total value of its equity?
If we drop the assumption that there are no information or transaction costs, in addition to dropping the no-tax assumption, then will the Modigliani and Miller model still suggest that the firm should take on greater proportions of debt in its capital structure? Explain.
Poly Ana Corporation has an abundant cash flow. It is so high that the managers take Fridays off for a weekly luncheon in Cancun using the corporate jet. Describe how