- Which of the following statements most accurately characterizes the static trade-off theory of capital structure? A) Regardless of how the firm is financed, the overall value of the firm and aggregate value of the claims issued to finance it remain the same. B) Firms have a preference ordering for capital sources, preferring internally-generated equity first, new debt capital second, and externally-sourced equity as a last resort. C) Firms will seek to use debt financing up to the point that the value of the tax shield benefit is outweighed by the costs of financial distress. D) Increasing the use of relatively lower cost debt causes the required return on equity to increase such that the overall cost of capital is unchanged. 2. Which of the following reasons is least accurate regarding why a firm’s actual capital structure may deviate from its target capital structure? A) Management may believe that now is an opportune time to issue equity. B) There may be economies of scale in issuing debt securities. C) The market values of outstanding debt and equity fluctuate. D) The book values of outstanding debt and equity are different from their market values. 3. Which of the following statements concerning the use of leverage is most accurate? A) The use of leverage in capital structures is broadly consistent in most developed economies. B) Firms in emerging markets tend to use longer maturities than firms in developed markets because the issuance costs are greater. C) A high degree of information asymmetry tends to reduce the use of debt in the capital structure. D) Companies in countries where the use of bank debt (as opposed to issuing bonds) is more prevalent tend to use more leverage. T/G
B? D? C?
D D The third is a coin flip for me . . . A?
C) D) D) I’m out on a limb on this: I know this was discussed, but might have the countries mixed up where this is used???
Nibs, I don’t think A) holds, cuz I specifically remember examples from the book where they talk about developed countries (ie. US, UK, Japan) and the differences in their uses of leverage…I think Japan was a lot different than Western countries…or something like that?
Crap, zimzim was right for question one = C.
Zimzim is on fire. 1. The correct answer was C) Firms will seek to use debt financing up to the point that the value of the tax shield benefit is outweighed by the costs of financial distress. The static trade-off theory of capital structure states that firms will seek to use debt financing up to the point that the value of the tax shield benefit is outweighed by the costs of financial distress. In other words, the capital structure is determined by the trade-off between these two factors. 2. The correct answer was D) The book values of outstanding debt and equity are different from their market values. The book values of equity and debt are generally not relevant to assessing a firm’s capital structure. It is the market values of equity and debt that determine the current capital structure. 3. Your answer: D was correct! Companies in countries where the use of bank borrowing is relatively more prevalent than the issuance of corporate bonds tend to use more leverage. The other statements are incorrect, based upon observations across countries. T/G
1 for 3, right at my long-term average.
You’re probably right. All I know is that for question 3 its definitely not B. What is the theory (if there is one) for D in question one. Is it just a MM proposition no taxes but still bankruptcy risk?
Wow, my best performance on here yet. I actually remembered that static trade-off crap from level 1…good to know I still have something left in the tank. Now if only they’d be questions like that in three weeks!