1) Which of the following statements is correct? a) increasing a company\'s debt
ID: 2782461 • Letter: 1
Question
1) Which of the following statements is correct?
a) increasing a company's debt ratio will decrease its WACC up to the point where risk outweighs return.
b) since debt financing is less expensive than equity financing, increasing a company's debt ratio will always decrease its WACC.
c) increasing a compnay's debt ratio will typically decrease the incremental costs of both debt and equity financing; however, it still may increse the company's WACC.
d) Since debt financing raises a company's financial risk, increasing its debt ratio will always increase its WACC.
2) There are many factors to consider when establishing dividend policy and payout ratio. Which of the following factors is LEAST important?
a) Investors' preference for dividend income vs. capital gains, or visa-versa...the "clientele effect".
b) "signaling" to the investment community via implied "asymmetric information" by management.
c) Whetehr or not competing compnaies in the same industry pay dividends...if they are, we should too.
d) The company's optimal target capital structure (debt/equity ratio)
3) Which of the following statements is correct?
a) Companies that are capital intensive are more likely to rely on debt finanxing.
b) companies with large tax-loss carry forwards are more likely to rely on debt finaning.
c) companies that are capital intensive are less likely to rely on debt finaning.
d) companies whose sales are very sensitive to changes in the business cycle are more likely to rely on debt financing (use more debt in its capital structure)
Explanation / Answer
Answer 1. a)
Increasing a company's debt ratio will decrease its WACC up to the point where risk outweighs returns as the WACC can be reduced using the interest tax shield but debt over the certain optimal percentage can increase the financial risk making the debt expensive.
Answer 2. b)
Signaling to the investment community via implied asymmetric information by management i.e management holding more information than the investors and there is failure to communicate properly or transparently can affect dividends and thus the investors decisions.
Answer 3. a)
Companies that are capital intensive i.e. using more of capital as compared to employee like oil and gas, metal and minings, airlines, etc industries tend to use more of debt financing.
Answer 1. a)
Increasing a company's debt ratio will decrease its WACC up to the point where risk outweighs returns as the WACC can be reduced using the interest tax shield but debt over the certain optimal percentage can increase the financial risk making the debt expensive.
Answer 2. b)
Signaling to the investment community via implied asymmetric information by management i.e management holding more information than the investors and there is failure to communicate properly or transparently can affect dividends and thus the investors decisions.
Answer 3. a)
Companies that are capital intensive i.e. using more of capital as compared to employee like oil and gas, metal and minings, airlines, etc industries tend to use more of debt financing.
Answer 1. a)
Increasing a company's debt ratio will decrease its WACC up to the point where risk outweighs returns as the WACC can be reduced using the interest tax shield but debt over the certain optimal percentage can increase the financial risk making the debt expensive.
Answer 2. b)
Signaling to the investment community via implied asymmetric information by management i.e management holding more information than the investors and there is failure to communicate properly or transparently can affect dividends and thus the investors decisions.
Answer 3. a)
Companies that are capital intensive i.e. using more of capital as compared to employee like oil and gas, metal and minings, airlines, etc industries tend to use more of debt financing.
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