Question 2 According to the static theory of capital structure, a firm borrows u

Question

Question 2

According to the static theory of capital structure, a firm borrows up to which one of the following points?

point where the firm is financed totally with debt

point where an additional dollar of debt would have a benefit exactly equal to its cost

point where WACC equals the debt-equity ratio

point where the debt-equity ratio equals 1.0

Question 3

According to M&M Proposition I with taxes, the value of a levered firm is equal to the value of the unlevered firm plus which one of the following?

current market value of the debt

par value of the debt

present value of the depreciation tax shield

present value of the interest tax shield

Question 4

Which one of the following is the equity risk arising from the daily operations of a firm?

Business risk

Financial risk

Operating risk

Strategic risk

point where the firm is financed totally with debt

point where an additional dollar of debt would have a benefit exactly equal to its cost

point where WACC equals the debt-equity ratio

point where the debt-equity ratio equals 1.0

Explanation / Answer

Ans 2.

According to Static theory of capital structure, a firm borrows upto a point where an additional dollar pf debt would have a benefit exactly equal to its cost. Answer is option (b). This gives us the optimal capital structure."It says that a firm borrows upto a point where the tax benefits from an extra dollar in debt is exactly equal to the cost that comes from the probability of financial distress" (For further knowledge you could also refer Fundamentals of Corporate Finance by Ross and Westerfield)

Ans 3. According to M&M Proposition I with taxes, the value of a levered firm is equal to the value of the unlevered firm plus the present value of interest tax shield. Ans d.

Ans 4. Business risk is the risk arising from daily operations of a firm. This risk could be because of changing regulations or tax laws or chnages in prices of raw materials etc.

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