WEEK 9 - TRADE OFF THEORY
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Questions and Answers

According to trade-off theory, beyond the level of _________, the marginal benefit of tax shield is outweighed by the marginal increase in the cost of equity.

  • Optimal level of debt (correct)
  • Optimal level of equity
  • Optimal WACC
  • Optimal Tax Rate
  • Which of the following is an accurate measure of gearing ratio?

  • Debt/Capital (correct)
  • Equity/Capital
  • Debt/Stock Price
  • Debt/Net Profit
  • According to Modigliani and Miller’s Proposition II (with tax), the optimal capital structure is:

  • 100% equity
  • 100% debt (correct)
  • 50% debt 50% equity
  • 25% debt 75% equity
  • The cost of having to sell assets at below market value is an example of:

    <p>Indirect bankruptcy costs (A)</p> Signup and view all the answers

    The fundamental principle behind tax exhaustion is:

    <p>Insufficient Profits (C)</p> Signup and view all the answers

    A high gearing ratio implies that a company has:

    <p>High Debt (C)</p> Signup and view all the answers

    According to Pecking Order Theory, the order of preference of capital would be:

    <p>Retained earnings &gt; Debt &gt; Equity (A)</p> Signup and view all the answers

    The explicit costs, such as the legal expenses, associated with corporate default are classified as _____ costs. midterm

    <p>direct bankruptcy (C)</p> Signup and view all the answers

    In general, the capital structures used by U.S. firms:

    <p>vary significantly across industries (D)</p> Signup and view all the answers

    One of the indirect costs of bankruptcy is the incentive for managers to take large risks. When following this strategy:

    <p>stockholders expropriate value from bondholders by selecting high-risk projects. (B)</p> Signup and view all the answers

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