s. More on capital structure theory As Aa The Modigliani and Miller theories are

Question

s. More on capital structure theory As Aa The Modigliani and Miller theories are based on several unrealistic assumptions about debt finanding. In reality, there are costs, taxes, and other factors associated with debt finanding. These costs or effects have led to several theories that explain the impact of these factors on the capital structure of a firm. Based on your understanding of the trade-of theory, what kind of firms are likely to use more leverage? O Firms with a higher proportion of variable-versus-fixed costs O Firms with a higher proportion of fixed-versus-variable costs Based on your understanding of the capital structure theories, identbfy the best option for the missing part of the statement. Option 1 Option 2 According to signalling theory, if managers expect the firm's stock price to decrease, they are ???? to raise capital through equity financing Encouraged Discouraged A leveraged buyout (LBO) helps the firm 2222 both its excess cash flows and managers' temptation to incur wasteful expenses. Reduce Increase

Explanation / Answer

1) Firms with a higher proportion a fixed-versus-variable costs. (Because the fixed portion constitutes the interest to Debt, so more leverage or debt, more interest or fixed costs.) 2) DISCOURAGED     (so as to stop further decrease in price through more equity issue) INCREASE    (as more leveraged buyout more fund is introduced in firm) MORE     (being more profitable firm can afford to bear more interest expense) 3) The statement is describes by the TRADE-OFF THEORY. (As per the trade-off theory for an optimal capital structure, a trade-off between interest tax shields and cost of financial distress is required.)

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