Assignment for Chap. 14: Capital Structure and Leverage
Finding or figuring out the answers to the following questions is the only way to learn the concepts of capital structure and leverage. Just reading the chapter and my summary lecture won’t do it.
Part I:
Use your own words to explain the terms in ST-1. Make believe you’re explaining it to your 12-year-old cousin, not to me. Please omit the Hamada equation, ROIC and unlevered beta.
The Modigliani-Miller tax irrelevance theory is optional. So skip key terms d and f.
Part II
List the determinants (factors that cause) of “business risk.”
Should managers of companies that have high levels of business risk increase operating leverage? Why or why not?
What is “financial risk?” It’s not the same as “business risk.”
Explain what asymmetric information means and what a new stock issue tends to signal.
How does the tax deductibility of interest affect the optimal target capital structure?
What are the 3 ways of measuring financial leverage?
What is financial flexibility (also called reserve borrowing capacity?)
Is financial flexibility increased or decreased by a high debt ratio?
If a firm’s equity ratio is 80%, how much is its debt ratio?
Let’s say the CSI bookstore outsourced the production of CSI sweatshirts to a Staten Island start-up company. The company’s fixed operating cost is $200,000, its variable costs are $10 per shirt and its sales price will be $20. What is the start-up company’s breakeven point? At what quantity of sweatshirts will the company start making a profit?
Now calculate breakeven sales revenue for that company.
Try to do problem 14-5 parts b and c.
What financial principle do you learn from the computations in 14-5 b and c?
