1. Martin Corporation is financed with 40% debt and 60% common equity. The after tax cost of debt is 10% and the cost of common equity is 14%. What is Martin’s weighted average cost of capital?
2. Martin is considering reducing it debt load and is contemplating a 20% debt and 80% common equity mix. If they do this, what should happen to the cost of debt (not the weighted cost – but the cost of each component)? The cost of equity (not the weighted cost)? Why?
3. Per the book, what risk increases with the additional use of debt by a corporation?
4. Assume that the restructuring is completed and Martin is now 20% debt and 80% common equity. The after tax cost of debt is 8% and the cost of common equity is 10%. What is Martin’s new weighted average cost of capital?
5. Should Martin make the capital structure change mentioned in the prior problem?
6. Instead, assume that the restructuring is completed and Martin is now 20% debt and 80% common equity. But the after tax cost of debt is 9% and the cost of common equity is 13.5%. What is Martin’s new weighted average cost of capital?
7. Now, should Martin make the capital structure change mentioned in the prior problem?
8. For a given profitable corporation (that pays taxes), what is the most expensive form of capital (between debt and common equity)? Why? Please state two reasons.
9. What is the difference between the weighted average cost of capital for a corporation and the marginal weight average cost of capital?
10. When weighting the components of capital to calculate the weighted average cost of capital, is it better to use book weights or market weights?
11. Why are accounts payable and accrued expenses not considered in the calculations of our weighted average cost of capital?
12. Leases are most like what source of funds?
13. Do most incremental cost of capital schedules slope upward or downward (when read left to right).
14. What is an optimal capital structure? 15. With regard to capital structure choice, what is the tax clientele effect?
16. What type of capital structure change could managers use today to signal their expectations of improved profitability in the future?
17. From chapter 18, if investors are assumed to be well informed, what opportunities are available to managers in choosing a capital structure?
18. From the book, in chapter 18, under what specific conditions is it more likely that information asymmetries would exist between managers and investors?