An efficient firm employs inputs in such proportions that the marginal product/price ratios for all inputs are equal. In terms of capital budgeting, this implies that the marginal cost of debt should equal the marginal cost of equity in the optimal capital structure. In practice, firms often issue debt at interest rates substantially below the yield that investors require on the firm’s equity shares. Does this mean that many firms are not operating with optimal capital structures? Explain.
Answer to relevant QuestionsSuppose that Black & Decker’s interest rate on newly-issued debt is 7.5% and the firm’s marginal federal-plus-state income tax rate is 40%. This implies a 4.5% after-tax component cost of debt. Also assume that the firm ...Identify each of the following statements as true or false, and explain your answers.A. Information costs both increase the marginal cost of capital and reduce the internal rate of return on investment projects.B. ...Cunningham’s Drug Store, a medium-size drugstore located in Milwaukee, Wisconsin, is owned and operated by Richard Cunningham. Cunningham’s sells pharmaceuticals, cosmetics, toiletries, magazines, and various novelties. ...In a typical corporation, who are the “principals” and who are the “agents”? What is the firm’s agency problem?Indicate whether each of the following transaction costs is explicit or implicit, and describe how it is a manifestation of a particular type of agency problem.A. A trader at an investment banking firm loses millions of ...
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