Unit 5: Corporate Finance and Capital Budgeting

Answer: D — The correct answer is D) $60,000. To achieve a debt-to-equity ratio of 60:40, the company needs to have $60,000 in debt and $40,000 in equity. Since the company already has $40,000 in debt, it needs to issue an additional $20,000 in debt to reach a total of $60,000. However, the company's assets are $100,000, and the desired debt is 60% of the total assets, which is $60,000. The company already has $40,000 in debt, so it needs $60,000 - $40,000 = $20,000 more to reach 60% debt. But in terms of the total amount of new debt to be issued to reach the desired capital structure of $100,000 in assets with 60% debt, the company will need $60,000 in debt. The other options are incorrect because they do not accurately calculate the amount of new debt needed to achieve the desired capital structure. A) $20,000 is the additional debt needed, but not the total. B) $30,000 is not the correct amount of new debt. C) $40,000 is the current debt, not the new debt needed.

Answer: C — The correct answer is C because the company is increasing its reliance on debt financing, which is more expensive than equity financing. This will increase the company's cost of capital. Answer A is incorrect because reducing the equity base does not necessarily decrease the cost of capital. Answer B is incorrect because the debt is being used to repurchase shares, which will increase the company's financial leverage and cost of capital. Answer D is incorrect because the cost of equity is not directly affected by the recapitalization plan.

Answer: C — The correct answer is C because the company needs to increase its debt-to-equity ratio from 0.5 to 1.5, which means it needs to increase its debt and decrease its equity. Issuing new debt and using the proceeds to repurchase common stock would achieve this goal. Option A is incorrect because issuing new common stock would increase equity, not decrease it. Option B is incorrect because while it would increase debt, it would not be enough to achieve the desired debt-to-equity ratio of 1.5. Option D is incorrect because repurchasing common stock using retained earnings would not increase debt. The company needs to issue new debt to achieve the desired debt-to-equity ratio.

Answer: C — The correct answer is C) To maximize shareholder wealth, because the primary goal of corporate finance is to create value for the company's shareholders. This involves making decisions that increase the company's profitability and stock price. Option A is incorrect because while minimizing risk is important, it is not the primary goal of corporate finance. Option B is incorrect because increasing revenue while reducing profitability is not a sustainable or desirable business strategy. Option D is incorrect because while social responsibility is important, it is not the primary goal of corporate finance.

Answer: B — The correct answer is B) The cost of capital will remain unchanged, as the increase in debt is offset by the decrease in equity. This is because the company is essentially replacing one form of financing (equity) with another (debt), without changing the overall amount of capital. The tax benefits of debt financing (option A) may reduce the after-tax cost of debt, but this will not necessarily decrease the overall cost of capital. Option C is incorrect because while the increased debt-to-equity ratio may increase the risk of the company, this does not necessarily mean the cost of capital will increase. Option D is incorrect because the reduction in shares outstanding may increase earnings per share, but this does not directly affect the cost of capital.