Finance Exam 3

The use of personal borrowing to change the overall amount of financial leverage to which the individual is exposed

The equity risk that comes from the nature of the firm's operating activities. Depends on the firm's assets and operations and is not affected by capital structure. The greater a firm's business risk, the greater the required return on the firm's assets will be, and, all other things being the same, the greater the firm's cost of equity will be.

The equity risk that comes from the financial policy (the capital structure) of the firm. Debt financing increases risk borne to stockholders, called financial risk).

The tax saving attained by a firm from interest expense

Activities which alter the firm's capital structure. Substitute one capital for another, firm's assets unchanged

The costs that are directly associated with bankruptcy, such as legal and administrative expenses

The costs of avoiding a bankruptcy filing incurred by a financially distressed firm

The direct and indirect costs associated with going bankrupt or experiencing financial distress

The theory that a firm borrows up to the point where the tax benefit from an extra dollar in debt is exactly equal to the cost that comes from the increased probability of financial distress. (Long-run financial goals or strategies)

Companies will use internal financing first. Then, they will issue debt if necessary. Equity will be sold pretty much as a last resort. (Shorter-run tactical issue of raising funds to finance investments)

A legal proceeding for liquidating or reorganizing a business

To avoid selling new equity, companies will want to stockpile internally generated cash. Gives managers the ability to finance projects as they appear and to move quickly if necessary.

Can be bought and sold in financial markets (claims such as those of bondholders and stockholders)

Cannot be bought and sold in financial markets (claims such as those of the government and potential litigants in lawsuits)

Occurs when a firm is unable to meet its financial obligations