70.2K

Verified Solution

Link Copied!

Which of the following are ways that a firm can reduce cash flows in order to prevent managers from wastefully spending excess cash flows? Check all that apply.

Funneling excess cash flows back to shareholders through higher dividends

Increasing the amount of debt in the firms target capital structure in the hope that higher debt-service requirements will force managers to be more disciplined

Funneling excess cash flows back to shareholders through stock repurchases

Minimizing the amount of debt in the firms capital structure so that the firm can borrow money at a reasonable rate when good investment opportunities arise

Green Goose Automation Company currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firms unlevered beta is 1.25, and its cost of equity is 11.75%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 11.75%. The risk-free rate of interest (rRFrRF) is 3%, and the market risk premium (RPMRPM) is 7%. Green Gooses marginal tax rate is 25%.

Green Goose is examining how different levels of debt will affect its costs of debt and equity, as well as its WACC. The firm has collected the financial information that follows to analyze its weighted average cost of capital (WACC). Complete the following table.

D/Cap Ratio	E/Cap Ratio	D/E Ratio	Bond Rating	Before-Tax Cost of Debt (rdrd)	Levered Beta (b)	Cost of Equity (rsrs)	WACC
0.0	1.0	0.00			1.25	11.75%	11.75%
0.2	0.8	0.25	A	8.1%		13.388%	11.925%
0.4	0.6	0.67	BBB	8.5%	1.875	16.125%
0.6	0.4	1.50	BB	10.9%	2.656		13.542%
0.8	0.2		C	13.9%	5.000	38.000%

Answer & Explanation Solved by verified expert

See Answer