9. Alternative capital structure theories

The Modigliani and Miller theories are based on several unrealistic assumptions related to the use of debt financing. In reality, there are costs, taxes, and other factors associated with the use of borrowed funds. These costs or effects have led to several theories that explain the impact of these factors on the capital structure decisions made by a firms managers.

Based on your understanding of the trade-off theory, what kind of firms are likely to use more leverage?

?Firms that have relatively higher business risk compared to other firms in their industry.

?Firms that have relatively lower business risk compared to other firms in their industry.

Based on your understanding of the capital structure theories, identify the best option for the missing part of the statement.

According to signaling theory, a firm with a very positive outlook might tend to use debt financing (beyond/equal to) its normal target capital structure.

Firms that maintain an adequate reserve borrowing capacity will be able to (lend/borrow) money at a reasonable cost when good investment opportunities arise.

True or False: The market timing theory that suggests that managers believe can select a good time to issue new stock (when prices are abnormally high) or sell new debt (when interest rates are exceptionally low) because the financial markets are not informationally efficient.

?False

?True