DISCUSSION QUESTIONS:

1. Evaluate the following statement: A firm’s stockholders will never want the firm to
invest in projects with negative net present value

The statement is incorrect. If a firm has debt. According to cost of debt

financing, if the company borrow too much money, it might be advantageous to
stockholders for the firm to undertake risky projects, even those with negative
net present values. This incentive results from the fact that most of the risk of
failure is borne by bondholders. For more details, shareholders prefer high risk
projects because they get nothing when recession happens regardless it’s low-
risk or high-risk project BUT if they are lucky, boom happens, they can get more
than low risk project. However, bondholders can be hurt because if it is
recession, high risk project just can get less than low risk project.
2. Due to large losses incurred in the past several years, a firm has $2 billion in tax loss
carryforwards. This means that the next $2 billion of the firm’s income will be free from
corporate income taxes. Security analysts estimate that it will take many years for the
firm to generate $2 billion in earnings. The firm has a moderate amount of debt in its
capital structure. The firm’s CEO is deciding whether to issue debt or equity to raise the
funds needed to finance an upcoming project. Which method of financing would you
recommend? Why?

The company should issue shares in order to solve the problem of funding.
The tax-loss carry forwards will let the company's tax rate to zero.
Therefore, the company will not take benefit from the tax shied in that debt
provided. In addition, the company has a moderate amount of debt, so if there
is an increase in the debt, then the other will allow the company is facing
financial crisis or even bankruptcy. As long as there are
bankruptcy costs, the company shall issue shares in order to fund this
project.
3. Evaluate the following statement: Assuming there are no taxes, no transaction costs,
and no costs of financial distress ( M&M theory with no corporate tax). If a firm
issues equity to repurchase some of its debt, the price per share of the firm’s stock will
increase since shares are less risky.

Theo đề bài  ko có corporate tax: increase equity, decrease debt  shares

become less risky but expected return of share decreases (these 2 effects offset
each other)  make share price unchanged, firm’s value is unchanged.
 4. Evaluate the following statement: Assuming there are no taxes, no transaction costs, and
no costs of financial distress ( M&M theory with no corporate tax). Moderate
borrowing will not increase the required rate of return on a firm’s equity.

R(s) = cost of equity/required rate of return/discounted rate

RS = R0 + (B/S)×(R0 - RB) > R0  RS increases  incorrect