1) According to the trade-off theory of capital structure,
- optimal capital structure occurs when the present value of tax
savings on account of additional borrowing just offsets the
increase in the present value of costs of distress.
- optimal capital structure occurs when the stockholders' right
to default is balanced by the bondholders' right to get interest
and principal payments.
- optimal capital structure occurs when the benefits of limited
liability is just offset by the value of the firm's lawyers'
claims.
- None of the options are correct.
2) What does "risk shifting" imply?
- When faced with bankruptcy, managers tend to invest in
high-risk, high-return projects.
- When faced with bankruptcy, managers do not invest more equity
capital.
- When faced with bankruptcy, managers may make accounting
changes to conceal the true extent of the problem.
- When faced with bankruptcy, managers invest in low-risk
projects to conserve capital.