Issuing Debt Instead of New Equity in a Closely Held

question 44

Multiple Choice

Issuing debt instead of new equity in a closely held firm more likely:

• A) causes the owners-managers to work less hard and shirk their duties as they have less capital at risk.
• B) causes the owner-managers to consume more perquisites because the cost is passed to the debtholders.
• C) causes both more shirking and perquisite consumption since the government provides a tax shield on debt.
• D) cause agency costs to fall as owner-managers do not need to worry about other shareholders.
• E) cause the owner-manager to reduce shirking and perquisite consumption as the excess cashflow must be used to meet debt payments.

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Definitions:

Mixed Cost

Mixed cost includes both fixed and variable components, meaning part of the cost varies with the level of activity while the other part remains constant.

Overhead Costs

Expenses related to the operation of a business that are not directly associated with the production of goods or services, such as rent, utilities, and administrative salaries.

Machine Setups

The process of preparing and adjusting machines for a specific production run.

Fixed Manufacturing Cost

Costs that do not change with the level of production, such as salaries of permanent staff and rent for factory space.