The Change in Firm Value Due to Infusion of Debt

question 9

Multiple Choice

The change in firm value due to infusion of debt in the presence of corporate taxes is:

• A) positive as equity holders face a lower effective tax rate.
• B) positive as equity holders gain the tax shield on the debt interest.
• C) negative because of the increased risk of default and fewer shares outstanding.
• D) negative because of a reduction of equity outstanding.

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Definitions:

Net Operating Income

The income generated from normal business operations after deducting operating expenses such as wages and cost of goods sold, excluding income from investments and other non-operational sources.

Variable Costing

An accounting method that only considers variable costs (costs that change with production levels) in product costing and decision-making.

Absorption Costing

A bookkeeping approach that encompasses the total expenses of production, including direct materials, direct labor, along with both variable and fixed overhead costs, into the pricing of a product.

Unit Product Cost

The total cost (both fixed and variable) to produce a unit of product, used for setting prices and analyzing efficiency.