Horizon Optical, an internet services provider, is considering changing its capital structure. The firm's beta is 1.25, the current risk-free rate of return is 5.50%, and the market risk premium is 7.50%. Horizon's return on equity was 16.50% and its debt to capital ratio is 10%. The company faces stiff competition and is a possible takeover target, but has significant anti-takeover protection in its corporate charter. The company projects its cost of equity will be 12.65% at its optimal capital structure. Which of the following arguments can be offered for Horizon moving quickly to its optimal capital structure?
I. Market competition
II. Horizon's low equity return differential
III. The takeover activity in the market
A. I only
B. II only
C. I and II only
D. I and III only
E. I, II, and III
Corporation has a current debt to capital ratio of 20%. The company is planning on adding debt as part of its expansion program for the coming year. Which of the following uses a distribution of EBIT to determine the maximum amount of debt a firm can accommodate before reaching a probability constraint of default?
A. The operating income approach
B. The cost of capital approach
C. The differential return approach
D. The comparative leverage approach