Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

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ANSWERS TO CHAPTER DISCUSSION QUESTIONS 457

research projects should not have large debt because of high expected

bankruptcy costs. Firms such as Microsoft that have an important founder who

is still part of the firm may be less subject to discipline problems compared to

firms where ownership is largely dispersed. This reduces the advantage of debt

financing as a disciplinary device for managers. Yet, asset substitution problems

and bankruptcy costs are high for firms operating in an environment with con-

siderable intangible assets, research projects, and the like. This also makes debt

financing less attractive. If Microsoft expands globally, the disciplinary effect of

debt financing may become more important because Microsoft will create more

business units worldwide.

CHAPTER 11 ESTIMATING CAPITAL COSTS:

PRACTICAL IMPLEMENTATION OF

THEORY’S INSIGHTS

1. A firm’s existing WACC only measures the rate of return investors require from

a company, given the firm’s existing business risk and financial strategy. If the

firm wereto move into morerisky ventures,then its current WACC would reflect

neither investors’ reaction to the increased risk nor the appropriate benchmark

for existing investments (e.g., a project or division) if that investment’s use of

funds does not fit the firm’s average risk profile. Good practice would be to use

the WACC for another company, which is primarily in the riskier (safer) line

of operations as ...