chapter15_1_a

chapter15_1_a - Chapter 15-1 Capital Structure in a Perfect...

Info iconThis preview shows pages 1–7. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 15-1 Capital Structure in a Perfect World
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
The Capital-Structure Question The value of a firm is defined to be the sum of the value of the firm’s debt and the firm’s equity. V = D + E The Capital Structure decision can be viewed as how best to slice up a the pie. If how you slice the pie affects the size of the pie, then the capital structure decision matters. 70% Debt 30% Equity
Background image of page 2
1. What is an optimal capital structure? D = market value of firm’s debt E = market value of firm’s equity V= D + E = market value of firm’s assets Questions: 1. Do shareholders want managers to maximize V or E? 2. What ratio of debt to equity maximizes the shareholders’ interests?
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
2. Maximizing firm value versus maximizing stockholder interests Example: J.J. Sprint Co 100 shares selling at $10 each E 0 = 1000 Initially unlevered D 0 = 0 Firm value: V 0 = 1000 + 0 = 1000 Management of Sprint considers becoming levered Borrow $500 D 1 = 500 Use $500 to pay special dividend of $5 per share Management believes that new firm value V 1 will be either: $1250, $1000, or $750
Background image of page 4
Example (continued) What is the value of debt and equity with the leverage? How much do shareholders profit/lose from increase in leverage? Key Observation: Conclusion: V 0 = 1,000 V 1 =1,250 V 1 =1,000 V 1 =750 Debt Value 0 500 500 500 Equity Value 1,000 750 500 250 V 1 =1250 V 1 =1000 V 1 =750 Capital gains -250 -500 -750 Dividends 500 500 500 Shareholder profit 250 0 -250
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
3. The effect of financial leverage on returns to stockholders: an example Unlevered capital structure (Current) 400,000 shares, price of $20 No debt Levered capital structure (Proposed) Issue $4,000,000 in debt, r=10% Use proceeds to repurchase $4,000,000 of equity Unlevered Levered Assets 8,000,000 8,000,000 Debt 0 4,000,000 Equity 8,000,000 4,000,000 Interest rate 10% 10% Stock price 20 20 Shares outstanding 400,000 200,000
Background image of page 6
Image of page 7
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

Page1 / 21

chapter15_1_a - Chapter 15-1 Capital Structure in a Perfect...

This preview shows document pages 1 - 7. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online