FI.Chapter17 - !P ef tF*scEi=i-Bs*ia;r=:=a*EEs:aHEeri E'8s...

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!P* **scEi=i .-€Bs"**ia;r= tF t a lnoc'ting of the Fnrincial M.n- agenent Association, a panel ses- sion loc sed olr horv firirs actunlly .c rh(ir ia !t i . pil., -lru,lur(. . Tfc p.rr iicipants ilclucled financial managers from Hershey Foods, Verizon, EC&C (r high trch trfl,'\,.rnd .' "un,bpr, f,'rher frrnr. in r,rrr- orLS industries. AlthouSh there wcrc ninor differcnccs nr flrilosophy anrl procedures among thc colrlpanies, se!cral ihc|nes frrn. rr p-.r. lr. F rl r. .liff., ull . .' ,pa ify .rn opl,rr rl , iprr.,l :rructrrr, :n.lF' d mdnaA, r\ even fccl uncomfortable about specifying a1r optnnal capitnl siructurc rangc. Ihus, finalr- cial managcrs worrv primarilv abolrt fthether their firms arc using kxr little or too Druch debt, not about the precisc optimal anount of de\t s(.or.l. ,{r'n rf ,r fi'm, lrtlal .;prr.rl -lru. tr,r. \'.rn(. \"'rdFlv nom thc tl-(o cti. .l optinr m, this nright not havc n]rich effcct on its skrck price. O!,erall, financial managcrs belie\,€ that capital structure clecisions are sec- ond,rr\ rn Inru.'rldn. p 1,. .,pe dlins J.' .i,r,. ef :=a*EEs: aHEeri*!+E'8s especialy those relnting to capit.rl budgcting an(t ihe stratc8ic dircction of the firm. ln Benernl, finnncial marugers focLrs on cnljfvht d "prudent" levcl of debt rather th.n on sciting a lnecise optimal levrl A prudent levrl is defirrcd as o|c that crpturcs Drosi ofihebcnefits ofdcbtyet (1) keeps ftrdn- cinl risk at a manageable level, (2) ensures future fin|ncing flcritrility, and (3) allou,s tle firm lo lnaintain a desirablo credil r.rting. Thus, a prudent level of debt lr,ill protcci ihe fornpany lrgiinst financial distrcss under all but the \rrorst econornic sccnarios, and it rLill errsLrre access to money an.l capital nr.rrkets |der rnost {onditions. As,\'ou read ihis chaptor think aboxi how vou r () ld makc capittrl structllre decl si(ms if you had that responsjbility. At the samc time, don't forSei ihe very inportant nrc. .,dc from r\q f\4\ Frllel *ssro. F,l.rb'i.l,irF th. flHlll (dprt.,l, r-.' inrprecise process at best, and it shorld be bascd on boih informed iudgncnt and (luantitativc analyses.
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Copiiol Strucrlre Theo'y: Arbiiroge Prooh of ihe Modis ioni-Mi er Modek Chapter 16 presented basic material on capital structure, induding an introduction to capital structure theory. We saw that debt concentrat€s a firm's busifless risk on its stockholders, thus mising stockholders' risk, but it also increases the expected relum on equity. We also saw that tllerc is some optimal level of debt that maximizes a company's stock price, and we illustrated tlds concept with a simple model. Now we to into more detail on capital structure theory This will give you a deeper understandint of the benefits and costs associated with debt financins. l7.l CapitalStructureTheory:ArbitrageProofs the Modigliani-Miller Models Until 1958, capitai structure th€ory consisted of loose assertions about investor behavior rather than carefully constructed models that could be tested by formal statistical analysis. In what has b€en caled the most inJluential set of financial papers ever published, Franco Moditliani and Merton Miller (MM)
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This note was uploaded on 06/08/2009 for the course FI 601-602 FI601-602 taught by Professor Prof.geary during the Spring '09 term at New Haven.

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FI.Chapter17 - !P ef tF*scEi=i-Bs*ia;r=:=a*EEs:aHEeri E'8s...

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