FM12 Ch 16 Show - Chapter 16 Capital Structure Decisions:...

Info iconThis preview shows pages 1–11. Sign up to view the full content.

View Full Document Right Arrow Icon
  1 Chapter 16 Capital Structure Decisions:  The Basics
Background image of page 1

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

View Full DocumentRight Arrow Icon
  2 Topics in Chapter Overview and preview of capital  structure effects Business versus financial risk The impact of debt on returns Capital structure theory, evidence, and  implications for managers Example: Choosing the optimal  structure
Background image of page 2
  3 Basic Definitions V = value of firm FCF = free cash flow WACC = weighted average cost of  capital r s  and r are costs of stock and debt w ce  and w d  are percentages of the firm  that are financed with stock and debt.
Background image of page 3

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

View Full DocumentRight Arrow Icon
  4 How can capital structure  affect value? V = t=1 FCF t (1 + WACC) t WACC= w d  (1-T) r d  + w ce r s
Background image of page 4
  5 A Preview of Capital Structure  Effects The impact of capital structure on value  depends upon the effect of debt on: WACC FCF (Continued…)
Background image of page 5

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

View Full DocumentRight Arrow Icon
  6 The Effect of Additional  Debt on WACC Debtholders have a prior claim on cash flows  relative to stockholders.  Debtholders’ “fixed” claim increases risk of  stockholders’ “residual” claim. Cost of stock, r s , goes up. Firm’s can deduct interest expenses. Reduces the taxes paid Frees up more cash for payments to investors Reduces after-tax cost of debt (Continued…)
Background image of page 6
  7 The Effect on WACC  (Continued) Debt increases risk of bankruptcy Causes pre-tax cost of debt, r d , to increase Adding debt increase percent of firm  financed with low-cost debt (w d ) and  decreases percent financed with high- cost equity (w ce ) Net effect on WACC = uncertain. (Continued…)
Background image of page 7

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

View Full DocumentRight Arrow Icon
  8 The Effect of Additional Debt  on FCF Additional debt increases the probability  of bankruptcy. Direct costs: Legal fees, “fire” sales, etc. Indirect costs: Lost customers, reduction in  productivity of managers and line workers,  reduction in credit (i.e., accounts payable)  offered by suppliers  (Continued…)
Background image of page 8
  9 Impact of indirect costs NOPAT goes down due to lost customers  and drop in productivity Investment in capital goes up due to  increase in net operating working capital  (accounts payable goes down as suppliers  tighten credit). (Continued…)
Background image of page 9

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

View Full DocumentRight Arrow Icon
  10 Additional debt can affect the behavior of  managers. Reductions in agency costs: debt “pre-commits,”  or “bonds,” free cash flow for use in making  interest payments.  Thus, managers are less likely  to waste FCF on perquisites or non-value adding  acquisitions. Increases in agency costs: debt can make 
Background image of page 10
Image of page 11
This is the end of the preview. Sign up to access the rest of the document.

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.

Page1 / 77

FM12 Ch 16 Show - Chapter 16 Capital Structure Decisions:...

This preview shows document pages 1 - 11. Sign up to view the full document.

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