12-7a[1].- Captial Structure.ppt

12-7a[1].- Captial Structure.ppt - Capital Structure...

Info iconThis preview shows pages 1–10. Sign up to view the full content.

View Full Document Right Arrow Icon
Ramesh Rao 1 FEx06 Capital Structure : Outline of Ideas A. General Background B. Capital Structure in Perfect Capital Markets C. Corporate Tax Effects D. Bankruptcy/Agency Costs E. Personal Taxes****** F. “Pecking Order” Theory G. Summary and Conclusions
Background image of page 1

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

View Full DocumentRight Arrow Icon
Ramesh Rao 2 FEx06 A. Background Managerial Decisions should be based on market values ______________________________ What is Firm Value? Two ways to look at this: Market Value of: LHS of balance sheet = A (existing assets) +NPV (wealth created) RHS of balance sheet = B (value of debt) + S (value of equity) _____________________________ LHS decisions: capital budgeting RHS decisions: capital structure or financial structure ______________________________ Our emphasis is on debt and equity We focus on the value of the “unlevered” and “levered” firms
Background image of page 2
Ramesh Rao 3 FEx06 Why Study Capital Structure? Traditional Perspective on Debt Debt is “bad” Modern Perspective on Debt; Debt can offer benefits Potential for confusion: personal v. corporate debt ______________________________ What is an optimal capital structure? Why is this definition relevant to stockholders? ______________________________ Why Study Capital Structure (financial leverage)? Managerial goals, cost of capital, tax reduction, capital budgeting
Background image of page 3

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

View Full DocumentRight Arrow Icon
Ramesh Rao 4 FEx06 How does financial leverage affect EPS and ROE ? Current Assets $20,000 Debt $0 Equity $20,000 Debt/Equity ratio 0.00 Interest rate n/a Shares outstanding 400 Share price $50 Proposed $20,000 $8,000 $12,000 2/3 8% 240 $50 Consider an all-equity with 400 shares outstanding. The firm is planning to issue debt. It borrows $8,000 and buys back 160 shares at $50 per share.
Background image of page 4
Ramesh Rao 5 FEx06 EPS and ROE Under Current (Unlevered) Capital Structure Recession Expected Expansion EBIT (NOI) $1,000 $2,000 $3,000 Interest 0 0 0 Net income $1,000 $2,000 $3,000 EPS $2.50 $5.00 $7.50 ROA 5% 10% 15% ROE 5% 10% 15% Current Shares Outstanding = 400 shares, where: share ice EPS ROE ASSETS EBIT ROA / Pr , = =
Background image of page 5

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

View Full DocumentRight Arrow Icon
Ramesh Rao 6 FEx06 EPS and ROE Under Proposed (Levered) Capital Structure Recession Expected Expansion EBIT $1,000 $2,000 $3,000 Interest @8% 640 640 640 Net income $360 $1,360 $2,360 EPS $1.50 $5.67 $9.83 ROA 5% 10% 15% ROE 3% 11% 20% Proposed Shares Outstanding = 240 shares
Background image of page 6
Ramesh Rao 7 FEx06 Combining previous two slides, Levered Firm (Proposed Shares = 240) Recession Expected Expansion EBIT $1,000 $2,000 $3,000 Interest 640 640 640 Net income $360 $1,360 $2,360 EPS $1.50 $5.67 $9.83 ROA 5% 10% 15% ROE 3% 11% 20% All-Equity Firm (Current Shares = 400 ) Recession Expected Expansion EBIT $1,000 $2,000 $3,000 Interest 0 0 0 Net income $1,000 $2,000 $3,000 EPS $2.50 $5.00 $7.50 ROA 5% 10% 15% ROE 5% 10% 15% ___________________________________________
Background image of page 7

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

View Full DocumentRight Arrow Icon
Ramesh Rao 8 FEx06 Financial Leverage and EPS (2.00) 0.00 2.00 4.00 6.00 8.00 10.00 12.00 1,000 2,000 3,000 EPS ($) Debt No Debt Break-even point EBIT ($) Advantage to debt Disadvantage to debt
Background image of page 8
Ramesh Rao 9 FEx06 Conclusions from this analysis? Known?
Background image of page 9

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

View Full DocumentRight Arrow Icon
Image of page 10
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 01/15/2010 for the course FIN 357 taught by Professor Hadaway during the Fall '06 term at University of Texas.

Page1 / 48

12-7a[1].- Captial Structure.ppt - Capital Structure...

This preview shows document pages 1 - 10. Sign up to view the full document.

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