CFFM6, ch 13, IM, 11-12-08 - Chapter 13 Capital Structure...

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Unformatted text preview: Chapter 13 Capital Structure and Leverage Learning Objectives After reading this chapter, students should be able to: Identify the trade-offs that firms must consider when they determine their target capital structure. Distinguish between business risk and financial risk and explain the effects that debt financing has on the firms expected return and risk. Discuss the analytical framework used when determining the optimal capital structure. Discuss capital structure theory and use it to explain why firms in different industries tend to have different capital structures. Chapter 13: Capital Structure and Leverage Learning Objectives 83 Lecture Suggestions This chapter is rather long, but it is also modular, hence sections can be omitted without loss of continuity. Therefore, if you are experiencing a time crunch, you could skip selected sections. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 13, which appears at the end of this chapter solution. For other suggestions about the lecture, please see the Lecture Suggestions in Chapter 2, where we describe how we conduct our classes. DAYS ON CHAPTER: 4 OF 58 DAYS (50-minute periods) 84 Lecture Suggestions Chapter 13: Capital Structure and Leverage Answers to End-of-Chapter Questions 13-1 Operating leverage is the extent to which fixed costs are used in a firms operations. If operating leverage is increased (fixed costs are high), then even a small decline in sales can lead to a large decline in profits and in its ROE. 13-2 a. The breakeven point will be lowered. b. The effect on the breakeven point is indeterminant. An increase in fixed costs will increase the breakeven point. However, a lowering of the variable cost lowers the breakeven point. So its unclear which effect will have the greater impact. c. The breakeven point will be increased because fixed costs have increased. d. The breakeven point will be lowered. 13-3 If sales tend to fluctuate widely, then cash flows and the ability to service fixed charges will also vary. Consequently, there is a relatively large risk that the firm will be unable to meet its fixed charges. As a result, firms in unstable industries tend to use less debt than those whose sales are subject to only moderate fluctuations, or relatively stable sales....
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CFFM6, ch 13, IM, 11-12-08 - Chapter 13 Capital Structure...

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