6thCh13P - CHAPTER13 CapitalStructureandLeverage...

Info iconThis preview shows pages 1–14. Sign up to view the full content.

View Full Document Right Arrow Icon
1 CHAPTER 13 Capital Structure and Leverage Business vs. financial risk Optimal capital structure Operating leverage Capital structure theory
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 Uncertainty about future operating income (EBIT),  i.e., how well can we predict operating income? Note that business risk does not include financing  effects. What is business risk? Probability EBIT E(EBIT) 0 Low risk High risk
Background image of page 2
3 What is operating leverage, and how  does it affect a firm’s business risk? Operating leverage is the use of  fixed costs rather than variable  costs. If most costs are fixed, hence do not  decline when demand falls, then the  firm has high operating leverage.
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 Effect of operating leverage More operating leverage leads to more  business risk, for then a small sales decline  causes a big profit decline. What happens if variable costs change? Sales $ Rev. TC FC Q BE Sales $ Rev. TC FC Q BE } Profit
Background image of page 4
5 Operating Leverage Operating breakeven when ROE=0 EBIT=PQ-VQ-F Solving for breakeven quantity: BE F Q P-V =
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 Uses of Breakeven Analysis Expansion of operations New Products New Technology Change in Price
Background image of page 6
7 Finding the Breakeven  Quantity Lotus Machinery expects to sell 10,000  widgets per month.  Its fixed costs are  $2,000 and each widget costs $1.50 in  variable costs.   What price must Lotus charge to break  even?
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 What is financial leverage? Financial risk? Financial leverage is the use of debt  and preferred stock. Financial risk is the additional risk  concentrated on common  stockholders as a result of financial  leverage.
Background image of page 8
9 Importance of the Financing  Decision Optimal capital structure maximizes firm  value. The value of a real asset is determined  by the level and risk of the cash flows that the  asset is expected to generate the way the asset is financed
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 Miller and Modigliani on Debt that the firm value is independent of  financial policy if there are  no taxes no transaction or information costs the real investment policy of the firm is  fixed
Background image of page 10
11
Background image of page 11

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

View Full DocumentRight Arrow Icon
12
Background image of page 12
13 An example: Illustrating effects of financial leverage Two firms with the same operating leverage, 
Background image of page 13

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

View Full DocumentRight Arrow Icon
Image of page 14
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 03/02/2011 for the course BMGT 340 taught by Professor White during the Spring '08 term at Maryland.

Page1 / 38

6thCh13P - CHAPTER13 CapitalStructureandLeverage...

This preview shows document pages 1 - 14. Sign up to view the full document.

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