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Topic 11 - Topic 11 Capital Structure Readings Chap 15 The...

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Topic 11 Capital Structure Readings: Chap 15
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Assets Liabilities & Equity Current Assets Current Liabilities Fixed Assets Long-term Debt Preferred Stock Common Equity The investment decision
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Assets Liabilities & Equity Current Assets Current Liabilities Fixed Assets Long-term Debt Preferred Stock Common Equity The financing decision
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Average Book Debt Ratios Industry Debt Ratio Software and programming 0.06 Semiconductors 0.09 Communications equipment 0.13 Biotech 0.28 Retail 0.34 Hotels and motels 0.37 Chemical manufacturing 0.53 Airlines 0.59 Electric utilities 0.60 Real estate operations 0.62 Beverages (alcohol) 0.63 -------------------------------------- -------- Average for US Companies 0.51
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Firm value VS shareholder value Why should the stockholders care about maximizing firm value? Perhaps they should be interested in strategies that maximize shareholder value. Changes in capital structure benefit the stockholders if and only if the value of the firm increases.
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Financial Leverage, 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 firm that is contemplating going into debt. (Maybe some of the original shareholders want to cash out.)
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EPS and ROE Under Current Structure Recession Normal 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% Current Shares Outstanding = 400 shares
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EPS and ROE Under Proposed Structure Recession Normal 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 1.8% 6.8% 11.8% ROE 3.0% 11.3% 19.7% Proposed Shares Outstanding = 240 shares
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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 in dollars, no taxes Advantage to debt Disadvantage to debt
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