Chapter+15_S

Chapter+15_S - Capital Structure Chapter 15 BDH Chapter...

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Capital Structure Chapter 15, BDH
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Chapter Outline 15.1 Capital Structure Choices 15.2 Capital Structure in Perfect Capital Markets 15.3 Debt and Taxes 15.4 Costs of Bankruptcy and Financial Distress 15.5 Optimal Capital Structure: The Tradeoff Theory 15.6 Additional Consequences of Leverage: Agency Costs and Information 15.7 Capital Structure: Putting It All Together 1
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Learning Objectives Examine how capital structures vary across industries and companies Understand why investment decisions, rather than financing decisions, fundamentally determine the value and cost of capital of the firm Describe how leverage increases the risk of the firm’s equity Demonstrate how debt can affect firm value through taxes and bankruptcy costs 2
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Learning Objectives (cont’d) Show how the optimal mix of debt and equity trades off the costs (including financial distress costs) and benefits (including the tax advantage) of debt Analyze how debt can alter the incentives of managers to choose different projects and can be used as a signal to investors Weigh the many costs and benefits to debt that a manager must balance when deciding how to finance the firm’s investments 3 Learning Objectives
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15.1 Capital Structure Choices The collection of securities a firm issues to raise capital from investors is called the firm’s capital structure . When raising funds from outside investors, a firm must choose what type of security to issue and what capital structure to have. A firm’s debt-to-value ratio, D E+D , is the fraction of the firm’s total value that corresponds to debt 4 15.1 Capital Structure Choices
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Figure 15.1 Debt-to-Value Ratio D E+D for Selected Industries 5 15.1 Capital Structure Choices
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15.2 Capital Structure in Perfect Capital Markets A perfect capital market is a market in which: Securities are fairly priced No tax consequences or transactions costs Investment cash flows are independent of financing choices Unlevered equity: equity in a firm with no debt Levered equity: equity in a firm that has debt outstanding Leverage will increase the risk of the firm’s equity and raise its equity cost of capital 6 15.2 Capital Structure in Perfect Capital Markets
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7 Financial Risk Vs Business Risk Financial Risk Increases with leverage Affects equity holders Reflected in r E Business Risk Depends on industry Related to income to equity holders (Div) Affects all stakeholders Related to operating income to the firm (EBIT) Reflected in r WACC 15.2 Capital Structure in Perfect Capital Markets
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15.2 Capital Structure in Perfect Capital Markets Modigliani and Miller (MM) concluded that with perfect capital markets the total value of a firm should NOT depend on its capital structure.
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This note was uploaded on 07/30/2011 for the course FIN 111 taught by Professor Mark during the Spring '11 term at HKU.

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Chapter+15_S - Capital Structure Chapter 15 BDH Chapter...

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