Lecture 39 - Business Finance (ACC501) Lesson 39 Review of...

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202 Business Finance (ACC501) Lesson 39 Review of the Previous Lecture M&M Propositions Business and Financial Risk Corporate Taxes & Capital Structure Topics Under Discussion Bankruptcy Costs Static Theory of Capital Structure Some Managerial Recommendations Net Working Capital Bankruptcy Costs Direct Bankruptcy Costs The costs that are directly associated with bankruptcy, such as legal and administrative expenses Indirect Bankruptcy Costs The costs of avoiding a bankruptcy filing incurred by a financially distress firm Financial Distress Costs The direct and indirect costs associated with going bankrupt or experiencing financial distress Static Theory of Capital Structure A firm borrows up to the point where tax benefit from an extra dollar in debt is exactly equal to the cost that comes from the increased probability of financial distress
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203 Optimal Capital Structure The maximum value of the firm, V L * is reached at a debt level of D*, so this is the optimal amount of borrowing Alternatively, the firm’s capital structure is composed of D*/ V L * in debt and (1 - D*/ V L *) in equity. The difference between the value of firm in static theory and the M&M value of the firm with taxes is the loss in value from the possibility of financial distress The difference between the static theory value of the firm and the M&M value with no
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This note was uploaded on 08/04/2011 for the course ACCT 501 taught by Professor Na during the Spring '11 term at Virtual University of Pakistan.

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Lecture 39 - Business Finance (ACC501) Lesson 39 Review of...

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