Chapter 16

Chapter 16 - 1 Chapter 16 Debt Policy Capital Structure...

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Unformatted text preview: 1 Chapter 16 Debt Policy Capital Structure Decision 2 Topics Covered Debt and Value in a Tax Free Economy Capital Structure and Corporate Taxes Cost of Financial Distress Explaining Financial Choices 3 Average Book Debt Ratios 4 Value and Capital Structure Assets Liabilities and Stockholders Equity Value of cash flows from firms real assets and operations Market value of debt Market value of equity Value of Firm Value of Firm 5 Value and Capital Structure The size of a pie have nothing to do with how it is sliced. The value of a firm is independent of its capital structure. 6 M&M (Debt Policy Doesnt Matter) Modigliani & Miller (MM)s Proposition I When there are no taxes and capital markets function well, the market value of a company does not depend on its capital structure. In other words, financial managers cannot increase value by changing the mix securities used to finance the company. 7 M&M (Debt Policy Doesnt Matter) Example- River Cruises - All Equity Financed 17.5% 12.5% 7.5% shares on Return 1.75 1.25 $.75 share per Earnings 175,000 125,000 $75,000 Incom e Operating Boom Norm al Slum p Econom y the of State Outcome m illion 1 $ Shares of Value M arket $10 share per Price 100,000 shares of Num ber Data 8 M&M (Debt Policy Doesnt Matter) Example cont. 50% debt 25% 15% 5% shares on Return 2.50 1.50 $.50 share per Earnings 125,000 75,000 $25,000 earnings Equity 50,000 50,000 $50,000 Interest 175,000 125,000 $75,000 Income Operating Boom Normal Slump Economy the of State Outcome 500,000 $ debt of ue Market val 500,000 $ Shares of Value Market $10 share per Price 50,000 shares of Number Data 9...
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Chapter 16 - 1 Chapter 16 Debt Policy Capital Structure...

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