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CapitalStructure - CapitalStructure CapitalStructure ratio...

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Capital Structure FINC 3630 Yost Capital Structure Optimal Capital Structure What is capital structure? How should a firm choose a debt to equity How should a firm choose a debt to equity ratio? The goal: _________________________ Which is done by: __________________ Which is done by: __________________ Financial Leverage Scenario A B C Market Value of Debt $0 $50 $75 Market Value of Equity $100 $50 $25 Market Value of Assets $100 $100 $100 Debt to Equity Ratio 0.0 1.0 3.0 Number of Shares ($1 each) 100 50 25
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Capital Structure FINC 3630 Yost Financial Leverage Scenario A B C Corporate Borrowing Rate 8% 8% 8% EBIT $20 $20 $20 Interest Expense $0 $4 $6 Taxes (assume 0%) $0 $0 $0 Net Income $20 $16 $14 Financial Leverage Scenario A B C ROA ROE EPS e (assume A = 1) 1.0 2.0 4.0 Asset Betas and Equity Betas Equity C Asset Debt] ) T - [(1 Equity Equity Equity Debt T - 1 1 C Asset Equity
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Capital Structure FINC 3630 Yost Financial Leverage What is financial leverage? What are the effects of financial leverage? What is meant by “homemade leverage”? The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed. Homemade Leverage Assume the firm in the previous example has no debt (Scenario A). Also assume you personally prefer to have the leverage in Scenario C. How could you do this on your own? The M&M Propositions Why is Keven obsessed with M&Ms? Franco Modigliani and Merton Miller won Nobel prizes for the following (irrelevance) propositions. Consider a world of no taxes (we will consider the role of taxes later), no bankruptcy costs, and perfect, efficient capital markets. People can borrow and lend at the same rate as the firm.
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Capital Structure FINC 3630 Yost M&M Proposition I (no taxes) Does capital structure matter?
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