Topic 11 - Topic 11 CAPITAL STRUCTURE First looks When a...

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Topic 11 CAPITAL STRUCTURE
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First looks Ø When a firm needs to raise new funds to undertake its investments, it must decide: which type of financing security it will issue to investors What considerations for this decision How does this decision affect the firm’s value Ø Perfect capital market is the capital market in which: All securities are fairly priced: market price equals to the present value of future cash flows No taxes or transaction costs associated with
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Capital Structure Choices Ø The relative proportions of debt, equity and other securities that a firm ahs outstanding constitute its capital structure. Ø Various financing choices will promise different future amounts to each security holder in exchange for the cash that it raise today. Ø Managers also need to consider whether the securities in the market, have tax consequences, entail transaction costs, or even change its future investment opportunities.
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Capital structure in Perfect Market Ø Example: Run a coffee shop in one year Upfront investment of $24,000 Cash flow generated after covering all operating costs at the end of the year is $34,500 Current risk free is 5% and risk premium is 10% è NPV= $6000 >0  accept the investment è How should you raise the funds, and what is the amount you will be able to raise?
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Equity Financing When the equity is used without debt, the firm is said to be unlevered. Recall the example: Raise fund by selling equity
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Topic 11 - Topic 11 CAPITAL STRUCTURE First looks When a...

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