Chapter_16_FA311_US2011_SS

Chapter_16_FA311_US2011_SS - Click to edit Master title...

Info iconThis preview shows pages 1–10. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Click to edit Master title style 12/29/11 1 12/29/11 Chapter 16 Financial Leverage and Capital Structure Policy Click to edit Master title style 12/29/11 2 12/29/11 Key Concepts and Skills Understand the effect of financial leverage on cash flows and the cost of equity Understand the impact of taxes and bankruptcy on capital structure choice Understand the basic components of the bankruptcy process Click to edit Master title style 12/29/11 3 12/29/11 Capital Restructuring We are going to look at how changes in capital structure affect the value of the firm, all else equal Capital restructuring involves changing the amount of leverage a firm has without changing the firms assets The firm can increase leverage by issuing debt and repurchasing outstanding shares of stock The firm can decrease leverage by issuing new shares of stock and retiring outstanding debt Click to edit Master title style 12/29/11 4 12/29/11 Choosing a Capital Structure What is the primary goal of financial managers? Maximize stockholder wealth We want to choose the capital structure that will maximize stockholder wealth We can maximize stockholder wealth by maximizing the value of the firm or minimizing the WACC Click to edit Master title style 12/29/11 5 12/29/11 Example: Financial Leverage, EPS and ROE Part I We will ignore the effect of taxes at this stage What happens to EPS and ROE when we issue debt and buy back shares of stock? Click to edit Master title style 12/29/11 6 12/29/11 Example: Financial Leverage, EPS and ROE Part I Click to edit Master title style 12/29/11 7 12/29/11 The Effect of Leverage How does leverage affect the EPS and ROE of a firm? When we increase the amount of debt financing, we increase the fixed interest expense If we have a really good year, then we pay our fixed cost and we have more left over for our stockholders If we have a really bad year, we still have to pay our fixed costs and we have less left over for our stockholders Leverage amplifies the variation in both EPS and ROE Reminder: in a restructuring effort, if we increase the amount of debt, we are implicitly decreasing the amount of equity. Click to edit Master title style 12/29/11 8 12/29/11 Example: Financial Leverage, EPS and ROE Part II Variability in ROE Current: ROE ranges from 6% to 20% Proposed: ROE ranges from 2% to 30% Variability in EPS Current: EPS ranges from $0.60 to $2.00 Proposed: EPS ranges from $0.20 to $3.00 The variability in both ROE and EPS increases when financial leverage is increased Click to edit Master title style 12/29/11 9 12/29/11 Financial Leverage and EPS Note: the slope of the dotted line (levered strategy) is steeper. This is because in the levered situation there are fewer shares outstanding and, consequently, a small increase in EBIT generates a bigger increase in EPS compared to the unlevered situation. Click to edit Master title style...
View Full Document

This note was uploaded on 12/28/2011 for the course FI 311 taught by Professor Booth during the Fall '06 term at Michigan State University.

Page1 / 40

Chapter_16_FA311_US2011_SS - Click to edit Master title...

This preview shows document pages 1 - 10. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online