Week 10 Lecture - Capital Structure - Theory and Evidence (Chapters 13) - 6 slides per page

Week 10 Lecture - Capital Structure - Theory and Evidence (Chapters 13) - 6 slides per page

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25/09/2010 1 FINS1613 Business Finance Week 10 Chapter 13 Capital Structure: Theory and Evidence 1 Revision Week 9 ± Chapter 12 ¾ We learnt how to determine R E , R D , R P using various methods ¾ We learnt how to calculate weights for R E , R D , R P for WACC ¾ We learnt how to calculate tax with classical and imputation tax systems ¾ We learnt when to calculate WACC with classical and imputation tax systems four different ways following Officer (1994) ± Chapter 15 ¾ We learnt about the various ways firms issue (raise) capital ¾ Equity – IPOs, Secondary equity offerings; Debt – long-term bonds ¾ We learnt how to calculate underpricing of IPOs ¾ IPO spread, direct costs, indirect costs 2 CONTENTS 1. Understand capital structure 2. What is the impact of leverage on the firm’s risk (i.e., understand financial risk) 3. Understand the ‘capital structure irrelevance’ theory of Modigliani and Miller (MM) Modigliani and Miller (MM). 4. Explain the impact of taxes and other factors on capital structure decisions. 5. Consider the empirical evidence on capital structure. 6. Outline the main factors that financial managers should consider when determining a firm’s financing strategy. 3 Leverage and Capital Structure: Chapter 13 Key Concepts and Skills ± Understand the effect of financial leverage on cash flows and cost of equity ± Understand the impact of taxes and Understand the impact of taxes and bankruptcy on capital structure choice ± Understand the basic components of bankruptcy 4 Chapter 13 Outline ± The Capital Structure Question ± The Effect of Financial Leverage ± Capital Structure and the Cost of Equity Capita Capital ± Corporate Taxes and Capital Structure ± Bankruptcy Costs ± Optimal Capital Structure ± Observed Capital Structures 5 WHAT IS THE CAPITAL STRUCTURE ± Definition: Capital structure mode of financing used to finance investments ¾ It is the proportion of Debt, Equity, Hybrids (etc.) that comprise the overall value of the firm ¾ [Recall that Value = Debt + Equity + Hybrids +. ..] ± Optimal capital structure: ¾ The structure that maximizes Shareholder wealth by minimizing WACC ± Target capital structure: ¾ The structure that management deems ideal ¾ This need not equal the optimal capital structure 6
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25/09/2010 2 ISSUES IN DETERMINING THE CAPITAL STRUCTURE? ± Overall issue: How should the firm finance investments? ± Steps: 1 Determine the financing choice 1. Determine the financing choices 2. Analyze the impact of these choices on the firm’s market value 3. Determine the optimal structure 7 WHAT ARE THE CHOICES ± Should the firm use retained earnings or seek external financing? ¾ How much capital must be raised externally versus internally? ± If external financing, ¾ How much should it borrow ¾ How much should it raise through issuing shares ± Financier: ¾ Should the firm use an intermediary (i.e., a bank or institution) or should the firm go directly to investors 8 Capital Restructuring ± We are going to look at how changes in capital structure affect the value of the firm,
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Week 10 Lecture - Capital Structure - Theory and Evidence (Chapters 13) - 6 slides per page

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