Chapter 14 - FIN 3403 - PowerPoint

Chapter 14 - FIN 3403 - PowerPoint - FIN 3403 Module 10 -...

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Unformatted text preview: FIN 3403 Module 10 - Chapter 14 Page 1 CHAPTER 14 Capital Structure and Leverage Capital Structure FIN 3403 - Business Finance Applications Basics Capital Structure Theories Breakeven Leverage Functions Business and Financial Risk Basic Equations Modigliani & Miller Using Valuation Equations Optimal Capital Structure Current View Stockholders vs. Bondholders Breakeven Analysis Assumptions : ¡ Firms A and B each have sales of 100 units with a price of $5 per it unit. ¡ Firm B has traded fixed costs for variable costs. ¡ Firm B has levered itself by issuing debt. FIN 3403 Module 10 - Chapter 14 Page 2 Breakeven Analysis Firm A Firm B Sales $500 $500 Variable Costs-$350-$200 Fixed Costs $0-$150 Units 100 EBIT $150 $150 Interest $0-$60 EBT $150 $90 Taxes (40%)-$60-$36 Net Income $90 $54 Breakeven Analysis ¡ EBIT Breakeven : Q* = [F] / [P - V] S* = [F] / [1 - (V/P)] S [F] / [1 (V/P)] ¡ Net Income Breakeven : Q* = [F + I] / [P - V] S* = [F + I] / [1 - (V/P)] Breakeven Analysis ¡ Firm B EBIT Breakeven : Q* = [$150] / [$5 - $2] Q* = 50 Units S* = [$150] / [1 - ($2/$5)] S* = [$150] /[.60] = $250 S* = [50 units] [$5] = $250 FIN 3403 Module 10 - Chapter 14 Page 3 Breakeven Analysis Units 50 Firm A Firm B Sales $250 $250 Variable Costs-$175-$100 Fixed Costs $0-$150 EBIT $75 $0 Interest $0-$60 EBT $75-$60 Taxes (40%)-$30 $24 Net Income $45-$36 Breakeven Analysis ¡ Firm B Net Income Breakeven : Q* = [$150 + $60] / [$5 - $2] Q* = 70 Units Q 70 Units S* = [$150 + $60] / [1 - ($2/$5)] S* = [$210] /[.60] = $350 S* = [70 units] [$5] = $350 Breakeven Analysis Units 70 Firm A Firm B Sales $350 $350 Variable Costs-$245-$140 Fixed Costs $0-$150 EBIT $105 $60 Interest $0-$60 EBT $105 $0 Taxes (40%)-$42 $0 Net Income $63 $0 FIN 3403 Module 10 - Chapter 14 Page 4 Capital Structure and Risk ¡ Factors to consider z Business risk z Financial risk (leverage) z Need for financial flexibility z Tax position z Managerial perspective ¾ Conservative ¾ Aggressive Capital Structure and Risk r S = r RF + [r M- r RF ][ β L ] β = β + β (1 T)(D/E β L = β U + β U (1-T)(D/E) r S = r RF + [r M- r RF ][ β U ] + [r M- r RF ][ β U ](1-T)(D/E) Capital Structure and Risk r S = r RF + Business risk premium + Financial risk premium ¡ Business risk concerns the uncertainty inherent in EBIT. FIN 3403 Module 10 - Chapter 14 Page 5 Business Risk Probability Lower Risk 0 EBIT Higher Risk Business Risk ¡ Business risk factors z Demand variability z Sales price variability Sales price variability z Input price variability z Ability to adjust output prices for changes in input prices z Operating leverage Operating Leverage 400 500 600 700 800 $225 Profit Fixed costs = $0; Variable Costs = $3.50/Unit : 100 200 300 400 1 2 3 4 5 6 7 8 9 1 1 1 1 2 1 3 1 4 1 5 Units Sold Revenues Costs Breakeven = 0 Units FIN 3403 Module 10 - Chapter 14 Page 6 Operating Leverage 400 500 600 700 800 Fixed costs = $150; Variable Costs = $2.00/Unit : $300 Profit 100 200 300 400 1 2 3 4 5 6 7 8 9 1 1 1 1 2 1...
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This note was uploaded on 01/11/2012 for the course FIN 3403 taught by Professor Tapley during the Fall '06 term at University of Florida.

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Chapter 14 - FIN 3403 - PowerPoint - FIN 3403 Module 10 -...

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