ffm11i14(3) - CapitalStructureandLeverage...

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Chapter 14 Capital Structure and Leverage Learning Objectives After reading this chapter, students should be able to: Explain why capital structure policy involves a trade-off between risk and return, and list the four primary  factors that influence capital structure decisions. Distinguish between a firm’s business risk and its financial risk. Explain how operating leverage contributes to a firm’s business risk and conduct a breakeven analysis,  complete with a breakeven chart. Define financial leverage and explain its effect on expected ROE, expected EPS, and the risk borne by  stockholders. Briefly explain what is meant by a firm’s optimal capital structure. Specify the effect of financial leverage on beta using the Hamada equation, and transform this equation  to calculate a firm’s unlevered beta, b U . Illustrate through a graph the premiums for financial risk and business risk at different debt levels. List the assumptions under which Modigliani and Miller proved that a firm’s value is unaffected by its  capital structure, then explain trade-off theory, signaling theory, and the effect of taxes and bankruptcy  costs on capital structure. List a number of factors or practical considerations firms generally consider when making capital  structure decisions. Briefly explain the extent that capital structure varies across industries, individual firms in each industry,  and different countries. Chapter 14:  Capital Structure and Leverage Learning Objectives 107
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Lecture Suggestions This chapter is rather long, but it is also modular, hence sections can be omitted without loss of continuity.  Therefore, if you are experiencing a time crunch, you could skip selected sections. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case  solution for Chapter 14, which appears at the end of this chapter solution.  For other suggestions about the  lecture, please see the “Lecture Suggestions” in Chapter 2, where we describe how we conduct our classes. DAYS ON CHAPTER:  3 OF 58 DAYS (50-minute periods) 108 Lecture Suggestions Chapter 14:  Capital Structure and Leverage
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Answers to End-of-Chapter Questions 14-1 Operating leverage is the extent to which fixed costs are used in a firm’s operations.  If operating  leverage is increased (fixed costs are high), then even a small decline in sales can lead to a large  decline in profits and in its ROE.
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This note was uploaded on 02/08/2012 for the course FINANCE MA 502 taught by Professor Chaudhry during the Spring '11 term at Instituto Balseiro.

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ffm11i14(3) - CapitalStructureandLeverage...

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