07Capital+Structure

07Capital+Structure - CapitalStructure...

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Capital Structure
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Key Questions in Corporate  Finance Valuation How do we decide between good and bad  projects? Financing How should projects that we choose to undertake  be financed?
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Real Investment Policy Which projects should a firm undertake? Open a new plant? Scale operations up or down? Acquire another company? Real investments can create value DCF analysis Positive NPV projects add value 
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Financing Policy Real investment policies imply funding needs But, what is the best source of funds? Internal funds? Debt? Equity?
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Financing Decision – Definitions The firm’s market value (V) = market value of  debt (D) + market value of equity (E) Unlevered firm - A firm with no debt. Levered firm  The value of a levered firm is the value of the stock plus the  value of the firm’s debt. Shareholders have a junior claim on cash flows, but they  retain the control rights.  Change in Capital Structure: proceeds of any  new security sale are used to retire another type  of security  NO change in the total asset size or composition of  assets.
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Book Value vs. Market Value Book value is a backward looking measure Tells us how much capital the firm has raised in  the past Market value is a forward looking measure Tells us how much value the investors place on  their investment today
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Operating Leverage Operating Leverage  Ratio of fixed costs to variable costs. Business Risk Uncertainty about demand (sales). Uncertainty about output prices. Uncertainty about costs. Product, other types of liability. Operating leverage - Fixed costs do NOT decline  when demand falls.
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Financial Leverage Financial leverage  The use of debt and preferred stock. Financial risk  The additional risk concentrated on common  stockholders as a result of financial leverage.
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Business Risk vs Financial Risk Business risk depends on business factors such as  competition, product liability, and operating  leverage Financial risk  depends only on the types of  securities issued More debt, more financial risk Concentrates business risk on stockholders
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Optimal Capital Structure Is there an optimal capital structure?
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This note was uploaded on 02/17/2012 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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07Capital+Structure - CapitalStructure...

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