BADM 7090 IVD 2010 - Corporate Financing Policy (Capital Structure)

BADM 7090 IVD 2010 - Corporate Financing Policy (Capital Structure)

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BADM 7090 Financial Management Unit IV.D Corporate Financing Policy: Capital Structure Text material: GSM, Chs. 12 (up to p. 425), 13 (up to p. 456) D. Chance
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVD p. 2 of 48 Questions Does borrowing as a source of capital offer any advantage over equity? How do companies determine how much to borrow?
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVD p. 3 of 48 Some Capital Structures of Major Corporations **This page updated Capital Structure Weights for Book Value and Market Value (December 31, 2009) (1) Book value Exxon Shaw Apple Wal- Star- P&G GOOGLE Dow South- AT&T Mobil Group Inc Mart Bucks Chem West Current liabilities / Assets 22.3% 71.0% 24.3% 32.5% 29.2% 17.5% 6.8% 19.9% 18.8% 13.7% Long-term liabilities / Assets 28.2% 2.5% 9.4% 24.7% 15.7% 31.5% 4.3% 48.1% 42.9% 48.3% Equity / Assets 49.5% 26.5% 66.3% 42.7% 55.1% 51.0% 88.9% 32.0% 38.3% 38.1% Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% (2) Market value Exxon Shaw Apple Wal- Star- P&G GOOGLE Dow South- AT&T Mobil Group Inc Mart Bucks Chem West Current liabilities / Assets 9.5% 63.3% 5.6% 15.1% 7.7% 9.7% 1.2% 14.1% 12.9% 10.9% Long-term liabilities / Assets 12.0% 2.2% 2.1% 11.4% 4.2% 17.4% 0.8% 34.1% 29.5% 38.6% Equity / Assets 78.6% 34.5% 92.3% 73.5% 88.1% 72.9% 98.0% 51.8% 57.5% 50.5% Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% * The ratios for Shaw Group and Wal-Mart are as of February 28, 2010 and January 31, 2010, respectively. ** Total equity includes non-controlling interests.
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVD p. 4 of 48 What Happens When a Company Uses Debt? Example Problem IV.D(1) : Consider two companies with equivalent assets of $10,000. Company A has no debt and Company B has debt of $4,000 at 6%. Determine the return on the shareholders’ investment for operating incomes of $1,000 and -$1,000.
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVD p. 5 of 48 What Happens When a Company Uses Debt? (cont.) Company A Company B Assets $10,000 $10,000 Debt $0 $4,000 Interest rate NA 6% Operating income $1,000 -$1,000 $1,000 -$1,000 Interest $0 $0 $240 $240 Net income $1,000 -$1,000 $760 -$1,240 Return on equity 10.00% -10.00% 12.67% -20.67% (Note: your textbook does this analysis by looking at EPS. See pp. 413-416.) Note how the company with no debt (A) has a return on equity of 10% in a good year and -10% in a bad year. The company with debt (B) has a higher return on equity in a good year, 12.67%, and a lower return on equity in a bad year, -20.67%. Debt magnifies gains and losses. Thus, there is both a positive and a negative side to debt.
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVD p. 6 of 48 What Happens When a Company Uses Debt? (cont.) Can a company find an optimal amount of debt? ( Fig. 13.2, p. 440)
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVD p. 7 of 48 What Happens When a Company Uses Debt? We shall first examine whether debt has a
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BADM 7090 IVD 2010 - Corporate Financing Policy (Capital Structure)

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