Chapter13 - Chapter 13 Capital Structure and Leverage...

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Chapter 13 Capital Structure and Leverage Learning Objectives After reading this chapter, students should be able to: Explain why capital structure policy involves a trade-oF between risk and return, and list the four primary factors that in±uence capital structure decisions. Distinguish between a ²rm’s business risk and its ²nancial risk. Explain how operating leverage contributes to a ²rm’s business risk and conduct a breakeven analysis, complete with a breakeven chart. De²ne ²nancial leverage and explain its eFect on expected ROE, expected EPS, and the risk borne by stockholders. Brie±y explain what is meant by a ²rm’s optimal capital structure. Specify the eFect of ²nancial leverage on beta using the Hamada equation, and transform this equation to calculate a ²rm’s unlevered beta, b U . Illustrate through a graph the premiums for ²nancial risk and business risk at diFerent debt levels. List the assumptions under which Modigliani and Miller proved that a ²rm’s value is unaFected by its capital structure, then explain trade-oF theory, signaling theory, and the eFect of taxes and bankruptcy costs on capital structure. List a number of factors or practical considerations ²rms generally consider when making capital structure decisions. Brie±y explain the extent that capital structure varies across industries, individual ²rms in each industry, and diFerent countries. Chapter 13: Capital Structure and Leverage Learning Objectives 85
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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 13, 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: 4 OF 58 DAYS (50-minute periods) 86 Lecture Suggestions Chapter 13: Capital Structure and Leverage
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Answers to End-of-Chapter Questions 13-1 Operating leverage is the extent to which fxed costs are used in a frm’s operations. IF operating leverage is increased (fxed costs are high), then even a small decline in sales can lead to a large decline in profts and in its ROE. 13-2 a. The breakeven point will be lowered. b. The e±ect on the breakeven point is indeterminant. An increase in fxed costs will increase the breakeven point. However, a lowering oF the variable cost lowers the breakeven point. So it’s unclear which e±ect will have the greater impact. c. The breakeven point will be increased because fxed costs have increased.
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This homework help was uploaded on 04/07/2008 for the course FIN 201 taught by Professor Geottle during the Spring '08 term at Northeastern.

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Chapter13 - Chapter 13 Capital Structure and Leverage...

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