ch16 - Fundamentals of Corporate Finance 2/e ROBERT PARRINO...

This preview shows page 1 - 11 out of 55 pages.

Fundamentals of Corporate Finance, 2/e ROBERT PARRINO, PH.D. DAVID S. KIDWELL, PH.D. THOMAS W. BATES, PH.D.
Image of page 1

Subscribe to view the full document.

Chapter 16: Capital Structure Policy
Image of page 2
Learning Objectives 1. DESCRIBE THE TWO MODIGLIANI AND MILLER PROPOSITIONS, THE KEY ASSUMPTIONS UNDERLYING THEM, AND THEIR RELEVANCE TO CAPITAL STRUCTURE DECISIONS. USE PROPOSITION 2 TO CALCULATE THE RETURN ON EQUITY. 2. DISCUSS THE BENEFITS AND COSTS OF USING DEBT FINANCING AND CALCULATE THE VALUE OF THE INCOME TAX BENEFIT ASSOCIATED WITH DEBT. 3. DESCRIBE THE TRADE-OFF AND PECKING ORDER THEORIES OF CAPITAL STRUCTURE CHOICE AND EXPLAIN WHAT THE EMPIRICAL EVIDENCE TELLS US ABOUT THESE THEORIES.
Image of page 3

Subscribe to view the full document.

Learning Objectives 4. DISCUSS SOME OF THE PRACTICAL CONSIDERATIONS THAT MANAGERS ARE CONCERNED WITH WHEN THEY CHOOSE A FIRM’S CAPITAL STRUCTURE.
Image of page 4
Capital Structure and Firm Value o A firm’s capital structure is the mix of financial securities used to finance its activities. o The mix will always include common stock and will often include debt and preferred stock. o The firm may have several classes of common stock, for example with different voting rights and possibly different claims on the cash flows available to stockholders.
Image of page 5

Subscribe to view the full document.

Capital Structure and Firm Value o The debt at a firm can be long term or short term, secured or unsecured, convertible or not convertible into common stock, and so on. o Preferred stock can be cumulative or noncumulative and convertible or not convertible into common stock. o The fraction of the total financing that is represented by debt is a measure of the financial leverage in the firm’s capital structure.
Image of page 6
Capital Structure and Firm Value o A higher fraction of debt indicates a higher degree of financial leverage. o The amount of financial leverage in a firm’s capital structure is important because it affects the value of the firm.
Image of page 7

Subscribe to view the full document.

Capital Structure and Firm Value o THE OPTIMAL CAPITAL STRUCTURE Managers at a firm choose a capital structure  so that the mix of securities making up the  capital structure minimizes the cost of financing  the firm’s activities. The capital structure that minimizes the cost of  financing the firm’s projects is also the capital  structure that maximizes the total value of those  projects and, therefore, the overall value of the  firm.
Image of page 8
Capital Structure and Firm Value o THE MODIGLIANI AND MILLER PROPOSITIONS M&M Proposition 1 Modigliani and Miller Proposition 1 states that the capital structure decisions a firm makes will have no effect on the value of the firm if: There are no taxes. There are no information or transaction costs. The real investment policy of the firm is not affected by its capital structure decisions.
Image of page 9

Subscribe to view the full document.

Capital Structure and Firm Value o THE MODIGLIANI AND MILLER PROPOSITIONS M&M Proposition 1 The real investment policy of the firm includes the criteria that the firm uses in deciding which real assets (projects) to invest in.
Image of page 10
Image of page 11

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern