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Unformatted text preview: ies between U.S. corporations and
those of other countries include industry patterns of
capital structure, large multinational company capital structures, and the trend toward greater reliance
LG3 544 PART 4 Long-Term Financial Decisions on securities issuance and less reliance on banks for
Research suggests that there is an optimal capital
structure that balances the firm’s benefits and costs of
debt financing. The major benefit of debt financing is
the tax shield. The costs of debt financing include the
probability of bankruptcy, caused by business and
financial risk; agency costs imposed by lenders; and
asymmetric information, which typically causes
firms to raise funds in a pecking order of retained
earnings, then debt, and finally external equity
financing, in order to send positive signals to the market and thereby enhance the wealth of shareholders.
Explain the optimal capital structure using a
graphical view of the firm’s cost-of-capital
functions and a zero-growth valuation model. The
zero-growth valuation model c...
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