Effective capital structure decisions can lower the

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Unformatted text preview: Chapters 4, 5, 6, 7, and 10 and the discussion of leverage in this chapter. 9. Of course, although capital structure is financially important, it, like many business decisions, is generally not so important as the firm’s products or services. In a practical sense, a firm can probably more readily increase its value by improving quality and reducing costs than by fine-tuning its capital structure. CHAPTER 11 Leverage and Capital Structure 435 Types of Capital All of the items on the right-hand side of the firm’s balance sheet, excluding current liabilities, are sources of capital. The following simplified balance sheet illustrates the basic breakdown of total capital into its two components, debt capital and equity capital. Balance Sheet Current liabilities Long-term debt Assets Debt capital Stockholders’ equity Preferred stock Common stock equity Common stock Retained earnings Equity capital Total capital The various types and characteristics of corporate bonds, a major source of debt capital, were discussed in detail in Chapter 6. The cost of debt is lower than the cost of other forms of financing. Lenders demand relatively lower returns because they take the least risk of any long-term contributors of capital: (1) They have a higher priority of claim agains...
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