Big Data Analysis and Storage Challenges

1
Running head: BIG DATA
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BIG DATA
MIT 681 : MSIT capstone
Student name: sunil patel
Student number: 15T1FG68
Professor name: Mark o’connell
Introduction
With the invention of new technology data management has
been viewed as one aspect where technology should be
implemented. Despite the existence of traditional approaches
and methodologies in data storage and management the way data
is handled differs from one organization to the other. Big data
analysis and storage remains a challenge to many, however
much has been achieved and individuals are reaping from the
changes which come with new technology techniques such as
cloud computing and many other data management technologies
(Curry 2016). With individuals having data sources such as the
Amazon websites and the yahoo among others proper data

storage and accessing tools are very important. It is very
important to appreciate the fact that for one to attain high
integrity levels in big data management and analysis there are
several factors to put into consideration.
These factors include but are not limited to: Flexibility The
method of analyzing and storing individual’s data should be
able to meet the ever changing technological changes and
demands. Maintainability The mechanism should be
maintainable by the users Accountability and reliability Users
should be able to trust the chosen system and rely on it without
fear of losing their data and any other critical information.
The term big data has brought a lot of influences in the data
storage, while it is used to refer to a collection of several data
from different sources majority are yet to accept the fact that
this has been there for ancients with traditional methods applied
to access and store the relevant data. Today due to raise in
technology security threats have diversified something which
calls for users to be alert and practice ethical secure methods
when using big data (Gandomi, & Haider 2015). Likewise users
need to put into consideration the necessity of the data and
ensure they observe the set policies so as to ensure that they do
not go against the laid procedures and regulations while using
the data. Additionally there are several big data approaches all
of which have certain capabilities in managing data.
To be able to succeed in big data approach individuals ought to
put into consideration the security concerns and the responses
each model offer. Data access, management and storage is a
very critical aspect therefore necessary frameworks should be
considered before anything. It is very important to establish the
programming languages used in the data storage systems; the
language extensions and query language since this are key
determinants of how successful the chosen approach will be. A
clear programming language which is able to accommodate the
technological demands remains crucial; the extension languages
should also be reliable and manageable. Any storage approach
which is not flexible cannot adapt changes this demands for a

new data storage system whenever there is a change in
technology and data type (Li, Gai, Qiu, Qiu & Zhao (2017).
Good and reliable big data architecture should be able to
support all the three major components of a generic architecture
which are, extraction, and transforming. The chosen design
should be able to allow users to extract data for use following
the necessary procedures and observing all the necessary
security precautions. Also the design should be able to
transform the data in a certain way such that it can be integrated
in the system and finally enable users to be able to load the
information (Guirguis, Pareek & Wilkes 2016). In order to
establish the correct database for use then it is important for
individuals to consider the following;
Online analytical processing (OLAP)
Some architectures do support an online analytical processing
something which limits users who do not up constant network
supply. If network connectivity is a challenge then it is very
advisable to avoid this architecture.
Query language
In this one needs to establish the language they are relying on
to access or manage their data. This can either be procedural,
language extensions or descriptive language.
Cloud computing option
There are architectures which support cloud computing while
others do not. When making a decision on which form of
database to use it is good to consider this option since cloud
computing offers more reliable and secure data management
techniques (Coronel & Morris 2016).
Scalability
Individuals need to consider whether their choice will be able
to meet the computing demand, data size and organization
requirements. Fault tolerance. The system should be able to
recover from any fault in an accountable and transparent matter.
Programming language This establishes the programming
language and design language supported by the system. The
choice of language is very important since different people will

come into contact with the system in different occasions, simple
and understandable language is very important (Abadi, Bajda-
Pawlikowski, Abouzied, & Silberschatz 2016).
Type of database.
In order to have an effective database and management system
NOSQL database is the best system since it offers quality
storage and retrieval services. Additionally it has high fault
tolerance and does not necessarily rely on distributed file
systems to function appropriately.like wise the system is able to
accommodate new technology requirements and perform within
the specified time (Lourenço Cabral, Carreiro Vieira, &
Bernardino 2015). Since this database supports data in forms of
documents it offers dynamic schemas, auto sharing capabilities
and replication abilities making it a very reliable database
system to be used in a business and even educational set up.
References
Abadi, Bajda-Pawlikowski, Abouzied, & Silberschatz, (2016).
U.S. Patent No. 9,495,427. Washington, DC: U.S. Patent and
Trademark Office. Curry (2016). The big data value chain:
definitions, concepts, and theoretical approaches. In New
horizons for a data-driven economy (pp. 29-37).
Cengage Learning. Gandomi & Haider (2015). Beyond the hype:
Big data concepts, methods, and analytics. International journal
of information management, 35(2), 137-144.

Guirguis, Pareek & Wilkes (2016). U.S. Patent No. 9,298,878.
Washington, DC: U.S. Patent and Trademark Office.
Li, Gai, Qiu, Qiu & Zhao (2017). Intelligent cryptography
approach for secure distributed big data storage in cloud
computing. Information Sciences, 387, 103-115.
Lourenço Cabral, Carreiro Vieira, & Bernardino (2015).
Choosing the right NoSQL database for the job: a quality
attributes evaluation. Journal of Big Data, 2(1), 18.
Springer, Cham. Coronel & Morris (2016). Database systems:
design, implementation, & management.
Slide 1
14-1
Dividends and Payout Policy
Dividend policy is an important subject in corporate finance,
and dividends are a major cash outlay for
many corporations. At first glance, it may seem obvious that a
firm would always want to give as much as
possible back to its shareholders by paying dividends. It might
seem equally obvious, however, that a firm
could always invest the money for its shareholders instead of
paying it out. Should the firm pay out money
to its shareholders, or should the firm take that money and
invest it for its shareholders?

Can the wrong dividend policy bankrupt a firm? The following
anecdote suggests that dividend
policy can play a role in a company’s downfall.
The automobile industry was quite prosperous in the 1920s, but
was hit hard by the depression. Studebaker
Corporation, which was relatively weak to begin with, suffered
more than other automotive manufacturers.
Part of the reason for its financial problems was the belief by
the firm’s president that dividends alone could
increase the value of the stock. He implemented a dividend
policy that increased the dividend payout ratio
from 43 percent in the early 1920s to 91 percent in 1929.
However, the dividend was held constant in 1930
and 1931 even as sales and earnings decreased. This led to a
payout ratio of 500 percent(!) in 1930 and 350
percent in 1931. In 1932, the company lost $8.7 million, but
still paid $1 million in dividends! The firm’s
financial health was damaged significantly by the generous
dividend policy and filed for reorganization in
March 1933. Tragically, the firm’s president took it very
personally and shot himself three months later.

14-2
Cash Dividends
• Regular cash dividend = cash payments made
directly to stockholders as part of a firm's
normal operations (usually each quarter)
• Extra cash dividend = paid over and above the
regular dividend (may not be repeated in the
future)
• Special cash dividend = similar to extra
dividend, but definitely won’t be repeated
• Liquidating dividend = some or all of the
business has been sold
The most common type of dividend is a cash dividend. Later in
the module, we discuss dividends paid in
stock instead of cash.
The basic types of cash dividends are these:

1. Regular cash dividend – normal dividends, usually paid on a
quarterly basis.
• Commonly, public companies pay regular cash dividends four
times a year.
2. Extra cash dividend – paid over and above the regular
dividend, may or may not be repeated
3. Special dividend – one-time dividend paid over and above the
regular dividend, won’t be repeated
• Special dividend is similar, but the name usually indicates that
this dividend is viewed as a
truly unusual or one-time.
4. Liquidating dividend
• The payment of a liquidating dividend usually means that
some or all of the business has been
liquidated
Slide 3

14-3
Dividend Payment
• Declaration Date – Board declares the dividend and it
becomes a liability of the firm
• Ex-dividend Date
– Occurs two business days before date of record
– If you buy stock on or after this date, you will not
receive the upcoming dividend
– Stock price generally drops by approximately the
amount of the dividend
• Date of Record – holders of record are determined,
and they will receive the dividend payment
• Date of Payment – checks are mailed
The Board of Directors declares dividends, after which the
dividends become a liability of the firm.
To make sure that dividend checks go to the right people,
brokerage firms and stock exchanges establish
an ex-dividend date. Ex-dividend date – occurs two days prior
to the date of record; if you purchase the
stock on or after the ex-dividend date, you will not receive the
dividend. If you buy the stock before this

date, you are entitled to the dividend. If you buy on this date or
after, the previous owner will get the
dividend.
Date of record—firm prepares the list of stockholders who will
receive dividends.
Date of payment – checks are mailed
Slide 4
14-4
Dividend Payment
Slide 5

14-5
The Ex-Dividend Day Price Drop
The value of the stock is the PV of expected future dividends
(eg. Dividend growth model)
You may wonder if it would be advantageous to buy a stock on
the day before the ex-dividend date.
If you bought the stock prior to the ex-dividend date, you would
pay $10 per share. This would entitle you
to receive the $1 dividend, which will be mailed on the payment
date. What is the value of your investment
after the stock goes ex-dividend? You have the $1 dividend plus
a share of stock that is now worth $9. In a
perfect world, this would result in a no-arbitrage opportunity.
However, you would owe taxes on the
dividend received. Consequently, if the stock price falls by the
full amount of the dividend, you are worse
off because you will have $1 dividend + $9 for the stock – taxes
paid on the dividend < $10. Therefore, if
the marginal investor is in a positive tax bracket (which is
always the case), then the stock price should fall
by less than the dividend amount to compensate the investor for

the taxes that must be paid on the dividend.
Slide 6
14-6
Does Dividend Policy Matter?
• Dividends matter
– The value of the stock is based on the present
value of expected future dividends
• Dividend policy may not matter
– Dividend policy is the decision to pay dividends
versus retaining funds to reinvest in the firm
– In theory, if the firm reinvests capital now, it
will grow and can pay higher dividends in the
future
The question we will be discussing here is whether the firm
should pay out cash now or invest the cash

and pay it out later.
In particular, should the firm pay out a large percentage of its
earnings now or a small (or even zero)
percentage?
Recall the dividend growth model:
P0 = D1 / (RE – g)
It can be shown that an increase in the future dividend, D1, will
reduce earnings retention and
reinvestment. This will reduce the growth rate, g. Therefore,
both the numerator and the denominator
increase, and the net effect on P0 is zero.
Slide 7
14-7
• Consider a firm that can either pay out dividends with one of
two

plans:
– Plan 1: can pay $10,000 per year for each of the next two
years, or
– Plan 2: can pay $9,000 this year, reinvest the other $1,000
into the
firm and then pay $11,120 next year.
– Investors require a 12% return.
• Compare the market value of the two plans:
▪ Present value of Plan 1 dividends:
PV of constant dividends = $16,900.51
▪ Present value of Plan 2 dividends:
PV growing dividends with reinvestment = $16,900.51
• If the company will earn the required return, then it doesn’t
matter
when it pays the dividends.
Illustration of Irrelevance
Assuming that the second dividend is a liquidating dividend and
the firm ceases to exist after period 2:
PV = 10,000 / 1.12 + 10,000 / 1.122 = 16,900.51
PV = 9,000 / 1.12 + 11,120 / 1.122 = 16,900.51

Recall the dividend growth model: P0 = D1 / (RE – g). In the
absence of market imperfections, such as taxes,
transaction costs and information asymmetry, it can be shown
that an increase in the future dividend, D1,
will reduce earnings retention and reinvestment. This will
reduce the growth rate, g. Therefore, both the
numerator and the denominator increase and the net effect on P0
is zero.
The idea behind the irrelevance argument is that if the firm has
a lower payout ratio now, it will reinvest
the capital into the firm, grow the firm faster and pay higher
dividends later. On the other hand, if the firm
has a higher payout ratio now, it will reinvest less capital back
into the firm and pay lower dividends later.
Slide 8
14-8
Factors Favoring a Low Payout

• Why might a low payout be desirable?
▪ Taxes:
• Individuals in upper income tax brackets might
prefer lower dividend payouts, with their immediate
tax consequences, in favor of higher capital gains
▪ Flotation costs:
• Low payouts can decrease the amount of capital
that needs to be raised, thereby lowering flotation
costs
▪ Dividend restrictions:
• bond indentures often contain a provision that
limits the level of dividend payments
• Taxes
Investors that are in high marginal tax brackets might prefer
lower dividend payouts. If the firm reinvests
the capital back into positive NPV investments, then this should
lead to an increase in the stock price. The
investor can then sell the stock when she chooses and pay
capital gains taxes at that time. Taxes must be
paid on dividends immediately, and even though qualified
dividends are currently taxed at the same rate as
capital gains, the effective tax rate is higher because of the
timing issue.

Currently, individuals in the higher marginal income tax
brackets pay 15% to 20% on capital gains and
dividends, while taxpayers in the lower brackets generally pay
nothing. The new tax law keeps the existing
0%, 15% and 20% brackets.
• Flotation costs
If a firm has a high dividend payout, then it will be using its
cash to pay dividends instead of investing in
positive NPV projects. If the firm has positive NPV projects
available, it will need to go to the capital
market to raise money for the projects. There are fees and other
costs (flotation costs) associated with
issuing new securities. If the company had paid a lower
dividend and used the cash on hand for projects, it
could have avoided at least some of the flotation costs.
• Dividend Restrictions
In some cases, a corporation may face restrictions on its ability
to pay dividends. Bond indentures often
contain a provision that limits the level of dividend payments.
There is a conflict of interest between stockholders and
bondholders. As a result, bond indentures contain

restrictive covenants to prevent the transfer of wealth from
bondholders to stockholders. Dividend
restrictions are one of the most common restrictive covenants.
They normally require that dividends be
forgone when net working capital falls below a certain level or
that dividends only be paid out of net income,
not retained earnings that existed before the bond agreement
was signed.
Slide 9
14-9
Factors Favoring a High Payout
• Why might a high payout be desirable?
▪ Desire for current income:
• Individuals who want current income (eg. retirees) can either
invest in
companies that have high dividend payouts or they can sell
shares of stock.
• Trust funds and endowments may prefer current income
because they may
be restricted from selling stock

▪ Uncertainty resolution:
• No guarantee that the higher future dividends will materialize
▪ Tax and legal benefits from high dividends:
• Corporate investors—taxable exclusion of at least 70% of
dividends received
from other corporations.
• Tax-exempt investors—tax-exempt investors do not care about
the
differential tax treatment between dividends and capital gains.
Desire for Current Income
• Individuals that want current income can either invest in
companies that have high dividend payouts or
they can sell shares of stock. An advantage to dividends is that
you don’t have to pay commission.
• Trust funds and endowments may prefer current income
because they may be restricted from selling
stock to meet expenses if it will reduce the fund below the
initial principal amount.
Tax and Other Benefits from High Dividends
• Corporate investors – at least 50% of dividends received from
other corporations does not have to be
included in taxable income (but there is no such exclusion for
capital gains)

• Tax-exempt investors – tax-exempt investors do not care about
the differential tax treatment between
dividends and capital gains. And, in many cases, tax-exempt
institutions have a fiduciary responsibility
to invest money prudently. The courts have found that it is not
prudent to invest in firms without an
established dividend policy
Conclusion
• Differences in tax laws and regulations cause some groups to
prefer dividends.
Slide 10
14-10
• Asymmetric information – managers have
more information about the health of the
company than investors
• Changes in dividends convey information
▪ Dividend increases
• Management believes it can be sustained
• Expectation of higher future dividends, increasing

present value
• Signal of a healthy, growing firm
▪ Dividend decreases
• Management believes it can no longer sustain the
current level of dividends
• Expectation of lower dividends indefinitely; decreasing
present value
• Signal of a firm that is having financial difficulties
Dividends and Signals
Changes in dividends may be important signals if the market
anticipates that the change will be maintained
through time. If the market believes that the change is just a
rearrangement of dividends through time, then
the impact will be small. The reaction to the information
contained in dividend changes is called the
information content effect.
Selling stock to raise funds for dividends also creates a “bird-
in-the-hand” situation for the shareholder.
Again, we are back to “all else equal.” Can a higher dividend
make a stock more valuable? If a firm must
sell more stock or borrow more money to pay a higher dividend
now, it must return less to the stockholder

in the future. The uncertainty over future income (the firm’s
business risk) is not affected by dividend policy.
Slide 11
14-11
Clientele Effects
• Investor preference:
- If a firm changes its policy, it will just have different
investors.
- Some investors prefer low dividend payouts
- Some investors prefer high payouts
- Investors will buy stock in companies that meet their dividend
preferences
• What do you think will happen if a firm
changes its policy from a high payout to a low
payout? … or vice versa?

Some investors prefer low dividend payouts and will buy stock
in those companies that offer low dividend
payouts.
Some investors prefer high dividend payouts and will buy stock
in those companies that offer high dividend
payouts.
In our earlier discussion, we saw that some groups (wealthy
individuals, for example) have an incentive to
pursue low-payout (or zero-payout) stocks. Other groups
(corporations, for example) have an incentive to
pursue high-payout stocks. Companies with high payouts will
thus attract one group, and low-payout
companies will attract another. These different groups are called
clienteles.
The clientele effect says that dividend policy is irrelevant
because investors that prefer high payouts will
invest in firms that have high payouts, and investors that prefer
low payouts will invest in firms with low
payouts. When a firm chooses a particular dividend policy, the
only effect is to attract a particular clientele.
If a firm changes its dividend policy, then it just attracts a
different clientele.

If a firm changes its payout policy, it will not affect the stock
value, it will just end up with a different set
of investors. This is true as long as the “market” for dividend
policy is in equilibrium. In other words, if
there is excess demand for companies with high dividend
payouts, then a low payout company may be able
to increase its stock value by switching to a high payout policy.
This is only possible until the excess demand
is met.
Slide 12
14-12
Stock Repurchase
• Company buys back shares of its own stock
– Open market = company buys its own stock in the open
market
– Tender offer = company states a purchase price and a
desired number of shares to be bought
– Targeted repurchase = firm repurchases shares from

specific individual shareholders
• Similar to a cash dividend in that it returns cash
from the firm to the stockholders
• This is another argument for dividend policy
irrelevance in the absence of taxes or other
imperfections.
A firm may choose to buy back outstanding shares instead of
paying a cash dividend (or instead of
increasing a regular dividend). If we assume no market
imperfections, then stockholder wealth is unaffected
by the choice between share repurchases and cash dividends.
Slide 13
14-13
• Stock repurchase allows investors to decide if
they want the current cash flow and associated
tax consequences.
• Given our tax structure, repurchases may be

more desirable due to the options provided
stockholders.
• The IRS recognizes this and will not allow a
stock repurchase for the sole purpose of
allowing investors to avoid taxes.
Real-World Considerations
One of the most important market imperfections related to cash
dividends versus share repurchases is the
differential tax treatment of dividends versus capital gains.
When a company does a share repurchase, the
investor can choose whether to sell their shares and take the
capital gain (loss) and the associated tax
consequences. When a company pays dividends, the investor
does not have a choice and taxes must be paid
immediately.
The IRS understands the tax differences between the two
methods for returning cash to stockholders and
prohibits stock repurchase plans solely for the purpose of
allowing investors to avoid taxes.

14-14
Tax Effects of Dividends and Stock
Repurchases
• Cash dividends:
– No investor control over timing or size
– Taxed as ordinary income
• Repurchase:
– Allows investors to decide if they want a current
cash flow
– Taxed only if:
• They choose to sell AND
• They reap a capital gain on the sale
– Gain may qualify as lower taxed capital gains if
shares owned more than one year.
When a company pays dividends, the investor does not have a
choice, and taxes must be paid immediately.
Historically, the lower tax rate on capital gains favored
repurchases over dividends.

When a company does a share repurchase, the investor can
choose whether to sell his/her shares and take
the capital gain (loss) and the associated tax consequences.
Slide 15
14-15
Information Content of Dividends &
Repurchases
• Changes in the dividend signal management’s view
concerning the firm’s future prospects
• Stock repurchases signal that management believes
the current stock price is low
• Tender offers send a more positive signal than open
market repurchases because the company is stating
a specific stock price
• Stock prices often increase when repurchases are
announced

An increase in dividends sends a signal that prospects are good
and that the firm will be able to maintain
the higher dividend. A decrease in dividends is usually an
indication that the firm can no longer sustain the
current dividend level. Note the Wall Street aphorism:
“Earnings declines are tolerable for a while, but the
market never forgives a dividend cut.”
Repurchase announcements are often viewed by market
participants as favorable signals of future firm
prospects and/or as evidence that management believes that
shares are currently undervalued. As a
consequence, share prices tend to rise when a buyback is
announced.
Tender offers are viewed more favorably than open market
repurchases because tender offers specify a
share price.

14-16
“America West Airlines announced that its Board of Directors
has
authorized the purchase of up to 2.5 million shares of its Class
B
common stock on the open market as circumstances warrant
over
the next two years …”
“Following the approval of the stock repurchase program by the
company’s Board of Directors earlier today. W. A. Franke,
chairman
and chief officer said ‘The stock repurchase program reflects
our
belief that America West stock may be an attractive investment
opportunity for the Company, and it underscores our
commitment
to enhancing long-term shareholder value.”
“The shares will be repurchased with cash on hand, but only if
and
to the extent the Company holds unrestricted cash in excess of
$200 million to ensure that an adequate level of cash and cash
equivalents is maintained.”
Example: Repurchase
Announcement
A quick search of stock repurchase announcements following
the terrorist attacks on September 11 found

at least nine companies that specifically cited a desire to
support American financial markets and confidence
in the long-term prospects of the economy and the company as
reasons for the repurchase. Some of these
companies were Cisco, E-Trade, and Pfizer. At least fourteen
other major companies made repurchase
announcements in the week that followed the attacks. These
announcements were for new or continuing
repurchases without specifically mentioning the attacks or
support for the markets. These companies
include Intel, Federal Express, and PeopleSoft.
Slide 17
14-17
• Corporations “smooth” dividends.
• Dividends provide information to the market.
• Firms should follow a sensible dividend policy:
– Don’t forgo positive NPV projects just to pay a dividend.

– Avoid issuing stock to pay dividends.
– Consider share repurchase when there are few better
uses for the cash.
What We Know and Do Not Know
A. Dividends and Dividend Payers
Dividends are large in the aggregate; however, the number of
firms that pay a dividend has declined over
time. This suggests that dividend payments are concentrated in
a relatively small set of (larger, older) firms.
This issue remains even after controlling for the increased use
of repurchases, although not to the same
extent following the tax cut on dividends in 2003.
B. Corporations Smooth Dividends
Because of the information content of dividend changes,
managers may prefer to maintain a more stable
dividend policy. This reduces the uncertainty surrounding
expected future dividends and should decrease
the risk attributed to the cash flows from the stock.
In July, 1995, Venture Corporation, a high-volume discount

retailer, announced the suspension of its
quarterly dividend following a period of poor earnings
performance. The price of the stock (which had
already fallen over the preceding months) fell by approximately
one-third on the day of the announcement.
Subsequent quarterly earnings were “disappointing,” and the
firm filed for bankruptcy and was liquidated
a few years later.
At about the same time, Edison Brothers, also a retailer,
announced that its dividend would be reduced in
order to “conserve cash for investment opportunities.” The price
of the stock fell dramatically, and the
dividend was subsequently reduced again about a year later.
Eventually the dividend was eliminated, and
the firm filed for bankruptcy. In both cases, dividend reductions
followed periods of poor earnings
performance and were followed by more poor performance. One
might say that the “signal” being sent by
the dividend cut was completely accurate!

14-18
• Aggregate payouts are massive and have
increased over time.
• Dividends are concentrated among a
small number of large, mature firms.
• Managers are reluctant to cut dividends.
• Managers smooth dividends.
• Stock prices react to unanticipated
changes in dividends.
Putting It All Together
This section can be summarized by five primary observations:
Aggregate payouts (dividends and repurchases) are massive and
have increased in absolute terms over the
years.
Dividends are concentrated among a small number of large,
mature firms.
Managers are reluctant to cut dividends, normally doing so only
due to firm-specific problems.

Managers smooth dividends, raising them slowly and
incrementally as earnings grow.
Stock prices react to unanticipated changes in dividends.
Slide 19
14-19
Pros and Cons of Paying Dividends
1. Cash dividends
underscore good results
and provide support to
stock price
2. Dividends may attract
institutional investors
3. Stock price usually
increases with a new or
increased dividend
4. Dividends absorb excess
cash and may reduce
agency costs

1. Dividends are taxed to
recipients
2. Dividends can reduce
internal sources of
funding
• May force firm to forgo
positive NPV projects
• May require external
financing
3. Once established,
dividends cuts are hard
to make without
adversely affecting a
firm’s stock price.
Pros Cons
Slide 20
14-20
Stock Dividends
• Distribute additional shares of stock instead of

cash
• Increases the number of outstanding shares
• Small stock dividend
– Less than 20 to 25%
– If you own 100 shares and the company declared
a 10% stock dividend, you would receive an
additional 10 shares
• Large stock dividend – more than 20 to 25%
Stock dividend – dividend paid in shares of stock rather than in
cash. Commonly expressed as a percentage,
e.g., a 25% stock dividend means you will receive 1 share for
every 4 that you own. As with a cash dividend,
the stock price declines proportionally.
Slide 21
14-21

Stock Splits
• Essentially the same as a stock dividend except
expressed as a ratio
– For example, a 2-for-1 stock split means you will have
two shares after the split for every one that you owned
before the split. (the same as a 100% stock dividend)
• Stock price is reduced when the stock splits
• The total value of owners' equity does not change
• Common explanation for split is to return price to
a “more desirable trading range”
Stock split – new outstanding shares issued to existing
stockholders, expressed as a ratio, e.g., a 2-for-1
split means you will receive 2 shares for every one that you
own. Again, the price drops proportionally.
Splits are usually, but not always, larger than dividends and are
treated differently for accounting purposes.
Some Details about Stock Splits and Stock Dividends
• Stock dividend – retained earnings transferred to par value and
capital accounts
• Stock split – par value adjusted to reflect the split with no
effect on retained earnings

Value of Stock Splits and Stock Dividends
• Benchmark case – no change in shareholder wealth
Slide 22
14-22
Reverse Stock Splits
• Reverse Split reduces number of shares
outstanding
– For example, a 1-for-5 stock split replaces every
5 shares of stock with one share
• Reasons:
1. Transactions costs may be less for investors
2. Liquidity might be improved
3. Too low a price not considered “respectable”
4. Exchange minimum price per share
requirements

Three popular reasons:
• Reduced transaction costs (higher priced stocks have lower
commissions on a percentage basis).
• Popular trading range—the price has gotten too low and it
affects the stock’s liquidity and marketability.
• Respectability—many people are leery about investing in
“penny stocks.”
Two technical reasons:
• Stock exchanges have minimum listing requirements.
• May combine a reverse split and a stock repurchase where the
company offers to buy out shareholders
who end up owning shares below some minimum number.
Slide 23
14-23
• A company’s stock is priced at $50 per share,
and it plans to pay a $2 cash dividend.

▪ Assuming perfect capital markets, what will the per
share price be after the dividend payment?
▪ If the average tax rate on dividends is 25%, what will
the new share price be?
Comprehensive Problem
In perfect market, new price = $48.
In imperfect market, new price = 48 + 2 × .25 = $48.50
Slide 1
Leverage and Capital Structure
A firm’s choice of how much debt it should have relative to
equity is known as a capital structure decision.
A firm’s capital structure is really just a reflection of its
borrowing policy. Should we borrow a lot of money,
or just a little?

In this module, we discuss the basic ideas underlying capital
structures and how firms choose them. We
will ignore investment decisions and focus on the long-term
financing, or capital structure, question.
Slide 2
13-2
Capital Structure
• Capital structure = percent of debt and
equity used to fund the firm’s assets
– “Leverage” = use of debt in capital structure
• Capital restructuring = changing the
amount of leverage without changing the
firm’s assets
▪ Increase leverage by issuing debt and
repurchasing outstanding shares
▪ Decrease leverage by issuing new equity
shares and retiring outstanding debt

Activities such as these that alter the firm’s existing capital
structure are called capital restructurings.
Slide 3
13-3
Capital Structure & Shareholder
Wealth
• The primary goal of financial managers:
▪ Maximize stockholder wealth
• Maximizing shareholder wealth =
▪ Maximizing firm value
▪ Minimizing WACC
• Objective: Choose the capital structure that
will minimize WACC and maximize
stockholder wealth
WACC tells us that the firm’s overall cost of capital is a
weighted average of the costs of the various

components of the firm’s capital structure. A primary reason for
studying the WACC (WACC is the
discount rate appropriate for the firm’s overall cash flows) is
that the value of the firm is maximized when
the WACC is minimized. When we described the WACC, we
took the firm’s capital structure as given.
Thus, one important issue that we will want to explore in this
module is what happens to the cost of capital
when we vary the amount of debt financing, or the debt-equity
ratio.
We want to choose the firm’s optimal capital structure capital
structure so that the WACC is minimized.
The “optimal” or “target” capital structure is that debt/equity
mix that simultaneously (a) maximizes the
value of the firm, (b) minimizes the weighted average cost of
capital, and (c) maximizes the market value
of the common stock.
Slide 4

13-4
• How does leverage affect the EPS and ROE of a firm?
• When we increase the amount of debt financing, we
increase the fixed interest expense.
• If we have a really good year, then we pay our fixed cost
and we have more left over for our stockholders.
• If we have a really bad year, we still have to pay our
fixed costs and we have less left over for our
stockholders.
• Leverage amplifies the variation in both EPS and ROE.
The Effect of Financial Leverage
When we increase the amount of debt financing, we increase the
fixed interest expense. The more debt
financing a firm uses in its capital structure, the more financial
leverage it employs. If we increase the
amount of debt in a restructuring, we are implicitly decreasing
the amount of outstanding shares.

13-5
• We will ignore the effect of taxes at this stage.
• What happens to EPS and ROE when we issue
debt and buy back shares of stock?
Example: Financial Leverage, EPS
and ROE – Part I
Slide 6
13-6
Trans Am Corporation Example
Table 13.1
Current Proposed
Assets $8,000,000 $8,000,000

Debt $0 $4,000,000
Equity $8,000,000 $4,000,000
Debt/Equity Ratio 0.0 1.0
Share Price $20 $20
Shares Outstanding 400,000 200,000
Interest rate 10% 10%
The Trans Am Corporation currently has no debt in its capital
structure. The CFO, Ms. Morris, is
considering a restructuring that would involve issuing debt and
using the proceeds to buy back some of the
outstanding equity.
As shown, the firm’s assets have a market value of $8 million,
and there are 400,000 shares outstanding.
Because Trans Am is an all-equity firm, the price per share is
$20.
Proposed capital structure: no debt to 50-50 debt-equity mix.

13-7
Trans Am Corp
With and Without Debt
Table 13.2
Recession Expected Expansion
EBIT $500,000 $1,000,000 $1,500,000
Interest 0 0 0
Net Income $500,000 $1,000,000 $1,500,000
ROE 6.25% 12.50% 18.75%
EPS $1.25 $2.50 $3.75
Current Capital Structure: No Debt
Recession Expected Expansion
EBIT $500,000 $1,000,000 $1,500,000
Interest 400,000 400,000 400,000
Net Income $100,000 $600,000 $1,100,000
ROE 2.50% 15.00% 27.50%

EPS $0.50 $3.00 $5.50
Proposed Capital Structure: Debt = $4 million
To investigate the impact of the proposed restructuring, we
compare the firm’s current capital structure to
the proposed capital structure under three scenarios.
Corporate EBIT varies depending on the economic conditions.
With no debt (the current capital structure) and no taxes,
There are 400,000 shares outstanding.
The firm’s assets have a market value of $8 million (Equity).
With $4 million in debt (the proposed capital structure),
There are 200,000 shares outstanding.
The firm’s assets have a market value of $4 million (Equity).
Because the interest rate is 10 percent, the interest bill is
$400,000.

EPS = NI/# of shares
ROE = NI/total Equity
Slide 8
13-8
Leverage Effects
Variability in ROE
– Current: ROE ranges from 6.25% to 18.75%
– Proposed: ROE ranges from 2.50% to 27.50%
Variability in EPS
– Current: EPS ranges from $1.25 to $3.75
– Proposed: EPS ranges from $0.50 to $5.50
The variability in both ROE and EPS
increases when financial leverage is
increased
The variability in both EPS and ROE is much larger under the
proposed capital structure (due to
leverage).

13-9
Break-Even EBIT
• If we expect EBIT to be greater than the break-even point,
then
leverage is beneficial to our stockholders
• If we expect EBIT to be less than the break-even point, then
leverage is
detrimental to our stockholders
• Find EBIT where EPS is the same under both the current and
proposed capital structures (Break-even point).
The first line, labeled “No debt,” represents the case of no
leverage. This line begins at the origin, indicating
that EPS would be zero if EBIT were zero. From there, every
$400,000 increase in EBIT increases EPS by
$1 (because there are 400,000 shares outstanding).

The second line represents the proposed capital structure. Here,
EPS is negative if EBIT is zero. This
follows because $400,000 of interest must be paid regardless of
the firm’s profits. Since there are 200,000
shares in this case, EPS is −$2 per share as shown. Similarly, if
EBIT were $400,000, EPS would be exactly
zero.
The important thing to notice in Figure 13.1 is that the slope of
the line in this second case is steeper. In
fact, for every $400,000 increase in EBIT, EPS rises by $2, so
the line is twice as steep.
This tells us that EPS is twice as sensitive to changes in EBIT
because of the financial leverage employed.
Another observation to make in this figure is that the lines
intersect. At that point, EPS is exactly the same
for both capital structures. To find this point, we can solve
[EPS without debt = EPS with debt].
Slide 10

13-10
Example: Break-Even EBIT
EPS = for both Capital Structures
( )
$2.00
400,000
800,000
EPS
$800,000EBIT
800,000EBIT2EBIT
400,000EBIT
200,000
400,000
EBIT
200,000
400,000EBIT
400,000
EBIT
==
=
-

-
=
-
=
[EPS without debt = EPS with debt]
EPS = Net income / # of shares outstanding
With no debt (the current capital structure) and no taxes, there
are 400,000 shares outstanding. With $4
million in debt (the proposed capital structure), there are
200,000 shares outstanding.
[(EBIT) / 400000] = [(EBIT – Interest) / 200000]
If EBIT is 800000, the firm has the same EPS regardless of
TAC’s capital structure

.
Slide 11
13-11
• Based on what we have seen so far, we
can draw the following three conclusions:
1. The effect of financial leverage depends on the company’s
EBIT. When EBIT is relatively high, leverage is beneficial.
2. Under the expected scenario, leverage increases the returns
to shareholders, as measured by both ROE and EPS.
3. Shareholders are exposed to more risk under the proposed
capital structure (with more leverage) because, in this case,
the EPS and ROE are much more sensitive to changes in EBIT.
Corporate Borrowing
Conclusions
Financial leverage increases ROE and EPS when EBIT is greater
than the crossover (break-even) point.
The variability of EPS and ROE is increased as leverage
increases.

Beyond the break-even point, EPS will be larger under the debt
alternative, but with additional debt, the
firm will have additional financial risk that would increase the
required return on its common stock. A
higher required return might offset the increase in EPS,
resulting in a lower firm value despite the higher
EPS.
Slide 12
13-12
Capital Structure Theory
• Modigliani and Miller (M&M) Theory of
Capital Structure
▪ M&M Proposition I – firm value (The Pie Model)
▪ M&M Proposition II – WACC
• The value of the firm is determined by the cash
flows to the firm and the risk of the firm’s assets
• Changing firm value
▪ Change the risk of the cash flows

▪ Change the cash flows
Our Trans Am example is based on a famous argument advanced
by two Nobel laureates, Franco
Modigliani and Merton Miller. Franco Modigliani and Merton
Miller published the first works attempting
to relate a firm’s capital structure with firm value.
Slide 13
13-13
Capital Structure Theory
Three Special Cases
• Case I – Assumptions
– No corporate or personal taxes
– No bankruptcy costs
• Case II – Assumptions
– Corporate taxes, but no personal taxes

– No bankruptcy costs
• Case III – Assumptions
– Corporate taxes, but no personal taxes
– Bankruptcy costs
You may wonder why we are even considering a situation in
which taxes do not exist.
One way to get a good understanding of what is relevant to the
capital structure decision is to start in a
“perfect” world and then relax assumptions as we go. By
relaxing one assumption at a time, we can get a
better idea of the impact on the capital structure decision. This
is the classic process of “model building” in
economics—start simple and add complexity one step at a time.
Slide 14
13-14
Case I – Propositions I and II

• Proposition I
– The value of the firm is NOT affected by changes in
the capital structure
– The cash flows of the firm do not change; therefore,
value doesn’t change
• Proposition II
– The WACC of the firm is NOT affected by capital
structure
– cost of equity depends on 3 factors: the required
return on the firm’s assets, the firm’s cost of debt
and the firm’s debt-equity ratio
M&M Proposition I—without corporate taxes and bankruptcy
costs, the firm cannot affect its value by
altering its capital structure.
M&M Proposition I states that the value of the firm (size of the
pie) is not related to how the firm is financed
(how the pie is divided).
M&M Proposition II—a firm’s cost of equity capital is a
positive linear function of its capital structure (still
assuming no taxes).

The main point with case I is that it doesn’t matter how we
divide our cash flows between our stockholders
and bondholders, the cash flow of the firm doesn’t change.
Since the cash flows don’t change; and we
haven’t changed the risk of existing cash flows, the value of the
firm won’t change.
M&M Proposition II also states that the cost of equity depends
on 3 factors: the required return on the firm’s
assets, the firm’s cost of debt and the firm’s debt-equity ratio.
Slide 15
13-15
Case I - Equations
• WACC = RA = (E/V) x RE + (D/V) x RD
• RE = RA + (RA – RD) x (D/E)

RA = the “cost” of the firm’s business risk
(i.e., the risk of the firm’s assets)
(RA – RD)(D/E) = the “cost” of the firm’s
financial risk (i.e., the additional return
required by stockholders to
compensate for the risk of leverage)
This is the famous M&M Proposition II, which tells us that the
cost of equity depends on three things: the
required rate of return on the firm’s assets, RA, the firm’s cost
of debt, RD; and the firm’s debt equity
ratio, D/E.
As more debt is used, the return on equity increases, but the
change in the proportion of debt versus
equity just offsets that increase, and the WACC does not
change.
Business risk – the risk inherent in a firm’s operations. It
depends on the systematic risk of the firm’s
assets and it determines the first component of the required
return on equity, RA.
Financial risk – the extra risk to stockholders that results from
debt financing. It determines the second
component of the required return on equity, (RA − RD)(D/E).

The main point with case I is that it doesn’t matter how we
divide our cash flows between our
stockholders and bondholders; the cash flow of the firm doesn’t
change. Because the cash flow doesn’t
change, and we haven’t changed the risk of existing cash flows,
the value of the firm doesn’t change
Note that case I is a world without taxes. That is why the term
(1 – TC) is not included in the WACC
equation.
Slide 16
13-16
CASE 1 - M&M Propositions I & II
Figure 16.3
The change in the capital structure weights (E/V and D/V) is
exactly

offset by the change in the cost of equity (RE), so the WACC
stays
the same.
Figure 13.3 summarizes our discussion thus far by plotting the
cost of equity capital, RE, against the debt-
equity ratio. As shown, M&M Proposition II indicates that the
cost of equity, RE, is given by a straight line
with a slope of (RA − RD). The y-intercept corresponds to a
firm with a debt-equity ratio of zero, so RA =
RE in that case. Figure 13.3 shows that, as the firm raises its
debt-equity ratio, the increase in leverage raises
the risk of the equity and therefore the required return, or cost
of equity (RE). Notice in Figure 13.3 that the
WACC doesn’t depend on the debt-equity ratio; it’s the same no
matter what the debt-equity ratio is.
Slide 17
13-17

• Data
▪ Required return on assets = 16%; cost of debt = 10%;
percent of debt = D/V = 45%
• What is the debt-to-equity ratio?
▪ D/E = (D/V) / (E/V) = (D/V) / (1 – D/V)
▪ D/E = (0.45) / (1 – 0.45) = 0.8182
• What is the cost of equity?
▪ RE = 16% + (16% - 10%)(.8182) = 20.91%
• Suppose instead that the cost of equity is 25%, what would the
the debt-to-
equity ratio then to be?
▪ 25% = 16% + (16% - 10%)(D/E)
▪ D/E = (25% - 16%) / (16% - 10%) = 1.5
Example: Case I
If the firm is financed with 45% debt, then it is financed with
55% equity. One way to compute the D/E
ratio is %debt / (1-%debt).
The second question is used to reinforce that RA does not
change when the capital structure changes.

M&M Proposition I – without corporate taxes and bankruptcy
costs, the firm cannot affect its value by
altering its capital structure.
You may not immediately see how to get the % of equity from
the D/E ratio. Note that D+E = V. We are
looking at ratios, so the actual dollar amount of D and E is not
important. All that matters is the relationship
between them.
Slide 18
13-18
• How does financial leverage affect systematic
risk?
– Rf)
systematic risk of the firm’s assets
• Proposition II

▪ Replace RA with the CAPM and assume that the debt
is riskless (RD = Rf)
– Rf)
The CAPM, the SML and Proposition II
According to Proposition II, RE = RA + (RA – RD)(D/E).
Intuitively, an increase in financial leverage should increase
systematic risk since changes in interest rates
are a systematic risk factor and will have more impact the
higher the financial leverage.
The assumption that debt is riskless is for simplicity and to
illustrate that even if debt is default risk-free, it
still increases the variability of cash flows to the stockholders,
and thus increases the systematic risk.
As more debt is used, the return on equity increases, but the
change in the proportion of debt versus equity
just offsets that increase and the WACC does not change.

13-19
– Rf)
• CAPM: R – Rf)
• Therefore, the systematic risk of the stock
depends on:
▪ Level of leverage, D/E, or “Financial risk”
Business Risk and
Financial Risk
This result assumes that the debt is risk-free. The effect of
leverage on financial risk will be even greater
if the debt is not default free.
Business risk – the risk inherent in a firm’s operations. It
depends on the systematic risk of the firm’s
assets and it determines the first component of the required
return on equity, RA.

Financial risk – the extra risk to stockholders that results from
debt financing. It determines the second
component of the required return on equity, (RA − RD)(D/E).
Slide 20
13-20
Case II – Corporate Taxes
• Interest on debt is tax deductible
• Therefore, when a firm adds debt, it
reduces taxes, all else equal
• The reduction in taxes increases the cash
flow of the firm
• The reduction in taxes reduces net income
• How should an increase in cash flows affect
the value of the firm?
The U.S. government subsidizes corporate debt by making
interest payments tax-deductible, which

reduces net income but increases cash flow.
Slide 21
13-21
Case II - Example
Interest Tax Shield = 500 * 0.21 = $105 per year
• Eg. The levered firm has 6,250 in 8% debt. 21%
corporate tax rate.
Unlevered Firm Levered Firm
EBIT 5,000 5,000
Interest 0 500
Taxable
Income
5,000 4,500
Taxes (21%) 1,050 945

Net Income 3,950 3,555
CFFA 3,950 4,055
Cash flow from assets is simply equal to EBIT – Taxes
(depreciation expense is the same in either case, so
it will not affect CFFA on an incremental basis).
The levered firm has 6,250 in 8% debt, so the interest expense =
.08(6,250) = 500
Tax saving equals to the interest payment ($500) multiplied by
the corporate tax rate (21 percent): $500
X .21 = $105. What we are seeing is that the total cash flow to
L (the levered firm) is $105 more.
Slide 22
13-22
Interest Tax Shield

• Annual interest tax shield
▪ Tax rate times interest payment
▪ $6,250 in 8% debt = $500 in interest expense
▪ Annual tax shield = .21($500) = $105
• Present value of annual interest tax shield
▪ Assume perpetual debt
▪ PV = $105 / .08 = $1,312.50
▪ PV = D(RD)(TC) / RD = D*TC = $6,250(.21) =
$1,312.50
The increase in cash flow in the example is exactly equal to the
interest tax shield. The interest tax shield
is the tax savings arising from the tax deductibility of interest.
It is the key benefit of borrowing over issuing
equity.
All else equal, a lower tax rate reduces the value of the tax
shield. Thus, the recent Tax Cuts and Jobs Act,
which reduced corporate tax rates, may induce firms to reduce
the amount of debt in their structure.

13-23
• The value of the firm increases by the present value
of the annual interest tax shield.
▪ Value of a levered firm (VL) =
Value of an unlevered firm (VU) + PV of interest tax shield
▪ Value of equity =
Value of the firm – Value of debt
• Assuming perpetual cash flows
▪ VU = EBIT(1-T) / RU
▪ VL = VU + DTC
Case II – Proposition I
RU is the cost of capital for an unlevered firm = RA for an
unlevered firm.
VU is just the PV of the expected future cash flow from assets
for an unlevered firm.

13-24
• Data
▪ EBIT = 25 million; Tax rate = 21%; Debt = $75 million;
Cost of debt = 9%; Unlevered cost of capital = 12%
• VU = 25(1-.21) / .12 = $164.58 million
• VL = 164.58 + 75(.21) = $180.33 million
• E = 180.33 – 75 = $105.33 million
Example: Case II – Proposition I
Slide 25
13-25
M&M Proposition I with Taxes

Proposition I with taxes: The value of the leveraged firm (VL)
is equal to the value of the unleveraged
firm (Vu) plus the present value of the interest tax shield.
Annual interest tax savings = D(RD)(TC)
We also assume perpetual cash flows to the firm. This is done
for simplicity, but the ultimate result is the
same even if you use cash flows that change through time. If we
assume perpetual debt, then the present
value of the interest tax savings = D(RD)(TC) ⁄ RD = DTC
Value of an unlevered firm, VU = EBIT(1 − TC)/RU, where RU
is the cost of capital for an all equity firm.
Value of a levered firm, VL = VU + DTC
Slide 26
13-26

• The WACC decreases as D/E increases
because of the government subsidy on
interest payments.
▪ RA = (E/V)RE + (D/V)(RD)(1-TC)
▪ RE = RU + (RU – RD)(D/E)(1-TC)
Case II – Proposition II
Slide 27
13-27
Case II – Graph of Proposition II
As a firm increases its debt-equity ratio, WACC declines.
Slide 28

13-28
• Now we add bankruptcy costs.
• As the D/E ratio increases, the probability of bankruptcy
increases.
• This increased probability will increase the expected
bankruptcy costs.
• At some point, the additional value of the interest tax shield
will be offset by the increase in expected bankruptcy cost.
• At this point, the value of the firm will start to decrease, and
the WACC will start to increase as more debt is added.
Case III
Note that we are talking about “expected” in a statistical sense.
If the firm goes bankrupt, it will have a
certain level of costs it will incur. If the firm is all equity, then
the expected bankruptcy cost is 0 since the
probability of bankruptcy is 0. As the firm adds debt, the
probability of incurring the bankruptcy costs
increases, and thus the expected bankruptcy cost increases.

13-29
• Direct costs
▪ Legal and administrative costs
▪ Ultimately cause bondholders to incur additional
losses
▪ Disincentive to debt financing
• Financial distress
▪ Significant problems in meeting debt obligations
▪ Firms that experience financial distress do not
necessarily file for bankruptcy.
Bankruptcy Costs
The key disadvantage to the use of debt is bankruptcy costs.
Direct bankruptcy costs are the legal and administrative
expenses. Generally, these costs are quantifiable,
measurable, and significant.

13-30
Case III - Indirect Bankruptcy Costs
• Indirect bankruptcy costs
– Larger than direct costs, but more difficult to
measure and estimate
– Stockholders wish to avoid a formal bankruptcy
– Bondholders want to keep existing assets intact so
they can at least receive that money
– Assets lose value as management spends time
worrying about avoiding bankruptcy instead of
running the business
– Lost sales, interrupted operations, and loss of
valuable employees, low morale, inability to
purchase goods on credit
Indirect bankruptcy costs (e.g., difficulties in hiring and
retaining good people because the firm is in

financial difficulty) are hard to measure and generally take the
form of forgone revenues, opportunity
costs, etc.
Financial distress costs – the direct and indirect costs of
avoiding bankruptcy.
Slide 31
13-31
Case III
With Bankruptcy Costs
• At some point, the additional value of the interest
tax shield will be offset by the expected
bankruptcy costs
• At this point, the value of the firm will start to
decrease and the WACC will start to increase as
more debt is added

As the debt-equity ratio increases, the probability of bankruptcy
increases.
As this probability increases, expected bankruptcy costs
increase.
At some point, the advantages of debt are outweighed by the
potential of bankruptcy.
Slide 32
13-32
Optimal Capital Structure
Figure 16.6
The Static theory of capital structure
Theory that a firm borrows up to the point where the tax benefit
from an extra dollar in debt is exactly
equal to the cost that comes from the increased probability of
financial distress.

-Firms borrow because tax shields are valuable
-Borrowing is constrained by the costs of financial distress
-The optimal capital structure balances the incremental benefits
and costs of borrowing
Slide 33
13-33
Figure 16.7
16-33
The optimal capital structure is the debt-equity mix that
minimizes the WACC.

13-34
Conclusions
• Case I – no taxes or bankruptcy costs
▪ No optimal capital structure
• Case II – corporate taxes but no bankruptcy costs
▪ Optimal capital structure = 100% debt
▪ Each additional dollar of debt increases the cash flow
of the firm
• Case III – corporate taxes and bankruptcy costs
▪ Optimal capital structure is part debt and part equity
▪ Occurs where the benefit from an additional dollar of
debt is just offset by the increase in expected
bankruptcy costs
Slide 35

13-35
The
Capital
Structure
Question
Case I – No taxes or bankruptcy costs; firm value is unaffected
by the choice of capital structure
Case II – Corporate taxes, no bankruptcy costs; firm value is
maximized when the firm uses as much debt
as possible due to the interest tax shield
Case III – Corporate taxes and bankruptcy costs; firm value is
maximized where the additional benefit from
the interest tax shield is just offset by the increase in expected
bankruptcy costs—there is an optimal capital
structure
Slide 36

13-36
Additional Managerial
Recommendations
• Taxes
– The tax benefit is only important if the firm has a
large tax liability
– Higher tax rate → greater incentive to use debt
• Risk of financial distress
– The greater the risk of financial distress, the less
debt will be optimal for the firm
– The cost of financial distress varies across firms
and industries
Taxes – tax shields are more important for firms with high
marginal tax rates. While firms all face the same
21 percent federal tax rate beginning in 2018, other taxes (such
as state taxes) create different effective tax
rates. The higher the effective tax rate, the greater the incentive
to borrow.
Financial distress – the lower the risk (or cost) of distress, the
more likely a firm is to borrow funds

13-37
Figure 16.9
Cash Flow = Payments to stockholders (E) + Payments to
creditors (D) + Payments to the government (G)
+ Payments to bankruptcy courts and lawyers (B) + Payments to
all other claimants
Slide 38
13-38
• Value of the firm = marketed claims +
nonmarketed claims

▪ Marketed claims are the claims of stockholders and
bondholders.
▪ Nonmarketed claims are the claims of the
government and other potential stakeholders.
• The overall value of the firm is unaffected by
changes in capital structure.
• The division of value between marketed claims
and nonmarketed claims may be impacted by
capital structure decisions.
The Value of the Firm
Marketed claims – claims against cash flow that can be bought
and sold (bonds, stock)
Nonmarketed claims – claims against cash flow that cannot be
bought and sold (taxes)
VM = value of marketed claims
VN = value of nonmarketed claims
VT = value of all claims = VM + VN = E + D + G + B + …
Given the firm’s cash flows, the optimal capital structure is the
one that maximizes VM or minimizes VN.

13-39
• Theory stating that firms prefer to issue debt
rather than equity if internal financing is
insufficient
▪ Rule 1: Use internal financing first.
▪ Rule 2: Issue debt next, new equity last.
• The pecking-order theory is at odds with the
tradeoff theory:
▪ There is no target D/E ratio.
▪ Profitable firms use less debt.
▪ Companies like financial slack.
The Pecking-Order Theory
Asymmetric information between buyers and sellers means that
existing firm owners know more than

potential investors. The view is that existing owners will sell
equity when it is overvalued, which is a
negative signal to investors. Thus, this is avoided at all costs,
particularly since equity issuance is also
costly.
A. Internal Financing and the Pecking Order
Rules of the pecking order:
#1: Use internal financing first
#2: Issue debt next
#3: New equity last
B. Implications of the Pecking Order
The pecking-order theory is in contrast to the tradeoff theory in
that:
-there is no target D/E ratio.
-profitable firms will use less debt.
-companies like financial slack.

13-40
• Capital structure does differ by industry.
• Differences according to Cost of Capital
2010 Yearbook by Ibbotson Associates,
Inc.
▪ Lowest levels of debt
• Drugs with 8.46% debt-to-equity
• Computer equipment with 10.02% debt-to-equity
▪ Highest levels of debt
• Cable television with 193.88% debt-to-equity
• Airlines with 177.19% debt-to-equity
Observed Capital Structure
Slide 41

13-41
• Assuming perpetual cash flows in Case II -
Proposition I, what is the value of the
equity for a firm with following values?:
▪ EBIT = $50 million
▪ Tax rate = 21%
▪ Debt = $100 million
▪ Cost of debt = 9%
▪ Unlevered cost of capital = 12%
Comprehensive Problem
Section 16.11
VU = $50 million (1 - .21) / .12 = $329.17 million
VL = $329.17 million + $100 million (.21) = $408.17 million
E = VL – Debt = $408.17 million - $100 million = $308.17
million

Implementing Cloud Services in a Data Analytics Firm
Name: sunil patel
Running head: IMPLEMENTING CLOUD SERVICES IN A
DATA ANALYTICS FIRM 1
MIT 681: capstone Assignment 2
Implementing Cloud Services in a Data Analytics Firm
The acceptance of cloud computing services is rapidly
increasing data analytics firms search for method that they can
use to exploit in relation to computing infrastructure without
owning physical assets. Presently, firm are not investing in
hardware, software, data centers, and support staff an
undertaking that has allowed them to concentrate on their
principal offerings. However, with opportunity comes risks and
therefore data analytic firms must effectively mitigate possible
liabilities and improve their processes decision-making. To this
effect, this paper intends to evaluate best approaches that a data
analytic firm can employ when using Cloud services.
Generally, cloud computing services (CCS) follow two models
namely public cloud and private cloud. A public cloud is a
computing infrastructure that has no usage restrictions in
relation to region or geographical factors. It uses shared
resources, and therefore it can be scaled up or down very
quickly. Besides, it is very efficient since users only pay for
what they use. Accordingly, data can be stored in one or several
locations simultaneously. Nonetheless, a public cloud has major

risks like its reliability, security, and compliance with
regulations. On the other hand, a private cloud refers to a
computing infrastructure operating from a localized region or
geographical environment and with resources are strictly
dedicated to a specific firm (Mahmood, 2013). Under this
model, reliability and security are contractually agreed upon
and a high degree of regulatory compliance is developed.
However, it is expensive and it cannot be scaled up or down as
fast as a public cloud.
Irrespective of the selected CCS model it is important to
understand the type of data being stored by the host so that one
can determine the risks involved. Most importantly, it is crucial
to make sure that data protection and privacy policies are
known, clear and under control. For instance, for a data analytic
firm, it would be prudent to understand what will happen to the
firm’s data once the agreement with the CCS provider is
terminated. The rationale is that some providers will store data
indefinitely and hence the firm should ensure that after the
termination of the contract, all data is completely removed and
expunged (Mahmood, 2013). Further, it is important to
understand the firm’s obligations under the current contract to
establish whether the firm’s data requires segregation in the
event that it is stored in a CCS that may co-mingle storage.
Alternatively, to leverage the risks involved in using either the
public or private cloud models, the firm can use the hybrid
cloud model. This model is attractive because it helps cloud
service customers to address their specific business needs, incur
low cost and at the same time leverage the leading-edge
functionality available under the public cloud model (Sarna,
2011). Conversely, by using private cloud it is able to manage
its sensitive data and applications. Thus, for the current firm the
deployment of the hybrid cloud model would be essential since
it would help the firm to leverage a combination of public and
private cloud deployments subject to its needs for available
resources, speed of execution, need for data security and, and a
range of other reasons.

Consequently, after selecting the model to use, the firm should
determine the most effective method to design, develop, deploy
and maintain the cloud applications. The strategy should be
guided by the firm’s needs and capabilities. Typically, there are
four options that the firm can consider:
· Internal development and deployment
· Autonomous cloud service development provider
· Cloud provider development and deployment
· Off-the-shelf subscription of a cloud application service
Choosing a methodology for implementing a cloud application
varies depending on the size of the firm. Typically, the skills
available at the current organization are only targeted towards
supporting the firm’s current applications and therefore it would
be sensible to consider contracting resources from a cloud
service provider. It is also in the firm’s objective to reduce its
expenses; besides the firm will enjoy the flexibility of re-
assigning internal skills to the cloud deployment as well as
accommodate the changeover to cloud internally (Mahmood,
2013). Finally, after the business case for cloud computing has
been executed and both business drivers and projected return on
investment have been determined, it is important to get the
approval and disapproval from the management.
Presently, firms are using either or a combination of existing
CCS models depending on its needs for execution speed,
available resources, data security and protection, and
centralized management to name a few. Thus, it will be
important for the firm t first identify its needs before it selects
the best model to use. In addition, it will be important to
develop “cloud native” applications as well as the architectures
and technologies that have advanced to support them. For
example, the use of microservices, “server-less” computing,
containers, and architecture are becoming common. Therefore,
for this firm it will be necessary to consider these aspects of
cloud computing when making a decision on which cloud
services to adopt.
IMPLEMENTING CLOUD SERVICES IN A DATA

ANALYTICS FIRM 5
References
Catlett, C. (2013). Cloud computing and big data. Amsterdam,
Netherlands: IOS Press.
Mahmood, Z. (2013). Cloud Computing. Computer
Communications And Networks. doi: 10.1007/978-1-4471-5107-
4
Sarna, D. (2011). Implementing and developing cloud
computing applications. Boca Raton, FL: CRC Press.

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