Capital Structure Decisions
CHAPTER 15
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Topics in Chapter
Overview and preview of capital structure effects
Business versus financial risk
The impact of debt on returns
Capital structure theory, evidence, and implications for managers
Example: Choosing the optimal structure
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Determinants of Intrinsic Value:
The Capital Structure Choice
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Basic Definitions
V = value of firm
FCF = free cash flow
WACC = weighted average cost of capital
rs and rd are costs of stock and debt
ws and wd are percentages of the firm that are financed with stock and debt.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
How can capital structure affect value?
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
A Preview of Capital Structure Effects
The impact of capital structure on value depends upon the effect of debt on:
WACC
FCF
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The 2017 Tax Cuts and Jobs Act (TCJA)
Corporate tax rate:
TCJA rate is flat 21%.
Previous rate was graduated, with top rate of 35%.
Limits on interest expense deductions:
Interest/EBITDA < 30% for 2018-2021
Interest/EBIT < 30% for subsequent years
Excess carried forward indefinitely.
Should cause firms to reduce debt.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Business Risk: Uncertainty in EBIT,
NOPAT, and ROIC
Uncertainty about demand (unit sales).
Uncertainty about output pri.